Stock market

Stock market

SouthUral State University

The Department of Economic and Management

Work on subject

The Student: Velichko O.S.

Group: E&M-263

The Tutor: Sergeeva L.M.

Chelyabinsk

1998

Contents

1. Market place

2. Trading on the stock exchange floor

3. Securities. Categories of common stock

1. Growth stocks

2. Cyclical stocks

3. Special situations

4. Preferred stocks

1. Bonds-corporate

2. Bonds-U.S. government

3. Bonds-municipal

4. Convertible securities

5. Option

6. Rights

7. Warrants

8. Commodities and financial futures

5. Stock market averages reading the newspaper quotations

1. The price-earnings ratio

6. European stock markets–general trend

1. New ways for old

2. Europe, meet electronics

7. New issues

8. Mutual funds. A different approach

1. Advantages of mutual funds

2. Load vs. No-load

3. Common stock funds

4. Other types of mutual funds

5. The daily mutual fund prices

6. Choosing a mutual fund

1. MARKET PLACE

The stock market. To some it’s a puzzle. To others it’s a source of

profit and endless fascination. The stock market is the financial nerve

center of any country. It reflects any change in the economy. It is

sensitive to interest rates, inflation and political events. In a very real

sense, it has its fingers on the pulse of the entire world.

Taken in its broadest sense, the stock market is also a control center.

It is the market place where businesses and governments come to raise money

so that they can continue and expend their operations. It is the market

place where giant businesses and institutions come to make and change their

financial commitments. The stock market is also a place of individual

opportunity.

The phrase “the stock market” means many things. In the narrowest

sense, a stock market is a place where stocks are traded – that is bought

and sold. The phrase “the stock market” is often used to refer to the

biggest and most important stock market in the world, the New York Stock

Exchange, which is as well the oldest in the US. It was founded in 1792.

NYSE is located at 11 Wall Street in New York City. It is also known as the

Big Board and the Exchange. In the mid-1980s NYSE-listed shares made up

approximately 60% of the total shares traded on organized national

exchanges in the United States.

AMEX stands for the American Stock Exchange. It has the second biggest

volume of trading in the US. Located at 86 Trinity Place in downtown

Manhattan, the AMEX was known until 1921 as the Curb Exchange, and it is

still referred to as the Curb today. Early traders gathered near Wall

Street. Nothing could stop those outdoor brokers. Even in the snow and rain

they put up lists of stocks for sale. The gathering place became known as

the outdoor curb market, hence the name the Curb. In 1921 the Curb finally

moved indoors. For the most part, the stocks and bonds traded on the AMEX

are those of small to medium-size companies, as contrasted with the huge

companies whose shares are traded on the New York Stock Exchange.

The Exchange is non-for-profit corporation run by a board of directors.

Its member firm are subject to a strict and detailed self-regulatory code.

Self-regulation is a matter of self-interest for stock exchange members. It

has built public confidence in the Exchange. It also required by law. The

US Securities and Exchange Commission (SEC) administers the federal

securities laws and supervises all securities exchange in the country.

Whenever self-regulation doesn’t do the job, the SEC is likely to step in

directly. The Exchange doesn’t buy, sell or own any securities nor does it

set stock prices. The Exchange merely is the market place where the public,

acting through member brokers, can buy and sell at prices set by supply and

demand.

It costs money it become an Exchange member. There are about 650

memberships or “seats” on the NYSE, owned by large and small firms and in

some cases by individuals. These seats can be bought and sold; in 1986 the

price of a seat averaged around $600,000. Before you are permitted to buy a

seat you must pass a test that strictly scrutinizes your knowledge of the

securities industry as well as a check of experience and character.

Apart from the NYSE and the AMEX there are also “regional” exchange in

the US, of which the best known are the Pacific, Midwest, Boston and

Philadelphia exchange.

There is one more market place in which the volume of common stock

trading begins to approach that of the NYSE. It is trading of common stock

“over-the-counter” or “OTC”–that is not on any organized exchange. Most

securities other than common stocks are traded over-the-counter. For

example, the vast market in US Government securities is an over-the-counter

market. So is the money market–the market in which all sorts of short-term

debt obligations are traded daily in tremendous quantities. Like-wise the

market for long-and short-term borrowing by state and local governments.

And the bulk of trading in corporate bonds also is accomplished over-the-

counter.

While most of the common stocks traded over-the-counter are those of

smaller companies, many sizable corporations continue to be found on the

“OTC” list, including a large number of banks and insurance companies.

