NaimExplain

How does competition among investors lead to efficient markets? Answer: Competition between investors will tend to produce an EFFICIENT MARKET - that is, a market in which prices rapidly reflect new information, and investors have difficulty making consistently superior returns. Of course, we all hope to beat the market, but, if the market is efficient, all we can rationally expect is a return that is sufficient on average to compensate for the time value of money and for the risk we bear. The efficient market theory comes in three flavors. the WEAK FORM states that prices reflect all the information contained in the past series of stock prices. In this case it is impossible to earn superior profits simply by looking for past patterns in stock prices. The SEMI-STRONG FORM of the theory states that prices reflect all published information, so that it is impossible to make consistently superior returns just by reading the newspaper, looking at the company's annual accounts, a...

How should Investors interpret price-earnings ratios? Answer: You can think of a share's value as the sum of two parts - the value of the assets in place and the PRESENT VALUE OF GROWTH OPPORTUNITIES, that is, of future opportunities for the firm to invest in high-return projects. The PRICE-EARNINGS (P/E) RATIO reflects the market's assessment of the firm's growth opportunities.

How can stock valuation formulas be used to infer the expected rate of return on a common stock? Answer: If dividends are expected to grow forever at a constant rate g, the expected return on the stock is equal to the dividend yield (DIV1/P0) plus the expected rate of dividend growth. The value of the stock according to this CONSTANT-GROWTH DIVIDEND DISCOUNT MODEL is P0 = DIV1 / (r-g).

How can one calculate the present value of a stock given forecasts of future dividends and future stock price? Answer: Shareholders generally expect to receive (1) cash DIVIDENDS and (2) capital gains or losses. The rate of return that they expect over the next year is defined as the expected dividend per share DIV1 plus the expected increase in price P1-P0, all dividend by the price at the start of year P0. Unlike the fixed interest payments that the firm promises to bondholders, the dividends paid to shareholders depend on the fortunes of the firm. That's why a company's common stock is riskier than its debt. The return that investors expect on any one stock is also the return that they demand on all stocks subject to the same degree of risk. The present value of a stock equals the present value of the forecast future return as the discount rate. The present value of a share is equal to the stream of expected dividends per share up to some horizon date plus the expect...

What information about company stocks is regularly reported in the financial Web sites of newspapers and online financial services? Answer: Firms that wish to raise new capital may either borrow money or bring new "partners" into the business by selling shares of COMMON STOCK. Large companies usually arrange for their stocks to be traded on a stock exchange. The stock listings report the stock's price, price change, trading volume, DIVIDEND YIELD, and price-earnings (P/E) ratio.