Equities and Indexes Common Stock Preferred Stock Equity Index Bond Index

Investments 32 Common Stock  Definition  Ownership shares in public companies  Characteristics  Voting rights  Shareholder can vote for company issues, e.g., executive compensation, board of directors, auditing firm, etc.  Residual Claims  Last in line of all claimants on the company, e.g., owns whatever is left after workers, suppliers, bondholders are paid off.  Limited Liability  Lose no more than original investment, e.g., you pay $90 for a share of IBM, you’ll lose no more than that.

Investments 33 Common Stock  A quote from WSJ (or YAHOO these days)YAHOO  A few questions  How much do you have to pay for a share at close?  What is last year’s earning?  Is the stock boring? 52 Weeks Hi Lo Stock (SYM)YLD% Hi DIVP/EVolume Lo Net Chg GenElec (GE) ,123, Close $0.10/Quarter

Investments 34 Preferred Stock  Definition  Non-voting share in a corporation  Characteristics  Fixed dividend stream (like bond coupon)  Dividend may be skipped yet cumulative  Dividend fully taxable  How different is it from a bond?

Investments 35 Indexes: Equity and Bond  What are they?  An indicator of average security prices  Why do we need them?  Tracking market returns  Benchmarking fund manager performance  Bases for derivatives, e.g., index options  Factors affecting an index  Representative?  Weighting of components?

Investments 36 Equity Indexes  DJIA  S&P 500, S&P Mid Cap.  NASDAQ 100  Nikkei 225 (Tokyo Stock Exchange)  FTSE 100 (London)  Wilshire 5000  MSCI-EAFE Index  Morgan Stanley Capital International Europe, Australia, Far East Index (including 21 developed countries outside North America)

Investments 37 Equity Indexes: DJIA  Some facts  30 industrial stock price-weighted average.  Oldest and best-known in the U.S.  Used to representing about a quarter of the market value of the NYSE stocks.  Quantitatively  Divisor changes when stock splits or stock is replaced by another

Investments 38 Equity Indexes: DJIA  Construction  Suppose DJIA has two stocks Divisor

Investments 39 Equity Indexes: DJIA  What happens when a stock splits?  At market close today, B has a 2-for-1 split  Where does the new divisor come from? Divisor

Investments 310 Equity Indexes: S&P 500  Including 500 NYSE, Amex, NASDAQ stocks  Considered to be a much broader index of the U.S. market than the DJIA  Numerous financial products derived from the index  Mutual funds indexed to the S&P 500 Index  S&P Depository Receipts (SPDR)  S&P 500 Index Options and Futures  Market value-weighted index – larger companies have more weight in S&P 500  S&P 500 is float-adjusted since Sep 16, 2005

Investments 311 Equity Indexes: S&P 500  Market value-weighted index - Calculation

Investments 312 Equity Indexes: S&P 500  When does the divisor change?  NOT for stock split  YES for stock replacement in the index  E.g., C replaces B in the index Divisor

Investments 313 Example: Amazon.com joining S&P 500 AMZN joins S&P 500 on Nov 18, 2005 Announcement is made after market closing on Nov 14, 2005

Investments 314 Equity Indexes  Equally Weighted Stock Indexes Equally weighted stock indexes place equal weight on each stock return, and call for a portfolio strategy that places equal dollar values in each stock. E.g., Stock A has a return of 2% and stock B has a return of 1%. An equally weighted index of A and B has a return of 0.5*2% + 0.5*1% = 1.5%  Constant portfolio rebalancing is required to track such an index

Investments 315 Bond Indexes  An indicator for bond market returns * Now Barclays Capital Aggregate Bond Index

Investments 316 Wrap-up  What are stocks and preferred stocks?  What are stock indexes for?  What are commonly used indexes?  DJIA: price-weighted - Old and Faithful  S&P: float value weighted - good “market” proxy  NASDAQ: new and dynamic  Less followed  Bond indexes: professionals pay more attention to it