FACULTY OF

BUSINESS, FINANCE
&
INFORMATION
TECHNOLOGY

CHAPTER 5 – STOCK & UNIT TRUST

By: Ms. Nur Izyan Jonaidi ([email protected])

Copyright© 2021 MAHSA UNIVERSITY

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Objectives
By the end of this chapter, you should be able to understand and
After completing this prepare :
lesson you will be
able to: • Concept of stock & unit trust
• Valuation of stock & unit trust
• Application of stock & unit trust
VALUE VS PRICE
Definition of Value

• Value is a subjective term as what is value to one person

may not be the same for other.
• The value of any asset MUST equal the present value of
its future cash flows, discounted at a rate that reflects its
inherent risk.
• Since neither the future cash flows nor the appropriate
discount rate can be known with certainty, valuation is
always an estimation.
• Several valuation methods are used to value a business
but not a single method can be vouched to predict the
exact price at which an entity can be sold.
Definition of Value

THINK ABOUT A PROPERTY (HOUSE).

HOW A PROPERTY IS VALUATED ?
• What investors buy is the future benefits and not
the past. The point to be carefully noted that
there is nothing called the ‘correct value’ or the
’right value’.
• It all depends upon the type of value which is
being measured, the purpose of valuation, the
methods adopted and the assumptions made.
 Definition of Price
• The price may be understood as ‘the amount of money or
other consideration asked for or given in exchange for
something else’.
• The price is therefore, an outcome of a transaction
• An oil reserve of Petro net L&G may not have any value
when the oil price is `70 and the extraction cost of that
oil is `110. However, when the price reaches to `130 and
is expected to prevail around this figure, it may have
significant value.
Relation of Value and Price

The stock's price only tells you a company's current value

or its market value.
STOCK
 Facts about Common Stock

• Represents ownership
• Ownership implies control
• Stockholders elect directors
• Directors elect management
• Management’s goal: Maximize the stock
price

10-
 Facts about Preferred Stock
• Hybrid security.
• Like bonds, preferred stockholders receive
a fixed dividend that must be paid before
dividends are paid to common
stockholders.
• However, companies can omit preferred
dividend payments without fear of
pushing the firm into bankruptcy.

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 Intrinsic Value and Stock Price
• Outside investors, corporate insiders, and analysts
use a variety of approaches to estimate a stock’s
intrinsic value (P0).
• In equilibrium we assume that a stock’s price equals
its intrinsic value.
– Outsiders estimate intrinsic value to help
determine which stocks are attractive to buy
and/or sell.
– Stocks with a price below (above) its intrinsic value
are undervalued (overvalued).
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 Determinants of Intrinsic Value and Stock Prices
Managerial Actions, the Economic Environment,
Taxes, and the Political Climate

“True” Investor “Perceived” Investor “Perceived”

“True” Risk
Cash Flows Cash Flows Risk

Stock’s Stock’s
Intrinsic Value Market Price

Market Equilibrium:
Intrinsic Value = Stock Price

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Different Approaches for Estimating the Intrinsic
Value of a Common Stock
• Corporate valuation model
• Discounted dividend model
• P/E multiple approach

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 CORPORATE
VALUATION MODEL
Capital Asset
Pricing
Model
(CAPM)
 CAPITAL ASSET PRICING MODEL (CAPM)

▪Investor’s required rate of returns is the minimum rate of

return necessary to attract an investor to purchase or hold a
security.
▪The required return for all assets is composed of two parts: the
risk-free rate and a risk premium.

The risk-free rate (Rf) is usually The risk premium is a function of

estimated from the return on both market conditions and the
treasury bills asset itself.
• ri= Required rate of return on Stock i
• rRF = Risk-free rate of return.
• rM = Required rate of return on a portfolio consisting of all stocks, which is
called the market portfolio.
• RPM = Risk premium on “the market.” RPM = (rM − rRF) is the additional
return over the risk-free rate required to induce an average investor to
invest in the market portfolio.
• Bi = systematic risk
 REQUIRED RATE OF RETURN - CAPM
▪CAPM (Capital Asset Pricing Model) is a model to measure the
investor’s required rate of return (provides a risk-return trade off
in which risk is measured in terms of beta).
▪CAPM provides for an intuitive approach for thinking about the
return that an investor should require on an investment, given
the asset’s systematic or market risk.
▪CAPM equation equates the expected rate of return on a stock
to the risk-free rate plus a risk premium for the systematic risk.
▪SML is a graphic representation of the CAPM, where the line
shows the appropriate required rate of return for a given stock’s
systematic risk.
CAPM IS …….

