Equity Valuation

Abstract

Together with the debt capital, another important part of the financing of a firm is the equity capital, a source of financing that is based on cash inflows provided by the ownership of the company, or by retention of profits.

Problems

• 1. Explain why banks hold more liquid assets than most other business.

• 2. Explain the difference between illiquidity and insolvency. Does the difference matter?

• 3. Explain why if the government announces it is abolishing insurance on deposits, a typical bank is likely to face liquidity problems.

• 4. If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure?

• 5. Would you expect the bid-ask spread to higher on actively or inactively traded stocks?

• 6. Discuss the moral hazard aspects created by deposit insurance.

• 7. Describe and compare the different types of trading orders available in the markets.

• 8. A bill has a bank discount yield of 6.65 % based upon the asked price, and 6.75 % based upon the bid price. The maturity of the bill (already accounting for skip-day settlement) is 90 days.

  • (a) Find the bid and asked prices of the bill.

  • (b) Calculate the bond equivalent yield of the bill as well as its effective annual yield based upon the asked price. Confirm that these yields exceed the discount yield.

• 9. The table below provides some price information on Marriott:

  Bid price	Ask price
  37.55	38.33

  You have placed a stop-loss order to sell at 37.80 €.

  • (a) By placing this order, what are you in effect asking your broker to do?

  • (b) Given the market prices, will your order be executed?

• 10. Consider the following limit order book of a specialist. The last trade in the stock occurred at a price of 45.55 €.

  Limit buy orders		Limit sell orders
  Price	Shares	Price	Shares
  35.50	5000	35.75	1000
  35.25	6000	35.90	2000
  35.00	8000	36.00	5000

  • (a) If a market buy order for 3000 shares comes in, at what prices will it be filled?

  • (b) What will happen if a market order to sell 5000 shares comes in?

• 11. Consider the following limit order book of a specialist. The last trade in the stock occurred at a price of 45.55 €.

  Limit buy orders		Limit sell orders
  Price	Shares	Price	Shares
  59.75	4000	55.75	1000
  59.50	5000	55.80	2500
  59.25	7000	56.00	4500

  • (a) If a market buy order for 1000 shares comes in, at what prices will it be filled?

  • (b) At what price would the next market-buy order be filled?

  • (c) You are the specialist: do you wish to increase or decrease your inventory of this stock?

• 12. You have borrowed 20,000 € on margin to buy shares in Disney, which is now selling at 80 € per share. Your account starts at the initial margin requirement of 50 %. The maintenance margin is 35 %. Two days later, the stock price falls to 75 € per share.

  • (a) Will you receive a margin call?

  • (b) How low can the price of Disney shares fall before you receive a margin call?

• 13. Explain why banks hold more liquid assets than most other business.

• 14. Explain the difference between illiquidity and insolvency. Does the difference matter?

• 15. Explain why if the government announces it is abolishing insurance on deposits, a typical bank is likely to face liquidity problems.

• 16. If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure?

• 17. Would you expect the bid-ask spread to higher on actively or inactively traded stocks?

• 18. Discuss the moral hazard aspects created by deposit insurance.