THE STOCK MARKET

THE FINANCIAL SYSTEMThe financial system is a network of institutions which connect investors with borrowers.

Institutions in the financial system include banks and stock exchanges.

The key to the financial system is information. Investors carry out research before buying stocks and bonds.

RISK VS. RETURNAn investment return is the money an investor receives above and beyond the sum of money she initially invested.

Low risk investment = low return.High risk investment = high return (maybe).

INVESTMENT PORTFOLIOAn investment portfolio is an investors’ collection of financial assets such as stocks, bonds, mutual funds.

The portfolio should reflect the risk tolerance of the investor

Diversification is spreading out investments to reduce risk.

BONDSBonds are loans made by investors to corporations or governments.

The borrower must pay the investor a fixed rate of interest (coupon rate) until maturity (due date).

Bonds can be very safe (U.S. treasury bonds) or very risky (junk bonds).

Why would a corporation or government sell bonds?

BOND EXAMPLEChipotle needs cash to expand its international operations. It decides to issues bonds (IOUs) to raise money for the expansion.

Chipotle issues 100,000 bonds of $1,000 apiece which pay the investor a coupon rate (interest) of 5% annually. The bonds mature in 5 years.

The investor receives $50 dollars a year and at the end of year 5 she gets her $1,000 back.

Investment return= $1,250

STOCKSWhen a person is buying stock, she is buying a piece of ownership in a corporation.

Stocks can be purchased directly from the company (primary market) or from other investors (secondary market).Stockholders get to vote for the board of directors who control the company.

1 share = 1 vote.

STOCKS CONT.Stocks are riskier than bonds.

If the corporation is profitable then the value of the stock rises and the stockholder shares in the profits.

If the corporation fails, the investor can lose his investment.

The value of a stock changes daily.

STOCKS VS. BONDSStocks you own, bonds you loan.

Why do corporations sell stock instead of bonds?

Why would an investor purchase stock instead of a bond?

MUTUAL FUNDSA mutual fund pools the money of many investors and the fund invests this money in a variety of stocks.

Mutual funds enable investors to invest in a broad range of companies in the market.

Mutual funds can be very broad, total stock market fund, or have specific focus such as energy or healthcare.

Mutual funds help investors diversify and reduce risk.

PROFITING FROM STOCKSThere are two ways an investor can profit from her stocks:

1. Dividends- payments made by corporations to shareholders (i.e. profit sharing).

Example- Facebook declares a dividend of $5 per share.

2. Capital gains- selling a stock for more than its original purchase price.

Short term capital gain = own for less than 1 year

Long term capital gain= own for more than 1 year

Example: Google Stock- $53.14 8/27/04

$537.76 4/11/14

TRADING STOCKSThe two major stock exchanges are:

New York Stock Exchange- The NYSE handles the most powerful and established corporations in the world.

Example- GM, Coca-Cola, Wal-Mart

NASDAQ- NASDAQ is an electronic trading network which specializes in technology stocks.

Example- Facebook, Amazon, Google

STOCKBROKERSStockbrokers connect buyers with sellers of stock.

Stockbrokers work for brokerage firms such as Merrill Lynch or Charles Schwab.

Stockbrokers are paid a commission each time they make a trade

STOCK INDEXDow Jones Industrial Average- The “Dow” monitors and reports the trading activity of 30 large companies.

The Dow as of 4/11/14 was at 16,026 points

The Standard & Poor’s 500- The S&P 500 tracks stocks in a variety on industries.

The S&P as of 4/11/14 was at 1,815 points

Dow Jones Index Companies

BULL AND BEAR MARKETSA bull market occurs when the stock market rises steadily over time.

A bear market occurs when the stock market falls over a period time.

Stock indexes like the Dow and S&P 500 indicate if the market is a bull or a bear

MARKET CRASHESThe Great Crash of 1929- On 10/28/29 the market crash began and the Dow declined nearly 25% in two days.

Black Monday- On 10/18/87 the Dow lost nearly 23% in a single day.

The Financial Crisis- The Dow declined from 14,000 in October 2007 to 7,949 in January 2009

REGULATIONSSecurities and Exchange Commission regulates trading stocks and bonds.

The goal of the SEC is to protect investors from fraud and deception in the sale of stocks and bonds.

The SEC also aims to create a level playing field for all investors and prevent insider trading.

Insider trading is buying or selling stock after learning about important, nonpublic information.

ALTERNATIVE INVESTMENTSAlternatives are illiquid, risky investments open to wealthy individuals and institutional investors.

Alternatives are not publically traded.

Loosely regulated by the government.

Example- a hedge fund is a high risk mutual fund only open to wealthy investors.

WHAT TYPE OF INVESTOR ARE YOU?You received a graduation gift of $100,000. Create an investment strategy to manage your money.

You investment strategy should answer the following questions:

Are you a cautious or an aggressive investor?

What industries will you focus on?

Will you purchase both domestic and foreign investments?

Would you buy stocks, mutual funds, bonds or all three?

How will you allocate your money among the different types of investments?