• REQUIRED RATE OF RETURN BASED

ON ITS SYSTEMATIC RISK.
• IT IS WHAT AN INVESTOR
SHOULD EXPECT FOR THE RISK
INVOLVED
 REQUIRED RATE OF RETURN - CAPM
▪Risk-free rate is the rate of return or discount rate for
risk-less investments that is typically measured by
Treasury bill rate.
▪The risk premium for a stock is composed of 2 parts:
a. The Market Risk Premium which is the return
required for investing in any risky asset rather than the
risk-free rate.
b. Beta, a risk coefficient which measures the
sensitivity of the particular stock’s return to changes in
market conditions.
 MEASURING MARKET RISK
▪Once the individual asset return and market return obtained, a
graph is prepare to see the relationship between that asset return
and market return.
▪Asset return is plot on Y-axis and market return on X-axis.
▪When all the returns are plotted, draw a line of best-fit for all
the stock returns relative to market returns which we call
Characteristic line.
▪The slope of the characteristic line is called BETA. It measures of
the firm’s market risk.
Example 6- XYZ returns are 1.2 times as volatile on
average as those of the overall market.
β = 1.2 means any increase by 100% in market return will
cause an increase by 20% in asset return
 MEASURING MARKET RISK - BETA
Interpreting beta (β)
➢Specifically, beta is a measure of how an individual stock’s
returns response (sensitivity) to a change is market returns.

➢The market’s beta is 1

• A firm that has a beta = 1 has average market risk. The
stock is no more or less volatile than the market.
• A firm with a beta >1 is more volatile than the
market.(sensitive)
• A firm with a beta < 1 is less volatile than the market. (less
sensitive)
• A firm with a beta=0 has no systematic risk.
 REQUIRED RATE OF RETURN - CAPM
Example
HD Corporation, a growing computer software developer,
wishes to determine the required return on asset Z, which has a
beta of 1.5. The risk-free rate of return is 7%; the return(rate) on
the market portfolio of assets is 11%.
Substituting βZ = 1.5, rf = 7%, and rM = 11% into the CAPM yields a
return of:

rZ = 7% + 1.5 [11% - 7%]

= 13%
Security Market Line

• The line that reflects the combination of risk and return available
on alternative investments is referred to as the security market
line (SML).
• The slope of the SML indicates the return per unit of risk required
by all investors.
• Assuming a straight line, it is possible to select any point on the
SML and compute a risk premium (RP) for an asset through the
equation.
• SML shows the trade-off between risk and expected return as a
straight line intersecting the vertical axis (i.e., zero-risk point) at
the risk-free rate
 SML – The line that reflect the attitude of investors
regarding the minimal acceptable return for a given level
Required of systematic risk. (SML)
rate of
return

13% .
11% Risk Premium

Risk-free Market Risk Premium

rate of This linear relationship
return between risk and required
(7%) return is known as the
Risk Free Rate Capital Asset Pricing Model
(CAPM).

1.0 1.5 Beta

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DISCOUNTED DIVIDEND
MODEL
 Discounted Dividend Model
• Value of a stock is the present value of the
future dividends expected to be generated by
the stock.
D1 D2 D3 D
Pˆ0 = + + + ... +
(1 + rs ) (1 + rs ) (1 + rs )
1 2 3
(1 + rs )

P = stock price
D = value of next year dividend
r = constant cost of equity capital
g = constant growth rate

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 Constant Growth Stock
• A stock whose dividends are expected to grow forever at
a constant rate, g.
D1 = D0(1 + g)1
D2 = D0(1 + g)2
Dt = D0(1 + g)t
• If g is constant, the discounted dividend formula
converges to:

ˆP0 = D0 (1 + g) = D1
rs − g rs − g

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 What happens if g > rs?
• If g > rs, the constant growth formula leads to
a negative stock price, which does not make
sense.
• The constant growth model can only be used
if:
rs > g.
g is expected to be constant forever.

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Use the SML to Calculate the Required Rate of Return (rs)

• If rRF = 7%, rM = 12%, and b = 1.2, what is the required

rate of return on the firm’s stock?
rs = rRF + (rM – rRF)b
= 7% + (12% – 7%)1.2
= 13%

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 Find the Expected Dividend Stream for the Next
3 Years and Their PVs
D0 = $2 and g is a constant 6%.

