1. FIN432 Vicentiu Covrig 1 Equity Markets (chapter 2)

2. FIN432 Vicentiu Covrig 2 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. www.nyse.com 2005 NYSE Average Daily Stock Volume (millions) 1,604 NYSE Average Trade Size per Sale (in shares) 334 Number of NYSE Non-US Stocks 453 NYSE Dollar Value of Trading Activity (billions of dollars) $56.1 Programs as % of Total NYSE56.9% Companies Listed on the NYSE 2,779

3. FIN432 Vicentiu Covrig 3 AMEX is also a specialist auction market Lower listing standards than NYSE More than 1,000 listings - 140+ Exchange Traded Funds - 15+ HOLDRs - 350+ structured products www.amex.com American Stock Exchange

4. FIN432 Vicentiu Covrig 4 Electronic market Negotiated market - Market makers are dealers - Price determination through bargaining 3,600+ issues - more technology firms - Dell, Microsoft, Intel www.nasdaq.com Nasdaq

5. FIN432 Vicentiu Covrig 5 Other U.S. stock markets Nasdaq SmallCap Market - 800 small firms seeking Nasdaq market maker sponsorship - No penny stocks (price < $1) Over-the-Counter Bulletin Board - 3,000+ securities offered by 300+ market makers - Penny stocks traded here Electronic Communication Networks (ECNs) - Electronic market for institutional investors to trade with each other

6. FIN432 Vicentiu Covrig 6 Dow Averages Charles Dow and Edward Davis Jones - Credited with inventing the 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 DJUA, DJTA

7. FIN432 Vicentiu Covrig 7 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. At the beginning of 2006 the divisor was 0.12493117. Note that a $1 change in a stock’s price causes the DJIA to change by 8 (=1/ 0.12493117)

8. FIN432 Vicentiu Covrig 8 Problems with price-weighted averages Stock splits require changes in the divisor Larger priced stocks move the index more than smaller priced stocks for the same % price move. - A $100 stock that increases 10% changes by $10. A $10 stock that increases 10% changes by $1. A change of $10 moves the DJIA ten times more than a $1 change. Difficult to index to a price-weighted average. 3M Co. Alcoa Inc. Altria Group Inc. American Express Co. American International Group Inc. Boeing Co. Caterpillar Inc. 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. Honeywell International Inc. Intel Corp. International Business Machines Corp. Johnson & Johnson JPMorgan Chase & Co. McDonald's Corp. Merck & Co. Inc. Microsoft Corp. Pfizer Inc. Procter & Gamble Co. SBC Communications Inc. United Technologies Corp. Verizon Communications Inc. Wal-Mart Stores Inc. Walt Disney Co.

9. FIN432 Vicentiu Covrig 9 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) - Generally the largest 500 firms in the U.S.  However, it is designed to match the sectors weights of the overall market composition.

10. FIN432 Vicentiu Covrig 10 Index Example Consider 3 stocks. - 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

11. FIN432 Vicentiu Covrig 11 What is the value of each index? Price-weighed average (40 + 60 + 80) / 2.5 = 72.00 Value-weighted index {($40X300 + $60X200 + $80X100) / ($30X300 + $50X100 + $60X100)} × 100 = {32,000 / 25,000} × 100 = 128.00

12. FIN432 Vicentiu Covrig 12 What is the value of each index after the $40 stock changes to $45? Price-weighed average (45 + 60 + 80) / 2.5 = 74.00 a 2.78% change Value-weighted index {($45X300 + $60X200 + $80X100) / ($30X300 + $50X100 + $60X100)} × 100 = {33,500 / 25,000} × 100 = 134.00 a 4.69% change

13. FIN432 Vicentiu Covrig 13 More Popular Indices Russell Indexes - Russell 3000 uses the 3,000 largest U.S. companies  Represents 98% of the investable US equity - Russell 1000 uses the 1,000 largest U.S. companies  Represents 92% of the investable US equity - Russell 2000 uses the 2,000 smallest companies n the Russell 3000  Considered a small cap index.

14. FIN432 Vicentiu Covrig 14 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 4,972 stocks (beginning of 2006) Dow Jones Wilshire 4500 - Contains the Wilshire 5000 firms less the S&P 500 firms - Considered a mid-cap 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

15. FIN432 Vicentiu Covrig 15 Nasdaq Indexes Nasdaq Composite Index - All common stocks listed on the Nasdaq Stock Market - 3,175 firms - Market value-weighted Nasdaq 100 Index - Largest 100 firms on the Nasdaq Stock Market - Large stock index, but technology oriented

16. FIN432 Vicentiu Covrig 16 Standard & Poor’s S&P 500 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

17. FIN432 Vicentiu Covrig 17 Global Stock Indexes Major Local Stock Market Index - Nikkei, Dax, FTSE Morgan Stanley Capital International Indexes - Global, regional, and local indexes - Emerging and developed markets

18. FIN432 Vicentiu Covrig 18 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 Securities Market Regulation Legislation Important to Investors, Issuers of Securities and Brokers/Dealers

19. FIN432 Vicentiu Covrig 19 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 Self-Regulatory Organizations (SROs)

20. FIN432 Vicentiu Covrig 20 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 changes of 1,000, 2,000, and 3,000. - The first breaker halts trading for 30 to 60 minutes. - The 2 nd breaker halts trading for 2 hours and the third breaker stops trading for the day. Collars: restricts index arbitrage when DJIA moves 200 points. - “Curbs” are in Circuit Breakers and Trading Limits

21. FIN432 Vicentiu Covrig 21 Learning objectives Discuss the trading on NYSE, AMEX and Nasdaq Discuss the other US stock markets Discuss the DJIA andS&P500 indices. Know how to calculate the indices. See the example in the slides. Know the Russell and Wilshire indices Discuss the Self Regulatory organizations. Discuss the Circuit Breakers and Trading limits. End of chapter CFA problems 2.1 and 2.2