Equity markets

Question 1

Factors affecting the level of equity market

Answer 1

• Expectations of future profits
  o affects the level of dividends
  o high level of profits are expected to coincide with high dividends and therefore more
  attraction to equity
• Expectations of real interest rates
  o Low real interest rates stimulates economic growth
  o Increase profitability and hence increase general equity market
  o The rate of return required by investors is low, so pv of future dividends payments
  will be higher
• Expectations of inflation
  o Rate of high inflation means that dividend growth is will also be high
  o Profits are expected to also increase in line with inflation
• Investor’s perception of the riskiness of equity investments (equity risk premium)
  o Additional return required by equity investors to compensate for the risks relative to
  risk free rates of return ( government bonds ) because of differences in
  ▪ Risk of default
  ▪ Lower marketability than government bonds
  ▪ Greater volatility of income ad capital values ( lower liquidity )
• The real level of economic growth in the economy
  o Real dividends and fundamental value of company is expected to grow roughly in
  line with real economic growth
• Currency fluctuations
  o A weaker domestic currency makes exports more competitive and so profits of
  companies that export goods and services should increase
  o Make import expensive and reduce corporate profits if firms cannot pass the higher
  costs of imported raw goods to consumers
  o Higher costs of raw material also increase inflation

Question 2

Factors affecting supply of equity

Answer 2

Factors affecting supply of equity
- Number of rights issue
- Share buy-backs
- Privatisation

Question 3

Factors affecting demand for equity

Answer 3

• Changes to tax rules
• Institutional flow of funds
• Attractiveness of alternative investments