Topic 6 - Equity Markets

Front 1

What are the two possible outcomes of an underwritten share issue? and what are the possible cash flows that would occur in each event between the underwriter and the issuing firms?

Back 1

The two outcomes are either
(1) share issue is not fully described to by investors or
(2) the issue is fully subscribed by the investors.

In the first case, the shortfall amount would devolve on the underwriter.
In the second case the underwriter would not need to make any subscription to the share issue and would be able to retain all commission received from the firm.

Front 2

Describe the general approach to valuing a share

Back 2

The general approach is to discount all future cash flows to the shareholder to their present value and add them together. The valuation process involves three steps.
1. Identify the timing and the size of the cash flow
2. decide on the appropriate discount rate
3. apply the discount rate to the cash flows in each period to obtain present values and sum the present values to obtain the price of the security.

Front 3

What government policies that have encouraged either direct or indirect share ownership by Australian adult population.

Back 3

Past privatisations of publicly owned corporations, taxation policy and retirement income policy.

Front 4

What are cash flows relevant to value shares?

Back 4

Expected dividends and sale price are cash inflows to the share investor and therefore a relevant to valuation of shares

Front 5

Describe what happens to the total risk of a portfolio as the number of securities is increased.

Back 5

Risk of a portfolio generally tends to decrease with increasing number of securities provided, however they are not perfectly correlated to one another. This is the benefit of diversification. however not all risk can be eliminated by diversification.

Front 6

Why are convertible securities more attractive to investors than simply holding a firm's preference shares or corporate bonds?

Back 6

Convertable securities behave like debt - fixed return, no capital appreciation or loss, but can be converted into shares later (perhaps when the company has proven to be successful). Thus, holders retain the opportunity to convert to ordinary shares and share in success, but enjoy a lower initial risk situation than with direct purchase of shares.

Front 7

Define the following terms as they relate to the secondary markets
- Depth
- Breadth
- Resilience

Back 7

- Depth: The existence of orders to buy at prices below the current market price and to sell at prices above the current price.

- Breadth: the buy and sell orders are in appropriate volume to stabilise the market.

- Resiliance: new orders flow in to respond to price changes.

Front 8

Explain the difference between systematic and unsystematic risk. Explain how beta captures systematic risk

Back 8

Systematic risk affects the whole system or market.

Unsystematic risk affects specific firms.

Beta measures the risk attached to a specific stock in relation to the market

Beta is estimated by regressions analysis by analysing the returns to a specific security over a given period in relation to the returns to the whole market.

The whole market is assumed to have a beta of one.

Front 9

Diversification

Back 9

diversification means reducing risk by investing in a variety of assets. If the asset values do not move up and down in perfect synchrony, a diversified portfolio will have less risk than the weighted average risk of its constituent assets, and often less risk than the least risky of its constituent.
"dont put all your eggs in one basket"