Chapter 10Chapter 10The Stock, Bond, and The Stock, Bond, and Mortgage Markets: Mortgage Markets:

Volatile Asset PricesVolatile Asset Prices

©2000 South-Western College Publishing

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Common StockCommon Stock

Equity claims representing ownership of the net income and assets of a corporation that receive a variable dividend after preferred stockholders have been paid and retained earnings have been put aside

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Preferred StockPreferred StockEquity claims representing ownership of the net income and assets of a corporation that receive a fixed dividend before common stockholders are entitled to anything

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ProgramProgram TradingTrading

•Pre-programming of computers to buy or sell a large number (basket) of stocks•Widely used by institutional investors

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Dow Jones Industrial Average Dow Jones Industrial Average (the Dow)(the Dow)

An index that measures stock price movements of

30 of the largest companies traded on the NYSE

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New York Stock Exchange New York Stock Exchange (NYSE)(NYSE)

•The world’s largest market for trading stocks located on Wall Street in New York•Trades the stocks of over 3,000 companies

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Dow Jones Industrial Average - 30 stocks of some of the largest companies in America, “the blue chip.”Dow Jones Transportation Average - 20 airline, trucking, and railroad stocks.Dow Jones 65 Composite Index - all stocks in the Dow Jones Industrial, Transportation, and Utility Averages.Standard & Poor’s 500 - weighted index of prices of 500 broad based corporations.

Stock Market IndexesStock Market IndexesIs the Most Famous the Best?Is the Most Famous the Best?

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New York Composite Index - weighted average of the market value of all stocks traded on the NYSE plus four subgroup indexes representing industrial, transportation, utility, and finance stocks.Wilshire Equity Index Value - weighted index of the value of all stocks listed on the NYSE, the American Stock Exchange, and over-the-counter stocks that NASDAQ members.NASDAQ Composite Index - a weighted index that measures changes in prices of all stock traded by the NASDAQ system.

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Cracking the Code -- The Stock MarketCracking the Code -- The Stock MarketBelow is a typical entry of the stock page

of the Wall Street Journal52 weeks

HIGH: 67 7/18 LOW: 26 11/18 STOCK: Gap Inc. SYM: GPS DIV YLD: .20 %: .3

PE: 41VOL 100S: 17847HIGH: 62 3/8LOW: 59 1/4NET CHANGE: -3¼

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The Ten Largest Companies (measured in market value) The Ten Largest Companies (measured in market value) Traded on the Big Board, February 1999Traded on the Big Board, February 1999

General ElectricMerck & Co., Inc.Wal-Mart Stores, Inc.Pfizer Inc. Exxon Corp.Coca Cola Co.International Business Machines Corp.AT&T Corp.American International

GroupLucent Technologies Inc.

Company name

Symbol Market Value of Outstanding Stock (billions)

Average Number of shares traded

GEMRKWMTPFEXONKOIBM

TAIG

LU

$328.7 194.1 194.0 161.8 161.8 157.5 156.7

144.0 138.7

133.9

4,813,5473,460,7423,414,3262,782,9584,224,2583,765,7535,331,253

5,331,2532,524,947

7,777,063

Exhibit 10-1

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American Stock ExchangeAmerican Stock Exchange

A stock exchange located in New York that trades the stock of over 660 companies

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Over-the-Counter MarketOver-the-Counter Market

A network of thousands of securities dealers located all over the country that trade stocks of more than 30,000 companies over the telephone or computer

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Association of Securities Association of Securities Dealers Automated Quotation Dealers Automated Quotation

System (NASDAQ)System (NASDAQ)

An association whose members trade stocks over an advanced computer system that provides immediate information about prices and the number of shares being traded

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The Returns to Stocks and Bonds Over TimeThe Returns to Stocks and Bonds Over Time

Exhibit 10 -2

$4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0

1969 1973 1978 1983 1988 1993 1998

Value of $100 invested in stocks in 1969a

Value of $100 invested in stocks in 1969b

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OOpen-end and Closed-end pen-end and Closed-end Mutual FundsMutual Funds

•Open-end: continually sells new shares to the public or buys outstanding shares from the public at a price equal to the net asset value•Closed-end: sells a limited number of shares and does not buy back outstanding shares

