1. Investments: Analysis and Behavior
Chapter 2- Equity Markets

2. Learning Objectives Learn where and how securities are traded.
Know how stock market performance is measured.
Know sector, industry, and global market indices.
Understand the relevant laws governing the investment industry.

3. Markets Primary Market Secondary Market
Market for new securities sold to investors for the first time to raise capital for the issuer
Secondary Market
Stock exchange where investors trade stocks with each other.

4. Equity Markets New York Stock Exchange An Agency Auction Market
Market in which brokers represent buyers and sellers and prices are determined by supply and demand.
Trading
All trading in a specific stock is done at the post where that stock is assigned on the NYSE floor.
Trading is managed by the specialist.
Employee of a NYSE firm who manages the market for an individual stock

5. The NYSE is the most prestigious stock exchange in the world
Publicly traded company NYSE Euronext
General Electric, Citigroup, Wal-Mart, Time Warner, IBM, Coca Cola
Has electronic trading system, Arca

6. American Stock Exchange
AMEX is also a specialist auction market
The nation’s second largest stock exchange
More than 1,000 listings
Public Float
One of the financial guidelines for listing on the AMEX (market value of $3 million)
Common stock held by unaffiliated institutional and individual investors (held by the public, not the company)

7. Nasdaq Electronic market
The largest organized equities (stock) market by trading volume and number of listed companies
Negotiated market
Market makers are dealers
Price determination through bargaining
3,900+ issues
more technology firms
Dell, Microsoft, Intel

8. Other U.S. stock markets Nasdaq SmallCap Market
800 small firms seeking Nasdaq market maker sponsorship
No penny stocks (defined as price < $1)
Over-the-Counter Bulletin Board
3,300+ securities offered by 230+ market makers
Penny stocks traded here
Electronic Communication Networks (ECNs)
Electronic market for institutional investors to trade with each other

9. Tracking the market Did the market go up or down today?
Every day, some stocks increase in price while others decline
So, what does an increasing marketing mean?

10. Dow Averages DJIA Divisor Charles Dow and Edward Davis Jones
Credited with inventing the first stock index
First stock index created in 1884
11 firms
Mostly railroad companies
Added up the stock prices and divided by 11. (price average index)
DJIA was started in 1896 with 12 stocks.
Modern era of 30 DJIA stocks began in 1928.
DJIA Divisor
Adjustment factor used to account for stock splits

11. Dow Jones Industrial Average
30 companies
Most important and largest firms
Selected by the editors of the Wall Street Journal
Formula
While originally 30, the divisor has been steadily reduced to account for stock splits. In early-2009 the divisor was
At that time, a $1 change in a stock’s price caused the DJIA to change by 7.96 points (=1/ ).

12. Problems with price-weighted averages
3M Co.
Alcoa Inc.
American Express Co.
AT&T Inc.
Bank of America Corp.
Boeing Co.
Caterpillar Inc.
Chevron Corp.
Citigroup Inc.
Coca-Cola Co.
E.I. DuPont de Nemours & Co.
Exxon Mobil Corp.
General Electric Co.
General Motors Corp.
Hewlett-Packard Co.
Home Depot Inc.
Intel Corp.
International Business Machines Corp.
Johnson & Johnson
JPMorgan Chase & Co.
Kraft Foods Inc. Cl A
McDonald's Corp.
Merck & Co. Inc.
Microsoft Corp.
Pfizer Inc.
Procter & Gamble Co.
United Technologies Corp.
Verizon Communications Inc.
Wal-Mart Stores Inc.
Walt Disney Co.
Problems with price-weighted averages
Changes in high-priced components move the DJIA more than low-priced components.
A 10% price change in a $100 DJIA (like IBM) is $10, and causes a point change in the DJIA.
A 10% price change in a $5 DJIA (like GM) is 50¢, and causes a 3.98 point change in the DJIA.
DJIA returns can be affected by timing of stock splits.
Stock splits require changes in the divisor.
Mimicking DJIA portfolio returns requires lots of rebalancing due to divisor changes.

13. Standard & Poor’s 500 Index
The 500-firm index started in 1957
Value-weighted index
Determine market capitalization of each firm (stock price × shares outstanding)
Add up the market capitalization for all 500 firms
Scale (Index Base set to 10)
500 leading U.S.-based companies.
Chosen by S&P committee.
Is not an index of the 500 largest companies.
Sector weights set to match overall market.
A preferred investment equity benchmark
Performance standard to be evaluated against

14. Index Example Consider 3 stocks. Consider two indices
Stock A is $40 and has 300 shares outstanding
Stock B sells for $60, outstanding shares of 200
Stock C costs $80 and has 100 shares.
Consider two indices
Price-weighted average, divisor=2.5
Value-weighted average
Base index value = 100
The stock originally sold for $30, $50, and $60 with outstanding shares of 300, 100, and 100, respectively

15. What is the value of each index?
Price-weighed average
( ) / 2.5 = 72.00
Value-weighted index
{($40X300 + $60X200 + $80X100) / ($30X300 + $50X100 + $60X100)} × 100 =
{32,000 / 20,000} × 100 =

16. What is the value of each index after the $40 stock changes to $45?
Price-weighed average
( ) / 2.5 = a 2.78% change
Value-weighted index
{($45X300 + $60X200 + $80X100) / ($30X300 + $50X100 + $60X100)} × 100 =
{33,500 / 20,000} × 100 = a 4.69% change

17. Market Capitalization
Large-cap
Firm value: $10 billion–$200 billion
Mid-cap
Firm value: $1 billion–$10 billion
Small-cap
Firm value: $300 million–$1 billion

18. Additional Popular Indices
Russell Indexes
Russell 3000 Index of the 3,000 largest market cap U.S. companies.
Represents 98% of the investable US equity
Russell 1000 Index of the 1,000 largest market cap U.S. companies.
Over 90% of investable US equity
Russell 2000 Index is comprised of the 2,000 smallest companies in the Russell 3000
Leading small cap index.

