Chapter 15 Investing in Stocks

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-2 Chapter Objectives Identify the functions of stock exchanges Describe how to interpret stock quotations Explain how to execute the purchase or sale of stocks Explain how to analyze a stock

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-3 Stock Exchanges Stock exchanges: facilities that allow investors to purchase or sell existing stocks New York Stock Exchange –Most popular organized exchange in U.S. –Floor traders: traders at a stock exchange who execute trades to fulfill orders placed by other investors

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-4 Stock Exchanges (cont’d) –Specialists: traders who help to make a market in one or more stocks by taking the position opposite of orders placed by clients –A typical stock transaction on the NYSE Other stock exchanges –American Stock Exchange –Other regional exchanges in large U.S. cities

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-5 Stock Exchanges (cont’d) Over-the-counter (OTC) market: an electronic communications network that allows investors to buy or sell securities –Market-makers: traders who execute trades on the OTC market and earn commissions in the form of a bid-ask spread –Less stringent listing requirements than for NYSE

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-6 Stock Exchanges (cont’d) –Electronic Communication Networks (ECN): computer systems that match up desired purchases and sales of stocks Allow for after-hours trading No person needed to perform the exchange

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-7 Stock Quotations Price quotations readily available from the Internet, stock brokers or financial newspapers Provide information about the price of each stock over the previous day or a recent period

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-8 Stock Quotations (cont’d)

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-9 Purchasing and Selling Stocks Selecting a broker –Analyst recommendations May be overly optimistic Must disclose ownership of stocks they recommend –Individual broker skills Information available on the Internet

Copyright ©2014 Pearson Education, Inc. All rights reserved Purchasing or Selling Stocks (cont’d) –Brokerage commissions Discount brokerage firm: a brokerage firm that executes your desired transactions but does not offer investment advice Full-service brokerage firm: a brokerage firm that offers investment advice and executes transactions

Copyright ©2014 Pearson Education, Inc. All rights reserved Financial Planning Online Go to finance.yahoo.com/?ufinance.yahoo.com/?u Click “Get Quotes” after typing the symbol of a stock in which you are interested. This site gives analyst recommendations about a stock that you specify.

Copyright ©2014 Pearson Education, Inc. All rights reserved Purchasing and Selling Stocks (cont’d) Placing an order –Name of the stock Ticker symbol: the abbreviated term that is used to identify a stock for trading purposes –Buy or Sell—specify what you want to do –Number of shares Round lot: shares bought or sold in multiples of 100 Odd lot: less than 100 shares of stock

Copyright ©2014 Pearson Education, Inc. All rights reserved Purchasing and Selling Stocks (cont’d) –Market order or limit order Market order: an order to buy or sell a stock at its prevailing market price Limit order: an order to buy or sell a stock only if the price is within the limits that you specify –Stop orders Stop order: an order to execute a transaction when the stock price reaches a specified level; a special form of limit order

Copyright ©2014 Pearson Education, Inc. All rights reserved Purchasing and Selling Stocks (cont’d) –Stop orders Buy stop order: an order for a brokerage firm to buy a stock when the price rises to a specified level Sell stop order: an order for a brokerage firm to sell a stock when the price falls to a specified level Placing on order online –Low commission

Copyright ©2014 Pearson Education, Inc. All rights reserved Financial Planning Online Go to This Web site provides information that you can use when making investment decisions. It also illustrates how you can trade stocks online, which typically reduces your transaction costs.

Copyright ©2014 Pearson Education, Inc. All rights reserved Purchasing and Selling Stocks (cont’d) Buying stock on margin –On margin: purchasing a stock with a portion of the funds borrowed from a brokerage firm –Federal Reserve limits margin to 50 percent –Margin call: a request from a brokerage firm for the investor to increase the cash in the account in order to bring the margin back up to the minimum level

Copyright ©2014 Pearson Education, Inc. All rights reserved Purchasing and Selling Stocks (cont’d) Short selling stock –Short selling (shorting): a process by which investors sell a stock that they do not own –Borrow stock from another investor and will have to return it

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks Technical analysis: the valuation of stocks based on historical price patterns Fundamental analysis: the valuation of stocks based on an examination of fundamental characteristics such as revenue or earnings, or the sensitivity of the firm’s performance to economic conditions

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d) Analyzing a firm’s financial condition –Balance sheet: a financial statement that indicates a firm’s sources of funds and how it has invested its funds as of a particular point in time –Income statement: a financial statement that measures a firm’s revenues, expenses, and earnings over a particular period of time

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d)

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d) –Accounting fraud Many firms recently used fraudulent financial statements Motivation for fraud –Manager compensation Analyzing economic conditions –Economic growth: a measure of growth in a country’s economy over a particular period

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d) –Gross domestic product (GDP): the total market value of all products and services produced in a country –Fiscal policy: the means by which the U.S. government imposes taxes on individuals and corporations and by which it spends its money –Impact of international economies One country’s strong economy can improve another’s and the opposite is also true

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d) –Interest rates Stocks perform better when interest rates are low Some stocks are more sensitive to interest rates than others The Federal Reserve uses monetary policy to influence interest rates

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d) –Inflation: the increase in the general level of prices of products and services over a specified period Consumer price index (CPI): a measure of inflation that represents prices of consumer products such as groceries, household products, housing and gasoline Producer price index (PPI): a measure of inflation that represents prices of products used to produce other products, such as coal, lumber, and metals

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-25

Copyright ©2014 Pearson Education, Inc. All rights reserved Financial Planning Online Go to Click on: OECD Economic Outlook This Web site provides information about economic conditions that can affect the values of investments.

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d) Industry conditions –Stock prices susceptible to industry conditions Industry indicators Integrating your analyses –Analyzing the firm, the economy and the industry allows assessment of future performance

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-28

Copyright ©2014 Pearson Education, Inc. All rights reserved Analyzing Stocks (cont’d) Limitations of stock analysis –Difficulty in forecasting future conditions –Favorable attributes are reflected in the stock price

Copyright ©2014 Pearson Education, Inc. All rights reserved Financial Planning Online Go to Click on: Market Data This Web site provides a summary of recent stock performance.

Copyright ©2014 Pearson Education, Inc. All rights reserved Financial Planning Online Go to finance.yahoo.com/indices?ufinance.yahoo.com/indices?u This Web site provides recent quotations of indexes that can be used as benchmarks when assessing your investment portfolio’s performance. Click on “Charts” to review historical movements in any specific index.

Copyright ©2014 Pearson Education, Inc. All rights reserved How Stock Investment Methods Fit Within Your Financial Plan Key decisions about investing in common stock for your financial plan are: –Should you consider buying stock? –What methods should you use for investing in stocks?

Copyright ©2014 Pearson Education, Inc. All rights reserved.15-33