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Chapter 8

Chapter 8. Stocks, Stock Markets, and Market Efficiency. Stocks. R epresents the original capital paid into or invested in the business by its founders S erves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors

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Chapter 8

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  1. Chapter 8 Stocks, Stock Markets, and Market Efficiency

  2. Stocks • Represents the original capital paid into or invested in the business by its founders • Serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors • Stock prices tell the value of the companies that issued the stocks • Fluctuate in quality and value

  3. Common Stocks • Shares in a firm’s ownership • Small denominations • Transferable • The shares are registered in the names of brokerage firms that hold them on investors’ behalf

  4. Common Stocks’ Rights • Stockholders are paid with dividends • Board of directors decide when to pay out dividends • Voting right, the shareholders elect the board of directors • Limited liability: the max loss of shareholders is their initial investment (the price paid for the stocks in the first place)

  5. Common Stocks Vs. Preferred Stocks • Preferred stockholders have a greater claim to a company's assets and earnings • Dividends are paid for preferred stockholders before common stockholders • Dividends are paid at regular intervals • No voting right • No election right

  6. Measuring The Level of the Stock Market • Stock-market indexes • Measuring method of a section of the stock market • Tell how much the value of an average stock has changed and how much total wealth has gone up or down • Manager’s performance benchmarks • World/Global index • MSCI World and S&P Global 100 • National index • The American S&P 500, the Canadian MSCI, • the Japanese Nikkei 225

  7. U.S Major Indexes

  8. The Dow Jones Industrial Average • Performance of 30 large, publicly owned companies based in the United States • The average is price-weighted, and to compensate for the effects of stock splits and other adjustments • The percentage change in the DJIA overtime is the percentage change in the sum of the 30 prices

  9. Price-Weighted Ex: • Purchasing of • Stock 1 at $50.00 • Stock 2 at $100.00 • An increase of 15% in the first stock • 1st stock price increases to $57.50 • Total value in the portfolio: $157.59 • An increase of 15% in the second stock • 2nd stock price increases to $115.00 • Total value in the portfolio: $165.00

  10. The Standard & Poor’s 500 Index • Index conducted from the price of many more stocks • 500 firms, the largest firms in the U.S. economy, trade on either of the 2 largest American stock market exchanges: the New York Stock Exchange and the NASDAQ • Value-weighted index

  11. Other U.S. Stock Market Indexes • Nasdaq Composite Index • 5,000 companies traded on the OTC (over-the-counter) market • Value-weighted index • Wilshire 5000 : covers all publicly traded stocks in the U.S. • 6,500 companies traded on The New York Stock Exchange, the American Stock Exchange, and the OTC • Value-weighted index

  12. Futures and Forwards • Are contracts that allow people/ investors to buy or sell a specific type of asset at a specific time and at a given price

  13. Differences Between Two Contracts • Futures contract: • Standardized contract • Clearing house guarantees the transactions • Settlement occurs at the end of the contract • Not delivery • Forwards contract: • Non-standardized (private) contract • Default might happen • Marked-to-market daily, daily changes are settled day by day until the end of the contract. • Used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place

  14. Options • Right, not obligation to buy or sell an asset on or before a particular date • To protect investors from unexpected price change • Call option: • Purchase at a specific price • Put option: • Sell at a specific price

  15. When-Issued Treasury Bills • A contract to buy or sell at an agreed to price, stated dollar amount of T-bills to be sold at the next weekly auction • Trading starts when BoC announces the size of the following week’s auction. And ends before the results of the auction are announced

  16. Valuing Stock Price Ptoday=[Dnext year/(1+i)] + [P next year/(1+i)^1] • P today : the purchase price of product • D next year : amount of dividend payment • P next year : sale price at 1 year later • i: interest rate

  17. Ptoday=[Dnext year/(1+i)] + [Din 2 years/(1+i)²] + [P next year/(1+i)²] • The price today is the present value of the sum of the dividends plus the present value of the price at the time the stock is sold 2 years from now

  18. Dividend Discount Model Ptoday = Dividend per share Discount rate – Dividend growth rate Ptoday = D today i - g

  19. The Stock Market’s Role in the Economy • Stock prices tell the market value of companies, which guides the allocation of resources • Stocks are less risky if holding for a long periods than short periods • Efficient stock markets not reflect the movement of stock price, caused by asymmetry of information

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