Financial MarketsChapter 11

Sections 3 & 4

Buying and Selling StocksCompanies issue stock and sell to investment

bankers in primary marketInitial public offering (IPO) is the sale that

raises money for the corporationStock exchange-secondary market where

securities are resold and boughtBuyers expect stock prices to rise, so they can

resell for a profitCapital gains-profit made from the sale of

stock

The Stock MarketWhy buy stock? Types of StockBuy to earn dividends &

share of company profits Invest who want income

& dividendsBuy to earn capital gains

through the resale of stock Investors who want

growth look for potential capital gains

Common Stock-gives shareholders voting rights, share of profits One vote per share owned

to elect board of directorsPreferred Stock-givers

shareholders share of profits but no voting rights Investors get guaranteed

dividends, paid off first if the company closes

Dividends do not increase if stock increases in value

Trading StockMost people buy stock to earn capital gainsStock prices are determined by demand and

supply; influencing factors:Company profits and lossesTechnological advancesOverall economy

Stockbroker-buys and sells securities for customers, earns a commission

Trading StockOrganized Stock Exchanges

Electronic MarketsNew York Stock Exchange

(NYSE) on Wall Street; oldest & largest in US Old School-Each stock

auctioned from trading post on exchange floor

Today-hand-held computers used to execute many trades

2006 merger allowed for electronic trades

American Stock Exchange (AMEX) companies smaller than on the NYSE

Over-the-counter (OTC) market stocks not traded on NYSE or AMEX

NASDAQ is centralized computer system for OTC trading Second largest exchange in

world in number of companies & shares traded

Companies from many sectors of IS economy, most in technology

OTC Bulletin Board is electronic market for smaller companies

Trading StockFutures & Options Market

Recent DevelopmentsMost investors do not

trade futures and options

Future-contract to buy, sell on specific future dates at preset price

Option- contract giving the right to buy & sell in the future at a preset price Investor pays small

fraction for stock’s current price for option

1990s regulations allow any firm to trade stocks in exchange

Through electronic communications networks (ECNs), 24-hour trading

Invest access Internet; huge growth in online brokerage companies Lower commissions than

traditional brokers Computer technology

matches buyers & sellers automatically

Measuring How Stocks PerformAbout half of U.S. households own stocksStock index-measures & reports the change

in prices of a set of stocksMeasures individual stocks and stock market

as a whole

Measuring How Stocks PerformStock Indexes Trading the DowU.S. Indexes: DIJA, Standard &

Poor’s 500, NASDAQ, CompositeGlobal Indexes: Hang Seng,

DAX, Nikkei 225, TSE 300, FTSE 100

Since 1896, Dow Jones Industrial Average change with U.S. economy Includes most successful

companies in most important economic sections

Uses points to measure changes in prices at which stocks are traded

Bull market-prices rise steadily over a relatively long period of time

Bear market-prices decline steadily over a relatively long period of time

1972-2000 longest bull market in history; most last 2-3 years

Dow affected by previous close, Fed, foreign indexes, & trade balance

About 21 stock markets overseas with over 1,000 larger companies each

Bonds and Other Financial InstrumentsBonds are issued by companies and

governmentsPar value- amount issuer must pay buyer at

maturityMaturity- date when bond is due to be repaidCoupon rate- interest rate bondholder gets

every year until maturity

Why Buy Bonds?Investors buy bonds for interest paid and

gains made by sellingYield- annual rate of return on a bondIf bond sold at par value, yield is same as

coupon rateIf sold for less, yield is higher; if sold for more,

yield is lowerBonds with longer maturity dates have higher

yields than with shorter

Why Buy Bonds?Types of Bonds

U.S. government issues treasury bonds, notes, & bills; very safe

Safety of foreign government bonds depend on the countryState & local governments issue bonds; no federal income taxCorporate bonds higher risk than government, pay higher

coupon rate Junk bonds-are high-risk, high yield corporate bonds

Buying BondsMost buyers want guaranteed returnsInvestors who sell before maturity want to make profit

As market interest rates rise, price of bonds with lower rate fallsMain risk to investors is default

Governments, companies get evaluated by credit-rating companies

Other Financial InstrumentsCertificates of Deposit

CDs primarily offered from banking institutions Pay fixed or variable interest, reinvested for

compound interestFDIC insures funds up to $100,000

Money Market Mutual FundsHave maturities of one year or lessHigher yield than savings accountsFunds not insuredTightly regulatedYield varies

Vocabulary

Stock Exchange secondary market where securities are resold and bought

Capital Gain profit made from the sale of stock

Common Stock gives shareholders voting rights, share of profits

Preferred Stock givers shareholders share of profits but no voting rights

Stockbroker buys and sells securities for customers, earns a commission

Future contract to buy, sell on specific future dates at preset price

Option contract giving the right to buy & sell in the future at a preset price

Stock Index measures & reports the change in prices of a set of stocks

Vocabulary

Bull Market prices rise steadily over a relatively long period of time

Bear Market prices decline steadily over a relatively long period of time

Par Value amount issuer must pay buyer at maturity

Maturity Date when bond is due to be paid

Coupon Rate interest rate bondholder gets every year until maturity

Yield annual rate of return on a bond

Junk Bond high-risk, high yield corporate bonds