Stock Valuation and Risk Lecture Note Flashcards

A set of vocabulary flashcards based on Chapter 11 of 'Financial Markets and Institutions' regarding stock valuation methods, CAPM, risk measures, and market efficiency.

Price-Earnings (PE) Method

A valuation approach that applies the mean industry price-earnings ratio to a firm's expected earnings for the next year, calculated as $\text{Valuation} = \text{Expected earnings per share} \times \text{Mean industry PE ratio}$.

Dividend Discount Model

A model that determines the value of a stock as the present value of all future dividends, represented as $\sum_{t=1}^{\infty} \frac{D_t}{(1+k)^t}$ where $\text{t}$ is the period, $D_t$ is the dividend, and $\text{k}$ is the discount rate.

Adjusted Dividend Discount Model

A valuation model where the stock value equals the present value of future dividends plus the present value of the forecasted price at which the stock will be sold at the end of the investment period.

Free Cash Flow Model

A valuation method for firms that do not pay dividends; it involves estimating free cash flows from operations, subtracting existing liabilities, and dividing by the number of shares.

Capital Asset Pricing Model (CAPM)

A model used to estimate the required rate of return ($R_j$) on a stock based on the risk-free rate ($R_f$), the market return ($R_m$), and the beta ($B_j$), using the formula $R_j = R_f + B_j(R_m - R_f)$.

Beta ($B_j$)

A measure of an asset's sensitivity to general stock market movements, calculated as the covariance between the stock's return ($R_j$) and the market return ($R_m$).

Market Risk Premium

The return of the market in excess of the risk-free rate, expressed as $(R_m - R_f)$, often estimated using $\text{30}$ or more years of historical data.

Investor Sentiment

A market-related factor representing the general mood of investors in the stock market.

January Effect

The tendency for small stocks to experience upward price pressure in January as portfolio managers invest in riskier, small stocks at the beginning of the year.

Earnings Surprises

Occurs when a firm's announced earnings are higher than expected, leading investors to revalue the stock upward based on higher future cash flow estimates.

Regulation FD

The regulation requiring firms to disclose material information publicly, ensuring that analysts no longer have an information advantage through private leakages.

Stock Return Formula

The measure of investment return over a period, calculated as $\text{Return} = \frac{(SP - INV) + D}{INV}$ where $SP$ is selling price, $INV$ is initial investment, and $D$ is dividends.

Volatility (Total Risk)

The degree of uncertainty surrounding a stock's future returns, typically forecasted using the historical method to derive the standard deviation of returns.

Implied Volatility

A measure of stock price volatility derived from a stock option pricing model.

Volatility Index (VIX)

A measure derived from S&P 500 stock options that reflects investors' expectations of stock market volatility over the next $\text{30}$ days.

Value at Risk (VaR)

A risk measurement method that estimates the largest expected loss for a particular investment position at a specified confidence level.

Sharpe Index

A reward-to-variability ratio that measures risk-adjusted returns when total variability is the most appropriate measure of risk.

Treynor Index

A measure of risk-adjusted returns used when beta is considered the most appropriate measure of risk.

Weak-Form Efficiency

A level of market efficiency suggesting that security prices reflect all market-related information, such as historical price movements and trading volume.

Semistrong-Form Efficiency

A level of market efficiency suggesting that security prices fully reflect all public information, including firm announcements and economic news.

Strong-Form Efficiency

A level of market efficiency suggesting that security prices fully reflect all information, including private or insider (insider) information.