equity finance - raising funds through stocks/shares
- debt finance - raising funds through bonds/loans
- dividends - paid from firm's profits to stockholders
- bonds pay predetermined amounts
- profits increase >> dividends increase
- stock markets represented nominally >> real value could decrease even as nominal value increases
stock price - equal to present value of future expected dividends
- $Qt = $Dt+1 / (1+it) + $Dt+2 / [(1+it)(1+it+1)] + ...
- same relationship when converted to real value and real interest rates
- higher expected future dividends >> higher real stock price
- higher current/expected real interest rates >> lower real stock price
- expecting high stock price later >> high current stock price
- random walk - w/ each step equally likely, mov'ts unpredictable
- major mov'ts really can't be predicted
- predictions based on expected policy/social/gov't shifts
effect of monetary expansion on stock market
- money increase >> LM curve shifts down >> equilibrium output increases, interest decreases (both briefly)
- stock market already anticipates move >> no effect on stock market
- stock market doesn't anticipate move >> stock prices increase
- expansion lowers interest rate and increases output (dividends)
effect of increased consumer spending on stock market
- sending increase >> IS curve shifts right >> output increases, interest increases (both in short term)
- output increase >> higher stock prices
- interest increase >> lower stock prices
- final, net outcome depends on LM slope
- flatter LM curve >> output increase dominates >> higher stock prices
- steeper LM curve >> interest increase dominates >> lower stock prices
- monetary reaction - Fed may choose to accomodate IS shift
- Fed accomodates shift >> increases money supply to keep interest rates from increasing >> stock prices rise for sure
- Fed chooses to do nothing >> stock prices may increase or decrease
- Fed counteracts inflation >> monetary contraction >> output stays constant, interest rises >> stock prices drop for sure
fundamental value - present value of expected dividends
- actual stock prices not equal to fundamental value >> sometimes underpriced or overpriced
- stock prices can increase as long as investors expect stock prices to increase
- rational speculative bubbles - growth of stock prices based on speculation
- prices above fundamental value (even if fundamental value is 0)
- investors expect to be able to sell stock at a higher value in a following year
- fads - deviations from fundamental value due to past success
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