The Stock Market Economics

How the Stock Market Works – Video n f2HJk f2HJk

Introduction The stock market is an addition to a company’s business. In this present- ation it will show you how the stock market works, and why it is so risky.

What is stock? n In the Stock Market, companies sell shares to the public. That means that the companies are actually selling power of the company to the public. If you buy 250 shares of a company with 500 separate shares, you own 50% of the company! When you own such a percentage of the company, you have a say in how the company is ran.

Shareholder’s Payoff n possible income: n dividends: payments made periodically, usually every quarter, to stockholders. Shareholders are eligible for dividends, but no guarantee. n capital gain: can sell stocks to earn price appreciation but may also incur loss from price decline. n limited liability

A Stock’s Value n When you own 1 share of a company(which has 500 shares total), you own.002 (.2%) of that company. That may not sound very big, but if that company is strong enough, that can be a lot of money! If the company is worth $500,000, and there are 500 shares, each share is worth $1,000; and that’s a lot of money!

Before a company goes Public n Before a company sells stock shares, the company is private; this means that there is only one share. That one share is worth all of the company’s earnings. That share is owned by the compa- ny’s owner.

When a company goes Public n If the owner of a private company feels the need to sell stocks, the company announces that they will go public; this is pretty self-explanatory. The company’s power will be distributed to the people.

When a company goes Public n When a company goes public, the owner of the company decides on how to split the company’s power (how many shares to sell). When someone buys a share, the company gets that money, but can no longer use that share as power.

How Stocks Work n Whenever someone buys a share, the company gets those proceeds. This adds to the company’s value, making the price of each stock rise a little. When people sell their stock, the price per share goes down a little, contrary to people buying shares.

Selling Stocks n A share holder can sell his/her stock at any time. The owner gets however much money the shares were worth when s/he sold them.

The Unpredictable Stock Market n The stock market is almost unpredictable. Sometimes, when a company introduces an interesting product, you can tell that the company will do well. But other than that, it may go down or up unexpectedly, making it hard to choose when to buy or sell. “Am I buying at a good time, or should I wait till it gets lower?”

Common vs. Preferred Stock n Preferred stock is less risky than Common Stock n Common Stock generally has a higher return than Preferred stock in the same corporation n The price of Common stock tends to change more than the price of preferred stock

The risks If you choose to be a share holder, consider the following: ¶ Knowing a history of the company you’re interested in, and seeking advice from a previous owner of that stock. · Buying at what seems like a “low moment.” This means, buy when the shares are low. ¸ Remembering the general rule of the market, “Buy low, sell high!”

The Risks (cont.) ¹ Asking an accountant, broker, or other specialist in the stock market. º Purchase stock in small amounts to avoid potential large losses.

Stock Exchanges n New York Stock Exchange n (NYSE, "Big Board" ) n NASDAQ n (National Association of Securities Dealers Automated Quotation System) electronic trading system n Dow Jones and S&P 500 indexes n listed companies n When a firm go public, it does not add to its debt. Instead, it brings in additional “owners” who supply it with funds.

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New York Stock Exchange n NYSE n Stock market index covering all common stocks listed on the New York Stock Exchange n Includes over 2000 stocks – Over 1600 are US Corporations – Over 350 are Foreign Corporations –

NASDAQ n Advantages: – Less Expensive to operate – Not limited in space – Investors can trade more kinds of stock – Can operate longer hours –

Dow Jones Industrial Average n Stock market index found by Charles Dow n Includes the performance of the industrial components of America’s stock market n Includes 30 of the largest and most highly held public US companies (blue chip stocks) – AT&T, McDonald’s, Microsoft – Boeing and Verizon Communication – Coca-Cola and Wal-Mart – Exon, Mobile, and Walt Disney

S&P 500 n Standard and Poor’s n Index which includes the stock of large cap corporations n Companies chosen by a committee – They are not necessary the largest 500 companies – Based on liquidity, size, and industry n There is also a S&P 400, 600, and 1500

n Microsoft Corporation n (MSFT) NASDAQ n $26.03 $ % n 52-Wk Rng – Highest and lowest share price achieved by the stock over the past 52 weeks. n P/E Ratio – Price-Earnings Ratio = (Current stock price)/(Current annual earnings per share) – luatingstocks/a/pe.htm luatingstocks/a/pe.htm n Volume – Volume of shares traded yesterday (in 100s) Open$26.11 High:$26.39 Low:$ Wk Rng$ $ P/E Ratio15.13 Volume71,527,599

n Fundamental analysis – macro-econ and firm performance  dividend  stock’s intrinsic value – P/E ratio, debt-to-equity ratio, return-on-assets ratio, price/earnings to growth ratio... n Technical analysis – volume of trade and price trend – moving averages, regressions, price correlations, cycles, chart. n Behavioral finance perspective – ‘sunspot’ and consumer confidence

Technical Anaylsis Cycles and WavesCandle Stick Chart

n Fundamental Finance View: – Stock prices are largely determined by the true financial conditions of firms, as reflected in their profits, market power, R&D prospects, etc. n Behavioral Finance View: – Stock prices are strongly affected by market psychology: – “irrational exuberance” or pessimism; – “beauty contest” guesses about the most attractive stocks to buy based on what other people are buying or selling (fads, herd following, …).

Pricing principle of ‘fundamental view’ n Basic principle of finance’: – value today = present value of future cash flows n e.g. for coupon bonds, bond price today = PV of all future cash flows: n Then, value of stock today (current price) = ?

How the Market set prices n The price is set by the buyer willing to pay the highest price n The market price will be set by the buyer who can take best advantage of the asset n Superior information about an asset can increase its value by reducing its risk

Show me the money… n You want to earn a return on your investment by: – Dividend payments – Increase in the price of share of stock n Amount of return depends on: – How much profit the company makes – Price of the stock – How much you own

Show me the money….. n Dividends n Selling the stock – Capital Gains – Capital Loss n Buy Low, Sell High

Follow-up  How a share’s value is determined  Buying and selling of stocks  Before and after companies sell stock  The risks of being a share holder  Stock Exchange  Shareholder’s Payoff