The Stock Market

1. The Stock Market

2. The Financial System • The financial system is a network of institutions which connect investors with borrowers. • Institutions in the financial system include banks and stock exchanges. • The key to the financial system is information. Investors carry out research before buying stocks and bonds.

3. Risk vs. return • An investment return is the money an investor receives above and beyond the sum of money she initially invested. • Low risk investment = low return. • High risk investment = high return (maybe).

4. Investment portfolio • An investment portfolio is an investors’ collection of financial assets such as stocks, bonds, mutual funds. • The portfolio should reflect the risk tolerance of the investor • Diversificationis spreading out investments to reduce risk.

6. bonds • Bonds are loans made by investors to corporations or governments. • The borrower must pay the investor a fixed rate of interest (coupon rate) until maturity(due date). • Bonds can be very safe (U.S. treasury bonds) or very risky (junk bonds).

7. Why would a corporation or government sell bonds?

8. Bond Example • Chipotle needs cash to expand its international operations. It decides to issues bonds (IOUs) to raise money for the expansion. • Chipotle issues 100,000 bonds of $1,000 apiece which pay the investor a coupon rate (interest) of 5% annually. The bonds mature in 5 years. • The investor receives $50 dollars a year and at the end of year 5 she gets her $1,000 back. • Investment return= $1,250

9. Stocks • When a person is buying stock, she is buying a piece of ownership in a corporation. • Stocks can be purchased directly from the company (primary market) or from other investors (secondary market). • Stockholders get to vote for the board of directors who control the company. • 1 share = 1 vote.

10. Stocks cont. • Stocks are riskier than bonds. • If the corporation is profitable then the value of the stock rises and the stockholder shares in the profits. • If the corporation fails, the investor can lose his investment. • The value of a stock changes daily.

12. Stocks vs. Bonds • Stocks you own, bonds you loan. • Why do corporations sell stock instead of bonds? • Why would an investor purchase stock instead of a bond?

13. Mutual Funds • A mutual fund pools the money of many investors and the fund invests this money in a variety of stocks. • Mutual funds enable investors to invest in a broad range of companies in the market. • Mutual funds can be very broad, total stock market fund, or have specific focus such as energy or healthcare. • Mutual funds help investors diversify and reduce risk.

15. Profiting from stocks • There are two ways an investor can profit from her stocks: • Dividends- payments made by corporations to shareholders (i.e. profit sharing). Example- Facebook declares a dividend of $5 per share. • 2. Capital gains- selling a stock for more than its original purchase price. • Short term capital gain = own for less than 1 year • Long term capital gain= own for more than 1 year • Example: Google Stock- $53.14 8/27/04 • $537.76 4/11/14

16. Trading Stocks • The two major stock exchanges are: • New York Stock Exchange- The NYSE handles the most powerful and established corporations in the world. • Example- GM, Coca-Cola, Wal-Mart • NASDAQ- NASDAQ is an electronic trading network which specializes in technology stocks. • Example- Facebook, Amazon, Google

17. Stockbrokers • Stockbrokers connect buyers with sellers of stock. • Stockbrokers work for brokerage firms such as Merrill Lynch or Charles Schwab. • Stockbrokers are paid a commission each time they make a trade

19. Stock index • Dow Jones Industrial Average- The “Dow” monitors and reports the trading activity of 30 large companies. • The Dow as of 4/11/14 was at 16,026 points • The Standard & Poor’s 500- The S&P 500 tracks stocks in a variety on industries. • The S&P as of 4/11/14 was at 1,815 points

20. Dow Jones Index Companies

21. Bull and bear markets • A bull market occurs when the stock market rises steadily over time. • A bear market occurs when the stock market falls over a period time. • Stock indexes like the Dow and S&P 500 indicate if the market is a bull or a bear

23. Market Crashes • The Great Crash of 1929- On 10/28/29 the market crash began and the Dow declined nearly 25% in two days. • Black Monday- On 10/18/87 the Dow lost nearly 23% in a single day. • The Financial Crisis- The Dow declined from 14,000 in October 2007 to 7,949 in January 2009

24. regulations • Securities and Exchange Commission regulates trading stocks and bonds. • The goal of the SEC is to protect investors from fraud and deception in the sale of stocks and bonds. • The SEC also aims to create a level playing field for all investors and prevent insider trading. • Insider trading is buying or selling stock after learning about important, nonpublic information.

25. Alternative investments • Alternatives are illiquid, risky investments open to wealthy individuals and institutional investors. • Alternatives are not publically traded. • Loosely regulated by the government. • Example- a hedge fund is a high risk mutual fund only open to wealthy investors.

26. What type of investor are you? • You received a graduation gift of $100,000. Create an investment strategy to manage your money. • You investment strategy should answer the following questions: • Are you a cautious or an aggressive investor? • What industries will you focus on? • Will you purchase both domestic and foreign investments? • Would you buy stocks, mutual funds, bonds or all three? • How will you allocate your money among the different types of investments?