2(1 + 0.06)1
0 g = 6%
1 2 3

2.00 2.12 2.247 2.382

2.12 X 0.8850= 1.8762
rs = 13%
2.247 X0.7831= 1.7596

2.382 X0.6931= 1.6509

**PLEASE REFER TO PVIF TABLE 13% RATE COLUMN

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 What is the stock’s intrinsic value?
Using the constant growth model:

D1 $2.12
P0 =
ˆ =
rs − g 0.13− 0.06
$2.12
=
0.07
= $30.29
 What is the stock’s expected value, one year
from now?
• D1 have been paid out already. So, expected P1 is the
present value (as of Year 1) of D2, D3, D4, etc.
D2 $2.247
Pˆ1 = =
rs − g 0.13 − 0.06
= $32.10

• Could also find expected P1 as:

P̂ = P (1.06) = $32.10

P̂ = 30.29 (1.06) = $32.10

1 0
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Find Expected Dividend Yield, Capital Gains Yield,
and Total Return During First Year
• Dividend yield
= D1/P0 = $2.12/$30.29 = 7.0%
• Capital gains yield
= (P1 – P0)/P0
= ($32.10 – $30.29)/$30.29 = 6.0%
• Total return (rs)
= Dividend yield + Capital gains yield
= 7.0% + 6.0% = 13.0%

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What would the expected price today be, if g = 0?
The dividend stream would be a perpetuity.

0 rs = 13% 1 2 3

2.00 2.00 2.00

PMT $2.00
P̂0 = = = $15.38
r 0.13

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 Valuing Common Stock with Nonconstant Growth

D0 = $2.00.
0 rs = 13% 1 2 3 4

g = 30% g = 30% g = 30% g = 6%

2.600 3.380 4.394 4.658
2.301
2.647
3.045
4.658
46.114 P̂3 = = $66.54
54.107 = Pˆ0 0.13 − 0.06

10-38
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 Find Expected Dividend and Capital Gains Yields
During the First and Fourth Years
• Dividend yield (first year)
= $2.60/$54.11 = 4.81%
• Capital gains yield (first year)
= 13.00% – 4.81% = 8.19%
• During nonconstant growth, dividend yield and capital
gains yield are not constant, and capital gains yield ≠ g.
• After t = 3, the stock has constant growth and dividend
yield = 7%, while capital gains yield = 6%.

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Nonconstant Growth: What if g = 0% for 3 years
before long-run growth of 6%?
D0 = $2.00.
0 r = 13% 1 2 3 4
s

g = 0% g = 0% g = 0% g = 6%
2.00 2.00 2.00 2.12
1.77
1.57
1.39
2.12
20.99 P̂3 = = $30.29
0.13 − 0.06
ˆ0
25.72 = P

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 Find Expected Dividend and Capital Gains Yields
During the First and Fourth Years
• Dividend yield (first year)
= $2.00/$25.72 = 7.78%

• Capital gains yield (first year)

= 13.00% – 7.78% = 5.22%

• After t = 3, the stock has constant growth and dividend yield = 7%, while capital gains
yield = 6%.

10-41
If the stock was expected to have negative growth (g = -6%), would
anyone buy the stock, and what is its value?

• Yes. Even though the dividends are declining, the

stock is still producing cash flows and therefore has
positive value.

D1 D 0 (1 + g)
ˆ
P0 = =
rs − g rs − g
$2.00 (0.94) $1.88
= = = $9.89
0.13 −(-0.06) 0.19

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 Find Expected Annual Dividend and Capital
Gains Yields
• Capital gains yield
= g = -6.00%
• Dividend yield
= 13.00% – (-6.00%) = 19.00%
• Since the stock is experiencing constant growth,
dividend yield and capital gains yield are constant.
Dividend yield is sufficiently large (19%) to offset
negative capital gains.

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 what
If preferred iswith
stock theanpreferred stock’s
annual dividend of $5expected return?
sells for $50,

D
Vp =
rp
$5
$50 =
rp

$5
rp =
ˆ
$50
= 0.10 = 10%

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 PRICE EARNING
MULTIPLE APPROACH
a. Earning per share (EPS)

𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
𝑻𝒐𝒕𝒂𝒍 𝒖𝒏𝒊𝒕 𝒐𝒇 𝒐𝒓𝒅𝒊𝒏𝒂𝒓𝒚 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒉𝒂𝒓𝒆𝒔

