Concepts of the Stock Market

Chapter 15.1

What is a Stock? A stock is a share of ownership in a

company When you buy a stock, you are paying for

a small percentage of everything that the company owns

When you own a stock, you are referred to as a stockholder or shareholder

What is the difference between

a Stock and a Bond? A stock means that you

own part of the company Owning stock also allows

you to receive a percentage of the profits that the company makes

A bond is simply a loan to a company

When you buy a bond, you get your original investment (principal) back plus interest

A bond is not a form of ownership in the company

Bond owners get paid back before stockholders if the company fails

How is Stock Performance Measured?

Several measures exist to measure stock performance. The two most common are:

o The Dow Jones Industrial Averageo The S & P 500 These measures allow the performance of

the stock market to be measured and compared over time.

They also are used as an indicator of the health of the economy as a whole.

Components of the DJIA 3M Altria Group Alcoa American Express Am. Intl. Group Boeing Caterpillar Citigroup DuPont Exxon Mobil General Electric General Motors Hewlett Packard Honeywell Int. IBM

Intel Corp. J.P. Morgan Johnson & Johnson McDonald’s Merck Microsoft Pfizer SBC Communications Coca-Cola Home Depot Proctor and Gamble United Technologies Verizon Wal-Mart Walt Disney

 10,543.22       -9.60 / -0.09%

Dow Jones Industrial Average

 Open: 10,530.36  YTD % Change: 0.85%

 

     

 High (day): 10,616.23  High (52wk): 10,794.95

     

 Low (day): 10,469.62  Low (52wk): 9,660.18

     

 Volume: 236,390,300.00  Last Close: 10,552.82

Why do Stock Prices Change? Stock prices rise and fall due to many

reasons:• The Value of the Business increases or

decreases• Profits increase or decrease• Interest rates rise or fall• The Economy shows growth or decline• Publicity about the company (good v. bad

news)

Market Nicknames A market that is

declining (stock prices falling) is referred to as a BEAR MARKET!

A market that is rising (stock prices increasing) is referred to as a BULL MARKET!

The Dow Chemical Company (NYSE)    DOW 44.54 -0.40 -0.89% Volume: 4,728,200

Why did Dow Stock Change in Value?

Speculate on reasons for the variations over the past year. . .o New product lineso Effects of Hurricanes Katrina

and Ritao Other possible ideas. . . .

So. . .What Caused the Crash of the Stock Market in 1929?

According to economist John Kenneth Galbraith:1. Bad distribution of income2. Bank failures and lack of regulation3. Foreign Trade Balance (imports v. exports)4. Lack of Economic Intelligence

AND . . . . .SPECULATION & MARGIN BUYING

Causes of the Crash: Speculation

Speculation: making high risk investments to achieve high rewards

Investors took chances hoping for a big payoff

In some instances, the value of a business’ assets was less than the value of its stock due to speculation and over-confidence

0

10

20

30

40

50

60

70

80

Value ofAssetsValue ofStock

What is MARGIN BUYING? Instead of buying stocks only with cash,

during the 1920s banks and brokers allowed investors to “buy on margin”

“Margin buying” means that an investor could pay a certain % as a down payment and borrow the remainder of the price of the stock

The goal was to sell the stock at a price higher than the purchase to pay back the loan plus interest and still make a profit!

Causes of the Crash: Margin Buying Allowed people to

invest without the immediate capital (Buy now, pay later)

Encouraged business growth and expansion

Furthered the stock buying frenzy in the country as prices rose

When prices fell, brokers tried to call in their loans

Investors who bought stocks on margin struggled to break even or lost their entire investment

Examples of Margin Buying: Positive

Stock Price $100 Margin $10 Borrowed $90

Selling Price$150

Repayment $90 + (interest) $23

Profit $37

This is a positive situation for the speculator because he can afford to pay back his loan plus interest and still make a profit.

The margin allowed him to buy stock that he could otherwise not afford.

Example of Margin Buying: Negative

Stock Price $100 Margin $10 Borrowed $90

Selling Price $90 Repayment $90 + (interest) $23

Profit/Loss $33

This is negative margin buying because the speculator was not able to sell the stock at a price that allowed him to pay back the broker’s interest and margin.

His gamble did not pay off and he lost money.

Rise of the Stock Market during the 1920s (Measured

by the DJIA) End of 1928 191 3/4/29 313 9/3/29 381 Prices begin to fall in September due to profit

taking 10/23/29 -21 pts. per hour 10/24/29 Black Thursday 10/25/29 Bank Intervention 10/29/29 Black Tuesday (4x more

shares sold) 11/13/29 198

Stock Market Performance1921 - 1940

Effects of the Stock Market Crash

Immediate cause of the Great Depression Caused income and profits to fall American factories closed due to overproduction Unemployment rose rapidly Small businesses closed (restaurants, shops) Farm prices fell even lower Banks closed The Dawes Plan (loans to Germany) ceased The Allies stopped repayment of loans World trade slowed and the Global Economy

starts a downward cycle