Transcript Investments: Analysis and Behavior

Investments: Analysis
and Behavior
Chapter 2- Equity Markets
Learning Objectives
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Learn where and how securities are traded.
Know how stock market performance is measured.
Know sector, industry, and global market indices.
Understand the relevant laws governing the investment
industry.
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Markets
Primary Market
Market for new securities sold to investors for
the first time to raise capital for the issuer
Secondary Market
Stock exchange where investors trade stocks
with each other.
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Equity Markets
 New York Stock Exchange
www.nyse.com
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.
 Employee of a NYSE firm who manages the market for
an individual stock
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The NYSE is the most prestigious stock
exchange in the world
 Publicly traded company NYSE Euronext
 General Electric, Citigroup, Wal-Mart, Time
Warner, IBM, Coca Cola
 Has electronic trading system, Arca
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American Stock Exchange
 AMEX is also a specialist auction market
 The nation’s second largest stock
exchange
 More than 1,000 listings
 www.amex.com
 Public Float
One of the financial guidelines for listing on
the AMEX (market value of $3 million)
Common stock held by unaffiliated institutional
and individual investors (held by the public,
not the company)
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Nasdaq
 Electronic market
 The largest organized equities (stock)
market by trading volume and number of
listed companies
 Negotiated market
Market makers are dealers
Price determination through bargaining
 3,900+ issues
more technology firms
Dell, Microsoft, Intel
www.nasdaq.com
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Other U.S. stock markets
 Nasdaq SmallCap Market
800 small firms seeking Nasdaq market maker
sponsorship
No penny stocks (defined as price < $1)
 Over-the-Counter Bulletin Board
3,300+ securities offered by 230+ market makers
Penny stocks traded here
 Electronic Communication Networks (ECNs)
Electronic market for institutional investors to trade with
each other
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Tracking the market
Did the market go up or down today?
Every day, some stocks increase in price
while others decline
So, what does an increasing marketing
mean?
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Dow Averages
 Charles Dow and Edward Davis Jones
Credited with inventing the first 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.
Modern era of 30 DJIA stocks began in 1928.
DJIA Divisor
Adjustment factor used to account for stock
splits
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Dow Jones Industrial Average
 30 companies
Most important and largest firms
Selected by the editors of the Wall Street Journal
 Formula
30
DJIAt 
P
i 1
it
DJIA divisor
 While originally 30, the divisor has been steadily reduced to
account for stock splits. In early-2009 the divisor was
0.125552709.
 At that time, a $1 change in a stock’s price caused the DJIA to
change by 7.96 points (=1/ 0.125552709).
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3M Co.
Alcoa Inc.
American Express Co.
AT&T Inc.
Bank of America Corp.
Boeing Co.
Caterpillar Inc.
Chevron Corp.
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.
Intel Corp.
International Business Machines Corp.
Johnson & Johnson
JPMorgan Chase & Co.
Kraft Foods Inc. Cl A
McDonald's Corp.
Merck & Co. Inc.
Microsoft Corp.
Pfizer Inc.
Procter & Gamble Co.
United Technologies Corp.
Verizon Communications Inc.
Wal-Mart Stores Inc.
Walt Disney Co.
Problems with price-weighted averages
 Changes in high-priced components move
the DJIA more than low-priced components.
 A 10% price change in a $100 DJIA (like
IBM) is $10, and causes a 79.65 point
change in the DJIA.
 A 10% price change in a $5 DJIA (like GM)
is 50¢, and causes a 3.98 point change in
the DJIA.
 DJIA returns can be affected by timing of
stock splits.
 Stock splits require changes in the divisor.
 Mimicking DJIA portfolio returns requires
lots of rebalancing due to divisor changes.
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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)
PQ

Value  weightedindex
P Q
 500 leading U.S.-based companies.
t
t
0
0
 Indexbasevalue
 Chosen by S&P committee.
 Is not an index of the 500 largest companies.
 Sector weights set to match overall market.
 A preferred investment equity benchmark
 Performance standard to be evaluated against
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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
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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 / 20,000} × 100 = 160.00
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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 / 20,000} × 100 = 167.50 a 4.69% change
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Market Capitalization
Large-cap
Firm value: $10 billion–$200 billion
Mid-cap
Firm value: $1 billion–$10 billion
Small-cap
Firm value: $300 million–$1 billion
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Additional Popular Indices
Russell Indexes
Russell 3000 Index of the 3,000 largest
market cap U.S. companies.
Represents 98% of the investable US equity
Russell 1000 Index of the 1,000 largest
market cap U.S. companies.
Over 90% of investable US equity
Russell 2000 Index is comprised of the 2,000
smallest companies in the Russell 3000
Leading small cap index.
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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
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
 Dow Jones Wilshire 5000
Composite Index
 Most comprehensive measure of the
U.S. stock market.
 Designed to represent the
performance of all USheadquartered equity securities
 Contains 4,787 stocks (early 2008)
Wilshire All Growth
Wilshire All Value
Wilshire Large Growth
Wilshire Large Value
Wilshire Mid Growth
Wilshire Mid Value
Wilshire Small Growth
 Dow Jones Wilshire 4500
 Contains the Wilshire 5000 firms less
the S&P 500 firms
 Considered a mid-cap index
Wilshire Small Value
Wilshire Small Cap 250
Wilshire Small Cap 250 Price
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Nasdaq Indexes
 Nasdaq Composite Index
All 5,000+ common stocks listed on the Nasdaq
Stock Market.
More than 3,000 firms.
Market value-weighted.
 Nasdaq 100 Index.
Largest 100 firms on the Nasdaq Stock Market.
Large stock index, but technology oriented.
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Standard & Poor’s
S&P 500 – Popular value-weighted index
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
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INDEX (NUMBER)
A quantity whose variation over a period of
time measures the change in some
phenomenon.
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Figure 2.2 The DJIA and S&P 500 Represent Diversified Portfolios of Large-Company Stocks. The Nasdaq
Composite Index Tracks Large Tech Stocks
2500%
2000%
Nas d aq
DJ IA
1500%
1000%
S&P 50 0
500%
Jan-08
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0%
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Global Stock Indexes
 Major Local Stock Market Indexes
Nikkei (Japan)
Dax (Germany)
FTSE (UK)
 Morgan Stanley Capital International
Indexes
Global, regional, and country indexes.
Emerging and developed markets.
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Figure 2.3 Global Stock Exchange Indexes
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Securities Market Regulation
Legislation Important to Investors, Issuers of Securities and
Brokers/Dealers
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
Sarbanes-Oxley Act
Law instituting public accounting reforms and investor protections
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Self-Regulatory
Organizations (SROs)
 SEC delegates regulatory authority
 National Association of Securities Dealers (NASD)
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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
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Market Surveillance
NYSE’s Stock Watch
Flags unusual volume and/or price changes.
Investigates questionable trades.
Intermarket Surveillance Group
Shares information and coordinates efforts to
detect manipulation
Securities Arbitration
Private form of dispute resolution with
binding outcomes
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Circuit Breakers
 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 daily changes of
1,000, 2,000, and 3,000 points.
 The first breaker halts trading for 30 to 60 minutes.
 The second breaker halts trading for 2 hours.
 The third breaker stops trading for the day.
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