• Earnings per share is an important financial measure, which indicates the profitability
of a company
• It is a tool that market participants use frequently to gauge the profitability of a
company before buying its shares
• It shows how much income could be earned by investors for every one share ($1)
invested in a company
• the higher the earnings per share of a company, the better is its profitability.
P/E Multiplier

• The price earnings ratio is the ratio of the market price per share to the earnings per
share.
• The PE ratio is consistently defined, with the numerator being the value of equity per
share and the denominator measuring earnings per share, both of which is a measure of
equity earnings.
 PRICE EARNING
MULTIPLE APPROACH
a. Earning per share (EPS)

𝑵𝒆𝒕 𝑰𝒏𝒄𝒐𝒎𝒆
𝑻𝒐𝒕𝒂𝒍 𝒖𝒏𝒊𝒕 𝒐𝒇 𝒐𝒓𝒅𝒊𝒏𝒂𝒓𝒚 𝒄𝒐𝒎𝒎𝒐𝒏 𝒔𝒉𝒂𝒓𝒆𝒔

• Earnings per share is an important financial measure, which indicates the profitability
of a company
• It is a tool that market participants use frequently to gauge the profitability of a
company before buying its shares
• It shows how much income could be earned by investors for every one share ($1)
invested in a company
• the higher the earnings per share of a company, the better is its profitability.
P/E Multiplier

• The price earnings ratio is the ratio of the market price per share to the earnings per
share.
• The PE ratio is consistently defined, with the numerator being the value of equity per
share and the denominator measuring earnings per share, both of which is a measure of
equity earnings.
UNIT TRUST
General definition

• CIS is a form of institutional investment

through which individuals pool their funds
and hire professionals to manage their
investments, with each investor entitled to a
proportional share of the net benefits of
ownership of the underlying assets.
What are investment funds?

The investment scheme of a

Want to invest money to
unit trust fund can be illustrated
meet particular objectives as a tripartite relationship
between the manager, the
trustee and the unitholders.

Also referred to as:

‘asset management’
or ‘fund management’

Select the most appropriate investments

(mainly shares, bonds and money Funds pool the money together of
market instruments) for their clients many investors
based on the objective of an individual
fund Also referred to as:
Collective investment funds or
Collective investment schemes or
Are created by investment managers in Mutual funds
which their clients can choose to invest.
Each fund includes a collection of
investors
Equities Bonds Properties Commodities Alternatives

Unit Trust Fund/ Mutual Funds/ Exchange Traded Fund (ETF)

TYPES OF COLLECTIVE INVESTMENT SCHEME

• investment in all the major asset classes to reduce

Balanced the risk of investing in a single asset class.
• A balanced unit trust fund generally has a portfolio
Funds comprising equities, fixed income securities and
cash.

• investments is focused in equities or securities of

listed companies (Bursa Malaysia).
Equity Funds • The performance of the units is therefore linked to
the performance of Bursa Malaysia.

• investment objective is to achieve the same return

Exchange as a particular market index.
• ETF often have low expense ratios and can be
Traded Funds bought and sold throughout the trading day
through a stockbroker, on an exchange.
 • investment focus on Malaysian Government
Fixed Income Securities, corporate bonds, and money market
instruments.

Funds • The objective of a fixed income fund is usually to

provide regular income..

• These funds invest in a range of companies that

closely match (or “track”) companies comprising a
Index Funds particular index.

• International equity funds are funds primarily

International invested in overseas stock markets.

Equity Funds
 • invest in liquid, low risk money market instruments
Money market that are in effect short-term deposits (loans) to
banks and other-low risk-financial institutions, and
Funds in short-term government securities.
• lower risk and provide stable income returns.

Real estate • These funds invest in a range of companies that

closely match (or “track”) companies comprising a
investment trusts particular index.

(REITS)

• International equity funds are funds primarily

invested in overseas stock markets.
Shariah Funds
 Net Asset Value Formula

• Net Asset Value is the net value of assets and liabilities of a mutual fund or ETF
expressed on a per-share basis
• NAV is the price at which investors buy or sell units of the fund
• NAV is usually calculated daily during business days and trade orders placed before the
cut-off time are executed on a same-day NAV basis while orders placed after the cut-off
time are executed on the following day’s NAV
• Number of outstanding shares of the fund change constantly depending upon the supply
and demand of the fund’s units as on any particular day
• Slight difference in NAV pricing for ETFs during trading hours provide arbitrage
opportunities for ETF traders
• Other measures such as CAGR or total annual return provide a better measure of fund
performance rather than net asset value