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Equities and Indexes

Equities and Indexes. Common Stock Preferred Stock Equity Index Bond Index. Common Stock. Definition Ownership shares in public companies Characteristics Voting rights Shareholder can vote for company issues, e.g., executive compensation, board of directors, auditing firm, etc.

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Equities and Indexes

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  1. Equities and Indexes Common Stock Preferred Stock Equity Index Bond Index

  2. Common Stock • Definition • Ownership shares in public companies • Characteristics • Voting rights • Shareholder can vote for company issues, e.g., executive compensation, board of directors, auditing firm, etc. • Residual Claims • Last in line of all claimants on the company, e.g., owns whatever is left after workers, suppliers, bondholders are paid off. • Limited Liability • Lose no more than original investment, e.g., you pay $90 for a share of IBM, you’ll lose no more than that.

  3. Common Stock • A quote from WSJ (or YAHOO these days) • A few questions • How much do you have to pay for a share at close? • What is last year’s earning? • Is the stock boring? 52 Weeks Hi Lo Net Chg Close Hi Lo Stock (SYM) DIV YLD% PE Volume GenElec (GE) 1.24 4.41 13.07 28.10 -0.73 42.15 25.60 28.88 28.08 47087660 $0.31/Quarter

  4. Preferred Stock • Definition • Non-voting share in a corporation • Characteristics • Fixed dividend stream (like bond coupon) • Dividend may be skipped yet cumulative • Dividend fully taxable • How different is it from a bond?

  5. Indexes: Equity and Bond • What are they? • An indicator of average security prices • Why do we need them? • Tracking market returns • Benchmarking fund manager performance • Bases for derivatives, e.g., index options • Factors affecting an index • Representative? • Weighting of components?

  6. Equity Indexes • DJIA • S&P 500, S&P Mid Cap. • NASDAQ 100 • Nikkei 225 (Tokyo Stock Exchange) • FTSE 100 (London) • Wilshire 5000 • MSCI-EAFE Index • Morgan Stanley Capital International Europe, Australia, Far East Index (including 21 developed countries outside North America)

  7. Equity Indexes: DJIA • Some facts • 30 industrial stock price-weighted average. • Oldest and best-known in the U.S. • Used to representing about a quarter of the market value of the NYSE stocks. • Quantitatively • Divisor changes when stock splits or stock is replaced by another

  8. Equity Indexes: DJIA • Construction • Suppose DJIA has two stocks Divisor

  9. Equity Indexes: DJIA • What happens when a stock splits? • At market close today, B has a 2-for-1 split • Where does the new divisor come from? Divisor

  10. Equity Indexes: S&P 500 • Including 500 NYSE, Amex, NASDAQ stocks • Considered to be a much broader index of the U.S. market than the DJIA • Numerous financial products derived from the index • Mutual funds indexed to the S&P 500 Index • S&P Depository Receipts (SPDR) • S&P 500 Index Options and Futures • Market value-weighted index – larger companies have more weight in S&P 500 • S&P 500 is float-adjusted since Sep 16, 2005

  11. Example: Amazon.com joining S&P 500 AMZN joins S&P 500 on Nov 18, 2005 Announcement is made after market closing on Nov 14, 2005

  12. Equity Indexes: S&P 500 • Market value-weighted index - Calculation

  13. Equity Indexes: S&P 500 • When does the divisor change? • NOT for stock split • YES for stock replacement in the index • E.g., C replaces B in the index Divisor

  14. Equity Indexes • Equally Weighted Stock Indexes Equally weighted stock indices place equal weight on each stock return, and call for a portfolio strategy that places equal dollar values in each stock. E.g., Stock A has a return of 2% and stock B has a return of 1%. An equally weighted index of A and B has a return of 0.5*2% + 0.5*1% = 1.5% • Constant portfolio rebalancing is required to track such an index

  15. Bond Indexes • An indicator for bond market returns

  16. Wrap-up • What are stocks and preferred stocks? • What are stock indexes for? • What are commonly used indexes? • DJIA: price-weighted - Old and Faithful • S&P: float value weighted - good “market” proxy • NASDAQ: new and dynamic • Less followed • Bond indexes: professionals pay more attention to it

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