Equivalence of HPR and DDM The book starts from the holding period return,and uses an inductive argument to derive the Discounted Dividend Model(DDM)method for evaluating stocks ■ Equivalently,we start with the discounted cash flow model,and obtain the holding period return THE COURSE OF FINANCE 2017 SPRING SJTU 11
Equivalence of HPR and DDM The book starts from the holding period return, and uses an inductive argument to derive the Discounted Dividend Model(DDM) method for evaluating stocks Equivalently, we start with the discounted cash flow model, and obtain the holding period return THE COURSE OF FINANCE 2017 SPRING SJTU 11
Notation Pi is the stock value in year j P1 is the stock value in year 1 Po is the stock value in year 0 >Di is the cash dividend in year j Di is the cash dividend in year 1 >K is the required rate of return on the stock THE COURSE OF FINANCE 2017 SPRING SJTU 12
Notation Pj is the stock value in year j P1 is the stock value in year 1 P0 is the stock value in year 0 Dj is the cash dividend in year j D1 is the cash dividend in year 1 K is the required rate of return on the stock THE COURSE OF FINANCE 2017 SPRING SJTU 12
HPR for the first year required rate of return 0+B-B=4+B-B P P This relationship tells you that next year's expected dividend yield the expected capital gain yield is equal to the required rate of return THE COURSE OF FINANCE 2017 SPRING SJTU 13
HPR for the first year This relationship tells you that next year’s expected dividend yield + the expected capital gain yield is equal to the required rate of return THE COURSE OF FINANCE 2017 SPRING SJTU 13 0 1 0 0 1 0 1 1 0 required_rate_ _ P P P P D P D P P o f return
Required rate of return The price and dividend next year are expected prices,so the required rate of return in any period equals the market capitalization rate,k k=D+B-R R THE COURSE OF FINANCE 2017 SPRING SJTU 14
Required rate of return The price and dividend next year are expected prices, so the required rate of return in any period equals the market capitalization rate, k THE COURSE OF FINANCE 2017 SPRING SJTU 14 0 1 1 0 P D P P k
Priceo Is Discounted Expected (Dividend1 Price1) Price is the present value of the expected dividend plus the end-of- year price discounted at the required rate of return B=2+B 1+k THE COURSE OF FINANCE 2017 SPRING SJTU 15
Price0 Is Discounted Expected (Dividend1 + Price1) Price is the present value of the expected dividend plus the end-ofyear price discounted at the required rate of return THE COURSE OF FINANCE 2017 SPRING SJTU 15 k D P P 1 1 1 0