Financial Markets, Banking, and Monetary Policy

CHAPTER 11 The Equity Market

WHAT YOU WILL LEARN IN THIS CHAPTER

• The ways in which firms raise funds from shareholders—new issuance or retained earnings.
• The features of preferred shares and some reasons why they are issued.
• The ways in which shares are issued in the primary and traded in the secondary markets.
• How a present value model is adapted to determine the price of a share of stock.
• How price depends on the share’s dividends and a discount factor that embodies a risk (or equity) premium over and above a risk-free interest rate to account for the greater risk of owning stock, and how higher discount rates lower the price of a share, while higher dividends raise the price.
• How the model can be adapted to account for prospective growth in dividends; and how more growth in expected dividends raises the price of a share.
• How the model can be transformed into one that relates the price of a share to earnings instead of dividends; how this form of the model highlights the importance of a firm’s dividend (or retained earnings) policy.
• How to use this version of the model to determine the price-earnings (P-E) ratio of a firm’s stock and why these vary across firms at any one time.
• How to view factors affecting the stock market as a whole and why the stock market is so sensitive to news on the economy
• How the stock market acts as a key channel of monetary policy.
• The key features of indexes of share prices, such as the Dow Jones and S&P.

BACKGROUND

Are you tempted to stop ...