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Chapter 10 : EQUITY MARKETS 2ed

Required material are as following: books 11th edition


10.1 What are equity securities: Common and preferred stocks (pages 281-284)
10.6 Equity Valuation Basics: (pages: 295-299)

Mr. Al Mannaei

Abstract

Equity

Capital

Debt

Abstract
Bonds (Debt) vs. Stock (equity)?!

Pay higher ?
Bear higher risk ?
Considered fixed income ?
Liquidation!
who will receive his money first bondholder or
shareholder ?!

Own part of the corporation ?

Introduction
What is equity ?
A stock (common/ preferred)
represent an ownership.
Public equity vs. Private equity ?
Public : listed companies in the stock market.
Private : Unlisted companies.
How can investors buy public or private equity ?!

Common Stock
What happen when you buy a common stock
(equity) ?
Own part from the corporation.
Right to vote (one vote per share).
A residual claim on income and assets in liquidation.
Limited Liability.
liability for the debts of the corporation is limited to
their investment in the common stock.

Common Stock
Example : VIVA need to collect 100 million as a
capital, the company sell 100 million shares,
Sara bought 10 million shares. What does this
mean ?!
-Sara own 10% from the company.
-Sara voting weight 10%.
-Sara is liable for 10% from company's debt.

Common Stock
Common shareholders may vote with their
shares to elect the members of the board of
directors.
Board of
Directors

Common
Shareholders

Executive
Management

Board of directors can be elected by cumulative


voting or straight voting.

Return
How does stock holder make profit ?!

From the capital gain* + dividends


You buy a stock form $21 a week you sell it for 27 ?
Capital gain >> $6
You buy 5 stocks form $21 a week you sell it for 18 ?
Capital loss>> 5* (-3) = -$15
You buy 200 stock, a year later the company pay $2 ?
Dividends = $2 * 200 = $400
*Capital gain is selling price buying price

Return
Reem bought 10,000 shares from Caribou. for
6$. A year later the company pay 0.5$
dividends per share, at that time the price of
the stock is 8$. Calculate total return ?!

Preferred Stock
A class of ownership in a corporation that has a
higher claim on the assets and earnings than
common stock.
-Owner of preferred Stock :
- Receive FIX dividends periodically.
- Dont have voting right.
- In case of liquidation, owner will receive their
money before shareholders of common stock .

Preferred Stock
Cumulative provision - arrearage plus
current dividends must be paid before any
payment made to common shareholders.
Non-participating preferred receive a fixed
level of dividends, thus not participating in
possible high earnings level of the corporation.
Adjustable-rate preferred, indexed to market
rates, varying with the index.

Preferred Stock
Case1: BISB make $20 million profit, the bank
decided to distribute 10 files per share, BISB
is paying for preferred stock 5 files annually.
Answer : Preferred stock holder will receive 5 files per share.

Case2: BISB make $10 million loss, the bank


decided NOT to distribute any dividends, BISB
is paying for preferred stock 5 files annually.
Answer : Preferred stock holder will receive 5 files per share

Summary
Common
Stock
Risk
Return
Liquidation
Payment
guaranteed/FI
X
Voting
Ownership

Preferred
Stock

Bond

Summary
Financial
security

Preferred
Stock

Bond

Highest Risk

Return

1Highest Return

Liquidation

Payment
guaranteed/FIX

Voting

Yes

NO

NO

Ownership

Yes

Yes

NO

Risk

Common
Stock

Preferred stock combines features of Common stock and Bonds

First to collect their money.

Primary vs. Secondary


Primary market :
IPO (Initial Public Offering).
Unseasonal offering.

Secondary: are where financial claims


resold and reprised.
Corporation

Investors

Investors

Primary vs. Secondary


You own 1000 Batelco. shares, recently the
company announce that it will rise capital by 20%
Rights offering.
Is the right offering primary or secondary market ?!
How many stock you are eligible for ?

MCQs
A stock purchased at $40 at the beginning of
the year paid $10 in dividends and was sold
for a net price of $42 at the end of the year.
The total annual return is :
a.25 %
b.100 %
c. 30 %
d. 28.6 %

MCQs
A shareholder in a troubled corporation is
not likely to lose his/her
a. money invested in the stock.
b. house.
c. dividends declared.
d. par value.

Common Stock (Recap.)


Represents ownership in a corporation.
Shareholders elect a board of directors.
Right to vote

Dividends is not guaranteed.


In the event of liquidation, common
shareholders have rights to a company's
assets only after bondholders, preferred
shareholders and other debt holders have
been paid in full.

Preferred Stock (Recap.)


The owner of the preferred share is part owner
of the company, just like acommon shareholder.
It contain a fixed payment (dividends).
These payments could come quarterly, monthly
or yearly.
NO voting right.
Liquidation! will priority compared to common
stock.
Character between stocks and bonds.

Equity Valuation Basics


Valuation >> how much it worth ?!
How to value a building ?!
Return >> Rent.

Equity Valuation Basics

Common Stock

Equity Valuation

Preferred Stock

Which type of stock is easier to evaluate ?


Why?!

Preferred Stock Valuation


Discount the expected dividend stream at the
required rate of return to determine its value*.

P0

r
A fixed-rate preferred stock approximates a
perpetuity (continues, infinity) and the value
can be found by dividing the annual dividends
by the discount rate.

*This approach known as Dividend Discount Model (DDM).

Preferred Stock Valuation


In 2010, ALBA issue preferred stock that
pays a 1 BD dividend annually , rate of
return is 12% per year, calculate the value
of the stock ?
D
P0
r

Preferred Stock Valuation


Three years later (2013), ALBA issue
preferred stock that pays a 1 BD dividend
annually , rate of return is 8% per year,
calculate the value of the stock ?

Preferred Stock Valuation


The preferred stock price varies as rates of
return change.
D
P0
r
What is the relation between price & :
Dividends ? +
Required Rate? -

Common Stock Valuation


In order to calculate the value of the stock, you
should :

Estimate the future cash flow of the company.


Select an appropriate discounting rate that
approximates the cash flow of the stock.

D1
P0
(r g )
(r-g) is the discounting rate, r : required rate, g: growth rate.

Common Stock Valuation


The value of a stock is the present value of
the dividends stream discounted at the
required rate of return minus growth rate.

D0 (1 g )
D1
P0

(r g )
(r g )

Common Stock Valuation


Price a share of common stock with current
dividends of $5, a dividend growth rate of
3% if the investors' required rate of return is
15%.

D0 (1 g )
D1
P0

(r g )
(r g )

Common Stock Valuation


Suppose a dividends on a stock today are $1
per share, and dividends are expected to
remain the same forever. If the required rate
of return is 8%, what is the value of the
stock ?

Exercise
ABC Company pays a 25 cent dividend every
month and the required rate of return is 6% per
year, calculate the value of the stock ?
Wait ! Is it common stock or preferred stock ?!

You purchase 100 shares of Adams Trading


Company stock today for $22.50 per share. At the
end of one year, you collect a dividend of $2.75 and
then sell the stock at $24.50 per share. What is
your total return on the stock? What is the dividend
yield? What is the capital gains yield?

What is the price of a share of common


stock that paid a $4.00 dividend this last
year, expects to grow steadily at 6 per cent
per year, and investors are requiring an 18
per cent rate of return?

Malley Corporation's preferred stock is


currently priced at $85, was issued at $100,
and pays an $8.00 annual dividend. What is
the market required rate of return?

Kaes Power Company promises to maintain


dividends of $5 per share on its common
stock, indefinitely. The stock currently sells
at $37.50 per share. What is the required
return on the stock?

Thank You

Kingsoft Office
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