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LoadLoad

• A sales commission required to be paid to a broker to buy into some mutual funds• By law, the load cannot exceed 8.5 percent of the investment

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No-Load Mutual FundNo-Load Mutual Fund

A mutual fund purchased directly from the company where the load is avoided

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A Sample of the Types of A Sample of the Types of Mutual Funds Mutual Funds (Stocks)(Stocks)

Aggressive Growth Funds invest in small companies with potential for growth seeking capital appreciation.Global Equity Funds invest in stocks from around the world achieving greater diversification than investing in comparable stocks from one country.

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Growth and Income Funds invest in companies that are expected to grow and that pay dividends.Income Equity Funds invest in companies that are expected to pay high dividends.Index Funds invest in a market basket of stocks that replicates the basket included in a stock market index.Sector Funds invest in stocks of particular industries.Socially Conscious Funds invest in companies they believe to be ethically responsible.

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A Sample of the Types of A Sample of the Types of Mutual Funds Mutual Funds (Bonds)(Bonds)

Corporate Bond FundsCorporate Bond Funds invest only in corporate bonds.Global Bond FundsGlobal Bond Funds invest in bonds from around the world.Ginnie Mae FundsGinnie Mae Funds invest in Ginnie Mae mortgage-backed securities.High Yield Bond FundsHigh Yield Bond Funds invest most of their portfolio in junk bonds.

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Long-term Municipal Bond FundsLong-term Municipal Bond Funds invest in a broad base of municipal funds; earnings are exempt from federal taxes.State Municipal Bond FundsState Municipal Bond Funds invest in municipal bonds from one state; earnings are exempt from federal taxes and from state taxes for investors living in the issuing state.U.S. Government Income FundsU.S. Government Income Funds invest in U.S. government bonds.

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A Sample of the Types of Mutual FundsA Sample of the Types of Mutual Funds(Stock and Bond Funds(Stock and Bond Funds))

Balanced Funds invest in some combination of stocks and bonds to preserve principle, generate income and achieve long-term growth.Flexible Portfolio Funds can vary relative investments between stocks, bonds, and money market instruments.Income Mixed Funds invest in stocks and bonds to earn high dividend and interest income.Convertible Securities Funds invest in securities that can be converted to common stock.

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Mortgage BondsMortgage Bonds

Bonds backed by personal property

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Collateral BondsCollateral Bonds

Bonds backed by financial assets

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Debenture BondsDebenture Bonds

Bonds with no specific no specific collateral backingcollateral backing but that

have a general claim on the other unpledged assets

of the issuer

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Subordinated Debenture Subordinated Debenture BondsBonds

Bonds with no collateral backing that have a general

claim after debenture bondholders have been paid

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Cracking the Code on Corporate BondsCracking the Code on Corporate Bonds

Bond Cur Yld Vol Close Net Chg

ATT 7.6 43 106 5/8 +1/8

The Wall Street Journal

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Treasury StripsTreasury Strips

A type of government securities that allow investors

to register and trade ownership of the interest

(coupon) payments and the principal amount of the

security

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Inflation-Indexed BondsInflation-Indexed Bonds

Bonds whose principal amount is adjusted for inflation at the time when coupon payments are made (usually every six months)

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General Obligation BondsGeneral Obligation Bonds

Municipal bonds to be repaid out of general tax revenues

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Revenue BondsRevenue Bonds

• Municipal bonds to be repaid out of the revenues from a specific project that the bond supports• Repayment is based on the success of the specific project

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Cracking the Code on Treasury BondsCracking the Code on Treasury Bonds

Rate Mo/Yr Bid Asked Chg Ask Yld

9 Nov. 18 138:12 139:18 +10 5.75

The Wall Street Journal

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Government National Mortgage Government National Mortgage Association (GNMA)Association (GNMA)

Government sponsored program that guarantees the timely payment of interest and principal on bundles of at least $1 million of standardized mortgages

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Mortgage-Backed Mortgage-Backed SecuritiesSecurities

•Securities backed by a pool of mortgages•They have a low default risk•They provide a steady stream of income