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Chapter 8. Stocks, Stock Markets, and Market Efficiency. Stocks. R epresents the original capital paid into or invested in the business by its founders S erves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors

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chapter 8

Chapter 8

Stocks, Stock Markets, and Market Efficiency

  • Represents the original capital paid into or invested in the business by its founders
  • Serves as a security for the creditors of a business since it cannot be withdrawn to the detriment of the creditors
  • Stock prices tell the value of the companies that issued the stocks
  • Fluctuate in quality and value
common stocks
Common Stocks
  • Shares in a firm’s ownership
  • Small denominations
  • Transferable
  • The shares are registered in the names of brokerage firms that hold them on investors’ behalf
common stocks rights
Common Stocks’ Rights
  • Stockholders are paid with dividends
    • Board of directors decide when to pay out dividends
  • Voting right, the shareholders elect the board of directors
  • Limited liability: the max loss of shareholders is their initial investment (the price paid for the stocks in the first place)
common stocks vs preferred stocks
Common Stocks Vs. Preferred Stocks
  • Preferred stockholders have a greater claim to a company's assets and earnings
  • Dividends are paid for preferred stockholders before common stockholders
    • Dividends are paid at regular intervals
  • No voting right
  • No election right
measuring the level of the stock market
Measuring The Level of the Stock Market
  • Stock-market indexes
    • Measuring method of a section of the stock market
    • Tell how much the value of an average stock has changed and how much total wealth has gone up or down
    • Manager’s performance benchmarks
  • World/Global index
    • MSCI World and S&P Global 100
  • National index
    • The American S&P 500, the Canadian MSCI,
    • the Japanese Nikkei 225
the dow jones industrial average
The Dow Jones Industrial Average
  • Performance of 30 large, publicly owned companies based in the United States
  • The average is price-weighted, and to compensate for the effects of stock splits and other adjustments
  • The percentage change in the DJIA overtime is the percentage change in the sum of the 30 prices
price weighted


  • Purchasing of
    • Stock 1 at $50.00
    • Stock 2 at $100.00
  • An increase of 15% in the first stock
    • 1st stock price increases to $57.50
    • Total value in the portfolio: $157.59
  • An increase of 15% in the second stock
    • 2nd stock price increases to $115.00
    • Total value in the portfolio: $165.00
the standard poor s 500 index
The Standard & Poor’s 500 Index
  • Index conducted from the price of many more stocks
  • 500 firms, the largest firms in the U.S. economy, trade on either of the 2 largest American stock market exchanges: the New York Stock Exchange and the NASDAQ
  • Value-weighted index
other u s stock market indexes
Other U.S. Stock Market Indexes
  • Nasdaq Composite Index
    • 5,000 companies traded on the OTC (over-the-counter) market
    • Value-weighted index
  • Wilshire 5000 : covers all publicly traded stocks in the U.S.
    • 6,500 companies traded on The New York Stock Exchange, the American Stock Exchange, and the OTC
    • Value-weighted index
futures and forwards
Futures and Forwards
  • Are contracts that allow people/ investors to buy or sell a specific type of asset at a specific time and at a given price
differences between two contracts
Differences Between Two Contracts
  • Futures contract:
    • Standardized contract
    • Clearing house guarantees the transactions
    • Settlement occurs at the end of the contract
    • Not delivery
  • Forwards contract:
    • Non-standardized (private) contract
    • Default might happen
    • Marked-to-market daily, daily changes are settled day by day until the end of the contract.
    • Used by hedgers that want to eliminate the volatility of an asset's price, and delivery of the asset or cash settlement will usually take place
  • Right, not obligation to buy or sell an asset on or before a particular date
  • To protect investors from unexpected price change
  • Call option:
    • Purchase at a specific price
  • Put option:
    • Sell at a specific price
when issued treasury bills
When-Issued Treasury Bills
  • A contract to buy or sell at an agreed to price, stated dollar amount of T-bills to be sold at the next weekly auction
  • Trading starts when BoC announces the size of the following week’s auction. And ends before the results of the auction are announced
valuing stock price
Valuing Stock Price

Ptoday=[Dnext year/(1+i)] + [P next year/(1+i)^1]

  • P today : the purchase price of product
  • D next year : amount of dividend payment
  • P next year : sale price at 1 year later
  • i: interest rate

Ptoday=[Dnext year/(1+i)] + [Din 2 years/(1+i)²]

+ [P next year/(1+i)²]

  • The price today is the present value of the sum of the dividends plus the present value of the price at the time the stock is sold 2 years from now
dividend discount model
Dividend Discount Model

Ptoday = Dividend per share

Discount rate – Dividend growth rate

Ptoday = D today

i - g

the stock market s role in the economy
The Stock Market’s Role in the Economy
  • Stock prices tell the market value of companies, which guides the allocation of resources
  • Stocks are less risky if holding for a long periods than short periods
  • Efficient stock markets not reflect the movement of stock price, caused by asymmetry of information