As there is no physical trading floor, over-the-counter trading is

accomplished through vast telephone and other electronic networks that link

traders as closely as if they were seated in the same room. With the help

of computers, price quotations from dealers in Seattle, San Diego, Atlanta

and Philadelphia can be flashed on a single screen. Dedicated telephone

lines link the more active traders. Confirmations are delivered

electronically rather than through the mail. Dealers thousands of miles

apart who are complete strangers execute trades in the thousands or even

millions of dollars based on thirty seconds of telephone conversation and

the knowledge that each is a securities dealer registered with the National

Association of Securities Dealers (NASD), the industry self-regulatory

organization that supervises OTC trading. No matter which way market prices

move subsequently, each knows that the trade will be honoured.

2. TRADING ON THE STOCK EXCHANGE FLOOR

When an individual wants to place an order to buy or sell shares, he

contacts a brokerage firm that is a member of the Exchange. A registered

representative or “RR” will take his order. He or she is a trained

professional who has passed an examination on many matters including

Exchange rules and producers.

The individual’s order is relayed to a telephone clerk on the floor of

the Exchange and by the telephone clerk to the floor broker. The floor

broker who actually executes the order on the trading floor has an

exhausting and high-pressure job. The trading floor is a larger than half

the size of football field. It is dotted with multiple locations called

“trading posts”. The floor broker proceeds to the post where this or that

particular stock is traded and finds out which other brokers have orders

from clients to buy or sell the stock, and at what prices. If the order the

individual placed is a “market order”–which means an order to buy or sell

without delay at the best price available–the broker size up the market,

decides whether to bargain for a better price or to accept one of the

orders being shown, and executes the trade–all this happens in a matter of

seconds. Usually shares are traded in round lots on securities exchanges. A

round lot is generally 100 shares, called a unit of trading, anything less

is called an odd lot.

When you first see the trading floor, you might assume all brokers are

the same, but they aren’t. There are five categories of market

professionals active on the trading floor.

Commission Brokers, usually floor brokers, work for member firms. They

use their experience, judgment and execution skill to buy and sell for the

firm’s customer for a commission.

Independent Floor Brokers are individual entrepreneurs who act for a

variety of clients. They execute orders for other floor brokers who have

more volume than they can handle, or for firms whose exchange members are

not on the floor.

Registered Competitive Market Makers have specific obligations to trade

for their own or their firm’s accounts–when called upon by an Exchange

official–by making a bid or offer that will narrow the existing quote

spread or improve the depth of an existing quote.

Competitive Traders trade for their own accounts, under strict rules

designed to assure that their activities contribute to market liquidity.

[pic]

And last, but not least, come Stock Specialists. The Exchange tries to

preserve price continuity– which means that if a stock has been trading at,

say, 35, the next buyer or seller should be able to an order within a

fraction of that price. But what if a buyer comes in when no other broker

wants to sell close to the last price? Or vice versa for a seller? How is

price continuity preserved? At this point enters the Specialist. The

specialist is charged with a special function, that of maintaining

continuity in the price of specific stocks. The specialist does this by

standing ready to buy shares at a price reasonably close to the last

recorded sale price when someone wants to sell and there is a lack of

buyers, and to sell when there is a lack of sellers and someone wants to

buy. For each listed stock, there are one or more specialist firms assigned

to perform this stabilizing function. The specialist also acts as a broker,

executing public orders for the stock, and keeping a record of limit orders

to be executed if the price of the stock reaches a specified level. Some of

the specialist firms are large and assigned to many different stocks. The

Exchange and the SEC are particularly interested in the specialist

function, and trading by the specialists is closely monitored to make sure

that they are giving precedence to public orders and helping to stabilize

the markets, not merely trying to make profits for themselves. Since a

specialist may at any time be called on to buy and hold substantial amounts

of stock, the specialist firms must be well capitalized.

In today's markets, where multi-million-dollar trades by institutions

(i. e. banks, pension funds, mutual funds, etc.) have become common, the

specialist can no longer absorb all of the large blocks of stock offered

for sale, nor supply the large blocks being sought by institutional buyers.

Over the last several years, there has been a rapid growth in block trading

by large brokerage firms and other firms in the securities industry. If an

institution wants to sell a large block of stock, these firms will conduct

an expert and rapid search for possible buyers; if not enough buying

interest is found, the block trading firm will fill the gap by buying

shares itself, taking the risk of owning the shares and being able to

dispose of them subsequently at a profit. If the institution wants to buy

rather than sell, the process is reversed. In a sense, these firms are

fulfilling the same function as the specialist, but on a much larger scale.

They are stepping in to buy and own stock temporarily when offerings exceed

demand, and vice versa.

So the specialists and the block traders perform similar stabilizing

functions, though the block traders have no official role and have no

motive other than to make a profit.

3. SECURITIES. CATEGORIES OF COMMON STOCK

There is a lot to be said about securities. Security is an instrument

that signifies (1) an ownership position in a corporation (a stock), (2) a

creditor relationship with a corporation or governmental body (a bond), or

(3) rights to ownership such as those represented by an option, subsription

right, and subsription warrant.

