Financial Markets Chapter 11 Sections 3 & 4

Buying and Selling Stocks Companies issue stock and sell to investment bankers in primary market Initial public offering (IPO) is the sale that raises money for the corporation Stock exchange-secondary market where securities are resold and bought Buyers expect stock prices to rise, so they can resell for a profit Capital gains-profit made from the sale of stock

The Stock Market Why buy stock? Types of Stock Buy to earn dividends & share of company profits Invest who want income & dividends Buy to earn capital gains through the resale of stock Investors who want growth look for potential capital gains Common Stock-gives shareholders voting rights, share of profits One vote per share owned to elect board of directors Preferred Stock-givers shareholders share of profits but no voting rights Investors get guaranteed dividends, paid off first if the company closes Dividends do not increase if stock increases in value

Trading Stock Most people buy stock to earn capital gains Stock prices are determined by demand and supply; influencing factors: Company profits and losses Technological advances Overall economy Stockbroker-buys and sells securities for customers, earns a commission

Trading Stock Organized Stock Exchanges Electronic Markets New York Stock Exchange (NYSE) on Wall Street; oldest & largest in US Old School-Each stock auctioned from trading post on exchange floor Today-hand-held computers used to execute many trades 2006 merger allowed for electronic trades American Stock Exchange (AMEX) companies smaller than on the NYSE Over-the-counter (OTC) market stocks not traded on NYSE or AMEX NASDAQ is centralized computer system for OTC trading Second largest exchange in world in number of companies & shares traded Companies from many sectors of IS economy, most in technology OTC Bulletin Board is electronic market for smaller companies

Trading Stock Futures & Options Market Recent Developments Most investors do not trade futures and options Future-contract to buy, sell on specific future dates at preset price Option- contract giving the right to buy & sell in the future at a preset price Investor pays small fraction for stock’s current price for option 1990s regulations allow any firm to trade stocks in exchange Through electronic communications networks (ECNs), 24-hour trading Invest access Internet; huge growth in online brokerage companies Lower commissions than traditional brokers Computer technology matches buyers & sellers automatically

Measuring How Stocks Perform About half of U.S. households own stocks Stock index-measures & reports the change in prices of a set of stocks Measures individual stocks and stock market as a whole

Measuring How Stocks Perform Stock Indexes Trading the Dow U.S. Indexes: DIJA, Standard & Poor’s 500, NASDAQ, Composite Global Indexes: Hang Seng, DAX, Nikkei 225, TSE 300, FTSE 100 Since 1896, Dow Jones Industrial Average change with U.S. economy Includes most successful companies in most important economic sections Uses points to measure changes in prices at which stocks are traded Bull market-prices rise steadily over a relatively long period of time Bear market-prices decline steadily over a relatively long period of time 1972-2000 longest bull market in history; most last 2-3 years Dow affected by previous close, Fed, foreign indexes, & trade balance About 21 stock markets overseas with over 1,000 larger companies each

Bonds and Other Financial Instruments Bonds are issued by companies and governments Par value- amount issuer must pay buyer at maturity Maturity- date when bond is due to be repaid Coupon rate- interest rate bondholder gets every year until maturity

Why Buy Bonds? Investors buy bonds for interest paid and gains made by selling Yield- annual rate of return on a bond If bond sold at par value, yield is same as coupon rate If sold for less, yield is higher; if sold for more, yield is lower Bonds with longer maturity dates have higher yields than with shorter

Why Buy Bonds? Types of Bonds Buying Bonds U.S. government issues treasury bonds, notes, & bills; very safe Safety of foreign government bonds depend on the country State & local governments issue bonds; no federal income tax Corporate bonds higher risk than government, pay higher coupon rate Junk bonds-are high-risk, high yield corporate bonds Buying Bonds Most buyers want guaranteed returns Investors who sell before maturity want to make profit As market interest rates rise, price of bonds with lower rate falls Main risk to investors is default Governments, companies get evaluated by credit-rating companies

Other Financial Instruments Certificates of Deposit CDs primarily offered from banking institutions Pay fixed or variable interest, reinvested for compound interest FDIC insures funds up to $100,000 Money Market Mutual Funds Have maturities of one year or less Higher yield than savings accounts Funds not insured Tightly regulated Yield varies

Vocabulary Stock Exchange secondary market where securities are resold and bought Capital Gain profit made from the sale of stock Common Stock gives shareholders voting rights, share of profits Preferred Stock givers shareholders share of profits but no voting rights Stockbroker buys and sells securities for customers, earns a commission Future contract to buy, sell on specific future dates at preset price Option contract giving the right to buy & sell in the future at a preset price Stock Index measures & reports the change in prices of a set of stocks

Vocabulary Bull Market prices rise steadily over a relatively long period of time Bear Market prices decline steadily over a relatively long period of time Par Value amount issuer must pay buyer at maturity Maturity Date when bond is due to be paid Coupon Rate interest rate bondholder gets every year until maturity Yield annual rate of return on a bond Junk Bond high-risk, high yield corporate bonds