Capital Markets, Stock & Bond Valuations, Market Cap

JWI 530 Financial Management I, week8 summary, 3/2/13

This week's lecture equipped us with valuable concepts such as capital markets, valuation of stock and bond, and market capitalization. The DQ made us think about best ways to raise capital for a firm - using equity or debt options - in the context of the broader economy.

fascinating takeaways
Dr DP

I. World's wealth ~ $200 trillion
- freely traded global capital markets
- bank deposits
- real estate value

II. Capital Markets
- home to world's wealth ; Massive warehouse of capital
- Forum for exchange of securities - stocks (equity) & bonds(debt) - of constantly changing value
- living, breathing organisms that provide opportunity and information
- beware, this is not a friendly entity: financial opportunities are created and destroyed
effective tools in right hands, WMD in wrong ones
- Offer govts, businesses and institutions the opportunity to raise capital.
- participants enter at their own peril; ignorance and weakness will be taken advantage of by others
- monitored and regulated by govt agencies to ensure fairness eg SEC, FINRA, FSA
- feedback mechanism to firms direction from outside perspective
- determine the business's cost of capital
- provides a window into status of competitors, customers, suppliers
- offer opportunities for a firm to invest excess capital and execute strategic acquisitons, mergers, sales

III. Bond Market vs Stock Market

Stocks (Equity)
- partial ownership in a firm
- entitlement for future dividends
- stock market is a physical or electronic space where buyers and sellers can exchange shares
- prices on electronic display eg NYSE
- specialists help in price-discovery process and complete transactions
- information is clear
- broad set of players; gets a lot of attention and dominates discussion
- $41 trillion

Bonds (Debt)
- obligation to pay interest over a fixed schedule in exchange of loan
- Information is Opaque as prices not generally available for public view;
trading prices to institutions dealing in trades of $1M or more published in investor info sources eg. Bloomberg
- mostly traded over the counter
- $83 trillion; dwarfs stock market; small changes in bonds cause big waves in stocks
- dictates flow of capital throughout the world

IV. Value

Intrinsic value (Fundamental value)
Perceived value (Market value)
Understand the difference to make informed decisions

Dislocation between Market Value vs Intrinsic value

Market value - physical cost of buying shares of a stock or purchase of a bond = f(what buyers ask to pay for security, what sellers are willing to sell for)
Intrinsic value - what the security is worth
Sometimes markets can be wildy off and market value can be misaligned from intrinsic value
When that happens there is a "dislocation" - an opportunity is born; exploit them
Best investors spot the dislocations effectively than other market players
They buy or sell the security before the market catches up with them
"Value is what you get. Price is what you pay", Warren Buffet

Bond Valuation
Bonds yield interest at fixed schedules into the future
Value of a bond = value of a series of payments into the future
Value of a bond is determined by the present value of the remaining payments the bond must make to the owner
Discount rate = f(prevailing interest rates & other factors)

Bond Price
Bond price = f(duration until maturity, govt interest-rate, ability of firm to meet obligation to shareholders)
Bond yield = what the investor gets paid

Stock valuation: capture fair value of one share of a company' stock
- an art and a science
- abstract
- attempt to quantify firm's survival ability and how much money it will create in the future
- valuation framework depends on context (company's industry, market, competitive position, other complex variables)
- Discounted Cash Flow (DCF) & NPV analysis: weapons of choice for valuing businesses
- Other techniques: Multiple valuations, Replacement value valuations, book value analysis

V. Market Capitalization
Share price * shares outstanding
- price to purchase entire equity stake of company
- measure of what the world thinks a company is worth