Equities and Indexes Common Stock Preferred Stock Equity

Equities and Indexes Common Stock Preferred Stock Equity Index Bond Index

Common Stock q Definition Ø q Ownership shares in public companies Characteristics Ø Voting rights q Ø Residual Claims q Ø Shareholder can vote for company issues, e. g. , executive compensation, board of directors, auditing firm, etc. Last in line of all claimants on the company, e. g. , owns whatever is left after workers, suppliers, bondholders are paid off. Limited Liability q Investments 3 Lose no more than original investment, e. g. , you pay $90 for a share of IBM, you’ll lose no more than that. 2

Common Stock q A quote from WSJ (or YAHOO these days) 52 Weeks Hi Lo Stock (SYM) DIV YLD% P/E Volume Hi 17. 52 5. 73 Net Lo Close Chg Gen. Elec (GE) 0. 40 2. 43 14. 68 74, 123, 574 16. 75 16. 35 16. 44 -0. 26 $0. 10/Quarter q A few questions Ø Ø Ø How much do you have to pay for a share at close? What is last year’s earning? Is the stock boring? Investments 3 3

Preferred Stock q Definition Ø q Characteristics Ø Ø Ø q Non-voting share in a corporation Fixed dividend stream (like bond coupon) Dividend may be skipped yet cumulative Dividend fully taxable How different is it from a bond? Investments 3 4

Indexes: Equity and Bond q What are they? Ø q Why do we need them? Ø Ø Ø q An indicator of average security prices Tracking market returns Benchmarking fund manager performance Bases for derivatives, e. g. , index options Factors affecting an index Ø Ø Representative? Weighting of components? Investments 3 5

Equity Indexes q q q q DJIA S&P 500, S&P Mid Cap. NASDAQ 100 Nikkei 225 (Tokyo Stock Exchange) FTSE 100 (London) Wilshire 5000 MSCI-EAFE Index Ø Morgan Stanley Capital International Europe, Australia, Far East Index (including 21 developed countries outside North America) Investments 3 6

Equity Indexes: DJIA q Some facts Ø Ø Ø q 30 industrial stock price-weighted average. Oldest and best-known in the U. S. Used to representing about a quarter of the market value of the NYSE stocks. Quantitatively Ø Divisor changes when stock splits or stock is replaced by another Investments 3 7

Equity Indexes: DJIA q Construction Ø Suppose DJIA has two stocks Divisor Investments 3 8

Equity Indexes: DJIA q What happens when a stock splits? Ø At market close today, B has a 2 -for-1 split Divisor Ø Where does the new divisor come from? Investments 3 9

Equity Indexes: S&P 500 q q q Including 500 NYSE, Amex, NASDAQ stocks Considered to be a much broader index of the U. S. market than the DJIA Numerous financial products derived from the index Ø Ø Ø q q Mutual funds indexed to the S&P 500 Index S&P Depository Receipts (SPDR) S&P 500 Index Options and Futures Market value-weighted index – larger companies have more weight in S&P 500 is float-adjusted since Sep 16, 2005 Investments 3 10

Equity Indexes: S&P 500 q Market value-weighted index - Calculation Investments 3 11

Equity Indexes: S&P 500 q When does the divisor change? Ø Ø Ø NOT for stock split YES for stock replacement in the index E. g. , C replaces B in the index Divisor Investments 3 12

Example: Amazon. com joining S&P 500 AMZN joins S&P 500 on Nov 18, 2005 Announcement is made after market closing on Nov 14, 2005 Investments 3 13

Equity Indexes q Equally Weighted Stock Indexes Equally weighted stock indexes place equal weight on each stock return, and call for a portfolio strategy that places equal dollar values in each stock. E. g. , Stock A has a return of 2% and stock B has a return of 1%. An equally weighted index of A and B has a return of 0. 5*2% + 0. 5*1% = 1. 5% q Constant portfolio rebalancing is required to track such an index Investments 3 14

Bond Indexes q An indicator for bond market returns * Now Barclays Capital Aggregate Bond Index Investments 3 15

Wrap-up q q q What are stocks and preferred stocks? What are stock indexes for? What are commonly used indexes? Ø Ø Ø q DJIA: price-weighted - Old and Faithful S&P: float value weighted - good “market” proxy NASDAQ: new and dynamic Less followed Ø Bond indexes: professionals pay more attention to it Investments 3 16