Financial Markets Chapter 11 Section 3 The Stock Market

Financial Markets  Objectives:  1. Understand the benefits and risks of buying stock.  2. Describe how stocks are traded.  3. Identify how stock performance is measured.  4. Explain the causes and effects of the Great Depression.

Financial Markets  New York Stock Exchange is a tangle of telephones, video monitors, computer screens, and frantic activity.  The wrong decision may mean the difference between gaining or losing thousands of dollars.  This is one of the places where stock is bought and sold – and futures are made and lost.

Financial Markets  Buying Stock  Stock is issued in portions known as shares  By selling shares, corporations raise money to start, run, and expand their businesses.  Stocks are also called Equities – claims of ownership in the corporation.

Financial Markets  Benefits of Buying Stock  Dividends – are profits by the corporation that are paid to the stockholders.  They are usually paid four times a year.  The size of the dividend depends on the amount of profit that the corporation made.  Capital Gains – the difference between a higher selling price and a lower purchasing price.  You could also have a capital loss

Financial Markets  Types of Stock  1. Income Stock – pays dividends at regular times each year.  2. Growth Stock – pays no or few dividends. Your earnings are reinvested into the stock  3. Common Stock  Voting Owners – help elect board of directors  4. Preferred Stock  Nonvoting owners – receive dividends before owners of common stock – get their investment back before common stockholders if company goes out of business.

Financial Markets  Stock Splits  Stock sometimes will split from a single share into more than one share.  It can happen at any time.  Companies seek to split stock when the prices becomes so high that it discourages buyers from buying the stock.

Financial Markets

 Risk of Buying Stock  Buying stock is a risky business because the firm selling the stock may earn lower profits than expected, or it may lose money.  If this happens, the dividends will be smaller than expected or nothing at all. The price of the stock may decrease and investors may choose to sell their stock.

Financial Markets  Stocks are MORE risky than bonds.  When a corporation goes bankrupt, it sells its equipment and land to pay back the owners of the corporation.  Creditors, including Bondholders, are paid first. Then if there is money left over, the stockholders get paid.

Financial Markets  How are Stocks Traded  Stockbrokers is a person who has links to buyers and sellers of stock.  Brokerage Firms are the people who specialize in trading stock.  They charge a fee to pay for their costs. Each transaction will cost you a fee.

Financial Markets  Stock Exchanges  This is a market for buying and selling stock.  They are secondary markets.  Most newspapers publish the results of daily activity on the floor of major stock exchanges.

Financial Markets  New York Stock Exchange (NYSE)  Most powerful in the country.  Began in 1972 – New York City/Wall Street  Sell seats on the floor – these seats allow a brokerage firm to come onto the floor to buy and sell stocks or bonds.  Cost is around $ 500,000 to $ 1 million/seat  Handle only the most established companies

Financial Markets  Over-the-Counter Market (OTC)  Electronic marketplace for stocks and bonds.  Investors may buy directly from a dealer or from a broker.  NASDAQ – National Association of Securities Dealers Automated Quotations  Created in  Second largest securities market in the US.  Use Computer terminals to do the trading.

Financial Markets  Futures – are contracts to buy or sell commodities at a specific date in the future at a price specified today.  Mostly for grain or livestock markets  Works like this…. A buyer and seller agree on a price ($ 4.50/bushel for soybeans) six or nine months down the road. Buyer pays a small fee today and the rest when the grain is delivered to him).

Financial Markets  Options – contracts that give investors the choice to buy or sell stock and other financial assets.  Call Option – the option to buy shares of stock at a specified time in the future.  Put Option – the option to sell shares of stock at a specified time in the future.  Each option comes with a fee that has to be paid to the other party.

Financial Markets  Call Option may cost you $ 10/share today. It gives you the right, but not the obligation, to purchase a certain stock at a price. If the price of stock went up, you get to buy it at the agreed upon price. If the price goes down, you can use your call option and cancel the contract.

Financial Markets  Put Option is for the seller.  He pays a $ 5 for the right to sell a particular stock that you do not own at a price that had been determined. If the price of the stock falls to say $ 40 (instead of the $ 50), you can make the buyer pay the original price of $50/share. IF the price of the shares go up to $ 60 – cancel the contract.

Financial Markets  Day-trading – people who buy stock and try to predict the changes and then sell that stock before the end of the day.  These people usually make dozens of trades a day.

Financial Markets  Stock Performance  Bull Market – a steady rise in the stock market over a period of time.  Bear Market – a steady decline in the stock market over a period of time.  The Dow (The Dow Jones Industrial Average)  Been around since 1896  They take the 30 most representative companies in each industry and come up with an index #

Financial Markets  S & P 500 (Standard & Poor 500)  Look at 500 different companies as a measure of the overall stock market performance.  Come up with an index #

Financial Markets  Great Crash of 1929  Black Tuesday – October 29,1929  Causes of the Crash  Stock Market had been soaring in the 1920s  Few companies and families held majority of the wealth in country.  Other people in country were suffering ie. Farmers  Manufacturers producing more goods than consumers were using.  These surpluses led to price decreases  Investor debt was pilling up  Speculation was popular – making high-risk investments with borrowed money in hopes of getting a big return

Financial Markets  Buying on Margin – this was done to attract less- wealthy investors. You paid a portion of the stock price when you bought it. You would borrow the rest from the brokerage firm. Paid the difference when you sold.  September Peak (3 rd ) – prices at an all time high  Then prices started to fall.  Brokers demanded repayment for the borrowed money people had borrowed for the sale of their stock.  By October 29 th – everything crashed

Financial Markets  Aftermath of the crash – start of The Great Depression.  After the crash – many people saw the stock market as too risky of an investment.  Today stock prices have been on the rise since the 1990s (on average).  Worse time was right after 911 when prices dropped considerably