People who own stocks and bonds are referred to as investors or,

respectively, stockholders (shareholders) and bondholders. In other words a

share of stock is a share of a business. When you hold a stock in a

corporation you are part owner of the corporation. As a proof of ownership

you may ask for a certificate with your name and the number of shares you

hold. By law, no one under 21 can buy or sell stock. But minors can own

stock if kept in trust for them by an adult. A bond represents a promise by

the company or government to pay back a loan plus a certain amount of

interest over a definite period of time.

We have said that common stocks are shares of ownership in

corporations. A corporation is a separate legal entity that is responsible

for its own debts and obligations. The individual owners of the corporation

are not liable for the corporation's obligations. This concept, known as

limited liability, has made possible the growth of giant corporations. It

has allowed millions of stockholders to feel secure in their position as

corporate owners. All that they have risked is what they paid for their

shares.

A stockholder (owner) of a corporation has certain basic rights in

proportion to the number of shares he or she owns. A stockholder has the

right to vote for the election of directors, who control the company and

appoint management. If the company makes profits and the directors decide

to pay part of these profits to shareholders as dividends, a stockholder

has a right to receive his proportionate share. And if the corporation is

sold or liquidates, he has a right to his proportionate share of the

proceeds.

What type of stocks can be found on stock exchanges? The question can

be answered in different ways. One way is by industry groupings. There are

companies in every industry, from aerospace to wholesale distributers. The

oil and gas companies, telephone companies, computer companies,

autocompanies and electric utilities are among the biggest groupings in

terms of total earnings and market value. Perhaps a more useful way to

distinguish stocks is according to the qualities and values investors want.

3.1 Growth Stocks.

The phrase "growth stock" is widely used as a term to describe what

many investors are looking for. People who are willing to take greater-than-

average risks often invest in what is often called "high-growth"

stocks—stocks of companies that are clearly growing much faster than

average and where the stock commands a premium price in the market. The

rationale is that the company's earnings will continue to grow rapidly for

at least a few more years to a level that justifies the premium price. An

investor should keep in mind that only a small minority of companies really

succeed in making earnings grow rapidly and consistently over any long

period. The potential rewards are high, but the stocks can drop in price at

incredible rates when earnings don't grow as expected. For example, the

companies in the video game industry boomed in the early 1980s, when it

appeared that the whole world was about to turn into one vast video arcade.

But when public interest shifted to personal computers, the companies found

themselves stuck with hundreds of millions of dollars in video game

inventories, and the stock collapsed.

There is less glamour, but also less risk, in what we will call—for

lack of a better phrase—"moderate-growth" stocks. Typically, these might be

stocks that do not sell at premium, but where it appears that the company's

earnings will grow at a faster-than-average rate for its industry. The

trick, of course, is in forecasting which companies really will show better-

than-average growth; but even if the forecast is wrong, the risk should not

be great, assuming that the price was fair to begin with.

There's a broad category of stocks that has no particular name but that

is attractive to many investors, especially those who prefer to stay on the

conservative side. These are stocks of companies that are not glamorous,

but that grow in line with the economy. Some examples are food companies,

beverage companies, paper and packaging manufacturers, retail stores, and

many companies in assorted consumer fields.

As long as the economy is healthy and growing, these companies are

perfectly reasonable investments; and at certain times when everyone is

interested in "glamour" stocks, these "non-glamour" issues may be neglected

and available at bargain prices. Their growth may not be rapid, but it

usually is reasonably consistent. Also, since these companies generally do

not need to plow all their earnings back into the business, they tend to

pay sizable dividends to their stockholders. In addition to the real growth

that these companies achieve, their values should adjust upward over time

in line with inflation—a general advantage of common stocks that is worth

repeating.

3.2 Cyclical Stocks.

These are stocks of companies that do not show any clear growth trend,

but where the stocks fluctuate in line with the business cycle (prosperity

and recession) or some other recognizable pattern. Obviously, one can make

money if he buys these near the bottom of a price cycle and sells near the

top. But the bottoms and tops can be hard to recognize when they occur; and

sometimes, when you think that a stock is near the bottom of a cycle, it

may instead be in a process of long-term decline.

3.3 Special Situations.

There’s a type of investment that professionals usually refer to as

“special situations”. These are cases where some particular corporate

development–perhaps a merger, change of control, sale of property, etc.–

seems likely to raise the value of a stock. Special situation investments

may be less affected by general stock market movements than the average

stock investment; but if the expected development doesn’t occur, an

investor may suffer a loss, sometimes sizable. Here the investor has to

judge the odds of the expected development’s actually coming to pass.

4. PREFERRED STOCKS

A preferred stock is a stock which bears some resemblances to a bond

(see below). A preferred stockholder is entitled to dividends at a

specified rate, and these dividends must be paid before any dividends can

be paid on the company's common stock. In most cases the preferred dividend

is cumulative, which means that if it isn't paid in a given year, it is

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