Question

Lala Beauty is a famous chain of personal health and beauty retailer offering comprehensive range of personal care, skin care and baby care products. It is a listed company in Hong Kong Stock Exchange. Suppose there is certainty that a company earns a profit of $1,000,000 every year forever and that the whole of this profit will be distributed to shareholders as dividend. And the company has issued in total 200,000 shares to shareholders. (a) What will be the price of each share if the interest rate is 5% per annum? (b) Alice is one of the investors of the stock market. Originally, she has no intention of buying Lala Beauty’s shares. However, after its share price has risen quite sharply in one morning, she decides to buy some shares. Is Alice’s action an exception to the law of demand? (c) Boris is a speculator who tries to ‘buy low and sell high’ to make a profit. If he succeeds in making a profit out of his speculative activities, by using demand and supply diagrams, show how will his actions affect the demand for OR supply of shares in the stock market during (i) periods when he thinks current prices are relatively low? (ii) periods when he thinks current prices are relatively high? Besides, do you think speculators (who are successful in making money) will make share prices more stable or less stable?

Answer 1

a) Total market value of the Lala Beauty = Profit attributable to shareholders / interest rate

= $1000000 / 5% = $200000000

Price of each share = $200m / 200000 shares = $100 per share

b)Alice action is exactly exception to the law of demand. As per law of demand, demand increases when the price is low and selling comes up and demand decreases when the share price is lower. Whereas Alice has brought the shares at the time when share prices were at its higher point.

c)

i) Boris, a speculator, during the period when he thinks current prices are relatively low, do purchases of the shares which makes hoarding of shares and shortage of shares in the market and making the prospective investors to quote higher price to bought the shares and make the share price to rise. Here, the speculators makes the share prices less stable.

ii) Boris during the period when the current price are relatively high, sell out the shares, which increases the supply of shares in the market at the higher share prices and making the intended sellers to ask lesser price to sell out their shares, which brings the share prices to lower levels. Here, the speculators makes the share prices more stable.