19. Dow Jones Wilshire Dow Jones Wilshire 5000 Composite Index
Dow Jones Wilshire 5000 (Full Cap) Price
Dow Jones Wilshire 4500 (Full Cap) Price
Dow Jones Wilshire 2500 Price
Dow Jones Wilshire U.S. Large-Cap Price
Dow Jones Wilshire U.S. Mid-Cap Price
Dow Jones Wilshire U.S. Small-Cap Price
Dow Jones Wilshire U.S. Micro-Cap Price
Dow Jones Wilshire U.S. Large-Cap Growth Price
Dow Jones Wilshire U.S. Large-Cap Value Price
Dow Jones Wilshire U.S. Mid-Cap Growth Price
Dow Jones Wilshire U.S. Mid-Cap Value Price
Dow Jones Wilshire U.S. Small-Cap Growth Price
Dow Jones Wilshire U.S. Small-Cap Value Price
Wilshire Large Cap 750
Wilshire Mid Cap 500
Wilshire Small Cap 1750
Wilshire Micro Cap
Wilshire All Growth
Wilshire All Value
Wilshire Large Growth
Wilshire Large Value
Wilshire Mid Growth
Wilshire Mid Value
Wilshire Small Growth
Wilshire Small Value
Wilshire Small Cap 250
Wilshire Small Cap 250 Price
Dow Jones Wilshire
Dow Jones Wilshire 5000 Composite Index
Most comprehensive measure of the U.S. stock market.
Designed to represent the performance of all US-headquartered equity securities
Contains 4,787 stocks (early 2008)
Dow Jones Wilshire 4500
Contains the Wilshire 5000 firms less the S&P 500 firms
Considered a mid-cap index

20. Nasdaq Indexes Nasdaq Composite Index Nasdaq 100 Index.
All 5,000+ common stocks listed on the Nasdaq Stock Market.
More than 3,000 firms.
Market value-weighted.
Nasdaq 100 Index.
Largest 100 firms on the Nasdaq Stock Market.
Large stock index, but technology oriented.

21. Standard & Poor’s S&P 500 – Popular value-weighted index
S&P MidCap 400 Index
400 firms
Stocks with market caps of $1.5 to $10 billion
S&P SmallCap 600 Index
600 firms
Average market cap of $600 million

22. INDEX (NUMBER)
A quantity whose variation over a period of time measures the change in some phenomenon.

24. Global Stock Indexes Major Local Stock Market Indexes
Nikkei (Japan)
Dax (Germany)
FTSE (UK)
Morgan Stanley Capital International Indexes
Global, regional, and country indexes.
Emerging and developed markets.

25. Figure 2.3 Global Stock Exchange Indexes

26. Law instituting public accounting reforms and investor protections
Securities Market Regulation Legislation Important to Investors, Issuers of Securities and Brokers/Dealers
Securities Act of 1933
Applies to firms going public—issuing new securities
Requires firms to register with government
Requires firms to provide investors with financial and material information
Exempts private placements and small issues
Securities Exchange Act of 1934
Focuses on securities trading
Creates and authorizes Securities and Exchange Commission (SEC) to enforce statutes, rules, and regulations
Protects investors against fraud
Sarbanes-Oxley Act
Law instituting public accounting reforms and investor protections

27. Self-Regulatory Organizations (SROs)
SEC delegates regulatory authority
National Association of Securities Dealers (NASD)
Regulates Nasdaq and OTC
Monitors sales practices
Administers tests and licenses for individuals
Ensures accurate sales information
NYSE, AMEX, CBOE--business practices and market operations
Municipal Securities Rulemaking Board
Banks—Fed Reserve, Comptroller of Currency, FDIC

28. Market Surveillance NYSE’s Stock Watch Intermarket Surveillance Group
Flags unusual volume and/or price changes.
Investigates questionable trades.
Intermarket Surveillance Group
Shares information and coordinates efforts to detect manipulation
Securities Arbitration
Private form of dispute resolution with binding outcomes

29. Circuit Breakers
On Monday, October 19, 1987, the DJIA lost over 22% of its value in a crash.
This event lead to the enactment of circuit breakers that pause or close trading during fast moving markets.
Breakers are set to 10%, 20%, and 30% of recent DJIA level.
At DJIA 10,000, the breakers are daily changes of 1,000, 2,000, and 3,000 points.
The first breaker halts trading for 30 to 60 minutes.
The second breaker halts trading for 2 hours.
The third breaker stops trading for the day.