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Finance and Financial Markets

Third Edition

by Keith Pilbeam

Chapter 9 - Stockmarkets and equities

Find an overview and useful learning resources below to accompany Finance and Financial Markets chapter nine.

Chapter Introduction

Stockmarkets around the world have undergone significant changes since the 1960s, now seeming to dominate much of the financial news headlines. The 1990s bull market in the USA came to a spectacular and sudden halt on 10 October 2002, with the NASDAQ falling from its all-time high of 5132 to 1108. This decline of 78 per cent shows how shares can become spectacularly overvalued. Indeed, the US stockmarket was trading in March 2009 close to levels it had seen in 1996, some 13 years earlier.

Stock exchanges have been heavily influenced by the introduction of new technology; for instance, the stock exchanges in London, Paris and Frankfurt are now screen-based, replacing the trading-floor environment. There have also been significant regulatory changes such as London’s ‘big bang’ in 1986 and regulatory changes in the USA following a number of scandals during the ‘bubble era’ of 1997– 2000. In addition, the markets are increasingly dominated by institutional investors, pension funds, unit trusts/mutual funds, investment companies and trusts, insurance companies and the like which impose different demands than the traditional small investor. For example, in the late 1950s roughly two-thirds of shares on the UK stockmarket were owned by small investors, but by the early 2000s this figure had declined to less than one-fifth. Conversely, the ownership of shares by institutions rose from around one-fifth in the late 1950s to roughly two-thirds in the early 2000s.

In this chapter, we briefly review the operation of some of the major stockmarkets. We then look at the different types of equities that are traded in these markets and examine the choice between debt and equity finance. We proceed to consider the theory behind the pricing of equities, and we also look at some of the key financial ratios that are used by analysts when analyzing companies traded on stockmarkets.

Learning Objectives

In this chapter you will learn about:
  • The relative size and importance of the major international stockmarkets
  • The different types of equity
  • The dividend discount model for the pricing of equities
  • Alternative methods to calculate the required rate of return
  • The impact of primary gearing on shareholder risk and return
  • The use of chartism, and technical analysis in the financial markets
  • How financial ratio analysis can be used to help determine equity valuation

Further Reading

Bodie, Z., Kane, A. and Marcus, A. (2008) Investments, 6th edn, McGraw-Hill.

English, J. (2008) Applied Equity Valuation: Models from Leading Investment Banks, Wiley.

Murphy, J. (1999) Technical Analysis of the Financial Markets: A Comprehensive Guide to Trading Methods and Applications, New York Institute of Finance.

Poddig, T. and Varmaz A. (2008) Equity Valuation: Models from Leading Investment Banks, Wiley.

Stowe, J., Robinson, T., Pinto T. and McLeavey D. (2007) Equity Asset Valuation, Wiley.

Multiple Choice Questions

Click here to launch multiple choice questions for chapter 9.