1. Financial Terms

2. Stock
“share”: 1) part ownership, 2) role in management decisions, 3) legal claim present and future profits
Value should = discounted value of all dividends to be paid out until bankrupt (“intrinsic value”)

3. Bonds Debt (company/government): used to raise money
Coupon rate: interest paid to bondholder
Maturity: time at which principal will be repaid
Par value: amount that will be repaid at maturity (market value may be above or below par)
Yield: annual rate of return if bond held to maturity
Market value and yield inversely related
Bond Ratings: AAAD
Junk bonds
But: Moody’s + S&P paid by those being rated conflict of interest Great Recession
Treasury (T) and Municipal bonds (munis) vs. Corporate bonds

4. Mutual Fund Combine money of many investors fund manager, prospectus
Diversify
Generally safer (all eggs)
Hedge fund: some counter-cyclical, can be highly-risky
Index funds, growth funds, income funds, micro-cap funds, etc.

5. Stock Markets NYSE DJIA (30) NASDAQ Money Market Currency Market
S&P 500
Wilshire 5000
NASDAQ
Money Market
Currency Market
Futures
Commodities
Options
Call option (right to buy stock)
Put option (right to sell stock)

6. Primary (IPO) + secondary markets
Stock options + principal-agent problem “quarter capitalism”
Moral hazard: Don’t pay back bonuses/options
Short-term thinking: low wages, low investment in capital and R+D
Income stocks
Dividends
Growth stocks (price rises faster)
Small cap, mid-cap, large cap (capitalization)
Stock splits: 2-for-1 (double # shares, cut price in half)
Sometimes merge: reverse split 1-for-2 (cut # shares in half, double price)

7. Smart Money

8. “Value Investing”
Painstaking analysis of companies’ books to determine if price above/below intrinsic value
Warren Buffet: Berkshire Hathaway (BRK-A: $128,000/share)

9. Efficient Markets Hypothesis (EMH)
Market smarter than you: all available information already factored in impossible to beat market in long-run, therefore “index funds” and leave it alone
Or highly speculative investments (microcaps)
 Buffet really good at flipping coin
“Random walk”: tomorrow’s prices unconnected to today’s and so on

10. “Behavioral Finance”
IF everyone extremely knowledgeable + rational EMH; some people aren’t (because think don’t need to) inefficiencies to capitalize on (check-out lines x a billion)
Market is stupid, skittish, emotional just like people
“Blood on the street”
“Investors follow the advice of financial gurus, fail to diversify, actively trade stocks and churn their portfolios, sell winning stocks and hold on to losing stocks thereby increasing their tax liabilities, buy and sell actively and expensively managed mutual funds, follow stock price patterns and other popular models. In short, investors hardly adopt the passive strategies expected of uninformed market participants by the efficient markets theory.”

11. Hedge Funds: “hedge your bets” countercyclical, v. high-risk investing
Some lost $6 billion in a week betting on gas prices
“Momentum Investing”: short-term trends (up yesterday, up tomorrow) “mean regression”; cheap > expensive (low Price/earnings ratios; long term PE average: 16)

12. Voting Machine vs. Weighing Machine
Short-term: fickle nature of investors
Long-term: tied to fundamentals
BUT: G. Soros, “reflexivity”
inefficiencies in the market can affect the fundamentals, making the market appear accurate
Until it crashes
E.g. ABC Corp is overvalued, allowing it to raise money to buy DEF Inc., which props up its earnings, which leads to higher stock prices, continuing the process until the underlining weakness of ABC is revealed bigger crash than if ABC hadn’t been able to expand in 1st place
The real market vs. the market we see (Jim Cramer)
EMH and its logic helped cause Great Recession

13. Why Care? What if market is a scam? 1) Impact on wealth (perception)
2) Ability of companies to raise money (stock issue + loans)
3) Leading indicator (where economy will be in 6 months) impacts decisions today
But, more and more of US companies’ profits come from overseas
What if market is a scam?