FIN 432 Vicentiu Covrig Equity Markets chapter 2

FIN 432 Vicentiu Covrig Equity Markets (chapter 2) 1

FIN 432 Vicentiu Covrig Equity Markets n New York Stock Exchange - An Agency Auction Market u Market in which brokers represent buyers and sellers and prices are determined by supply and demand. www. nyse. com - Trading u. All trading in a specific stock is done at the post where that stock is assigned on the NYSE floor. u. Trading is managed by the specialist. 2005 NYSE Average Daily Stock Volume (millions) 1, 604 NYSE Average Trade Size per Sale (in shares) 334 Number of NYSE Non-US Stocks 453 NYSE Dollar Value of Trading Activity (billions of dollars) $56. 1 Programs as % of Total NYSE 56. 9% Companies Listed on the NYSE 2, 779 2

FIN 432 Vicentiu Covrig American Stock Exchange n n AMEX is also a specialist auction market Lower listing standards than NYSE More than 1, 000 listings - 140+ Exchange Traded Funds - 15+ HOLDRs - 350+ structured products www. amex. com 3

FIN 432 Vicentiu Covrig Nasdaq n n Electronic market Negotiated market - Market makers are n dealers Price determination through bargaining 3, 600+ issues - more technology firms - Dell, Microsoft, Intel www. nasdaq. com 4

FIN 432 Vicentiu Covrig Other U. S. stock markets n n n Nasdaq Small. Cap Market - 800 small firms seeking Nasdaq market maker sponsorship - No penny stocks (price < $1) Over-the-Counter Bulletin Board - 3, 000+ securities offered by 300+ market makers - Penny stocks traded here Electronic Communication Networks (ECNs) - Electronic market for institutional investors to trade with each other 5

FIN 432 Vicentiu Covrig Dow Averages n Charles Dow and Edward Davis Jones - Credited with inventing the stock index - First stock index created in 1884 u 11 firms u. Mostly railroad companies u. Added up the stock prices and divided by 11. (price average index) n - DJIA was started in 1896 with 12 stocks DJUA, DJTA 6

FIN 432 Vicentiu Covrig Dow Jones Industrial Average n n 30 companies - Most important and largest firms - Selected by the editors of the Wall Street Journal Formula While originally 30, the divisor has been steadily reduced to account for stock splits. At the beginning of 2006 the divisor was 0. 12493117. Note that a $1 change in a stock’s price causes the DJIA to change by 8 (=1/ 0. 12493117) 7

FIN 432 3 M Co. Vicentiu Covrig Alcoa Inc. Altria Group Inc. Problems with price-weighted averages American Express Co. American International Group Inc. Boeing Co. Caterpillar Inc. n Citigroup Inc. Coca-Cola Co. n E. I. Du. Pont de Nemours & Co. Exxon Mobil Corp. General Electric Co. General Motors Corp. Hewlett-Packard Co. Home Depot Inc. $10. A $10 stock that increases 10% changes by $1. A change of $10 moves the DJIA ten times more than a $1 change. Honeywell International Inc. Intel Corp. International Business Machines Corp. Johnson & Johnson JPMorgan Chase & Co. Mc. Donald's Corp. Merck & Co. Inc. Microsoft Corp. Stock splits require changes in the divisor Larger priced stocks move the index more than smaller priced stocks for the same % price move. - A $100 stock that increases 10% changes by n Difficult to index to a price-weighted average. Pfizer Inc. Procter & Gamble Co. SBC Communications Inc. United Technologies Corp. Verizon Communications Inc. Wal-Mart Stores Inc. Walt Disney Co. 8

FIN 432 Vicentiu Covrig Standard & Poor’s 500 Index n The 500 -firm index started in 1957 - Value weighted index u. Determine market capitalization of each firm (stock price × shares outstanding) u. Add up the market capitalization for all 500 firms u. Scale (Index Base set to 10) - Generally the largest 500 firms in the U. S. u. However, it is designed to match the sectors weights of the overall market composition. 9

FIN 432 Vicentiu Covrig Index Example n Consider 3 stocks. - Stock A is $40 and has 300 shares outstanding - Stock B sells for $60, outstanding shares of 200 - Stock C costs $80 and has 100 shares. n Consider two indices - Price-weighted average, divisor=2. 5 - Value-weighted average u. Base index value = 100 u. The stock originally sold for $30, $50, and $60 with outstanding shares of 300, 100, and 100, respectively 10

FIN 432 Vicentiu Covrig What is the value of each index? n Price-weighed average (40 + 60 + 80) / 2. 5 = 72. 00 n Value-weighted index {($40 X 300 + $60 X 200 + $80 X 100) / ($30 X 300 + $50 X 100 + $60 X 100)} × 100 = {32, 000 / 25, 000} × 100 = 128. 00 11

FIN 432 Vicentiu Covrig What is the value of each index after the $40 stock changes to $45? n Price-weighed average (45 + 60 + 80) / 2. 5 = 74. 00 a 2. 78% change n Value-weighted index {($45 X 300 + $60 X 200 + $80 X 100) / ($30 X 300 + $50 X 100 + $60 X 100)} × 100 = {33, 500 / 25, 000} × 100 = 134. 00 a 4. 69% change 12

FIN 432 Vicentiu Covrig More Popular Indices n Russell Indexes - Russell 3000 uses the 3, 000 largest U. S. companies u. Represents 98% of the investable US equity - Russell 1000 uses the 1, 000 largest U. S. companies u. Represents 92% of the investable US equity - Russell 2000 uses the 2, 000 smallest companies n the Russell 3000 u. Considered a small cap index. 13

FIN 432 Vicentiu Covrig Dow Jones Wilshire 5000 (Full Cap) Price Dow Jones Wilshire 4500 (Full Cap) Price Dow Jones Wilshire 2500 Price Dow Jones Wilshire U. S. Large-Cap Price Dow Jones Wilshire U. S. Mid-Cap Price Dow Jones Wilshire U. S. Small-Cap Price Dow Jones Wilshire U. S. Micro-Cap Price Dow Jones Wilshire U. S. Large-Cap Growth Price n Dow Jones Wilshire U. S. Large-Cap Value Price Dow Jones Wilshire U. S. Mid-Cap Growth Price Dow Jones Wilshire U. S. Mid-Cap Value Price Dow Jones Wilshire 5000 Composite Index - Most comprehensive measure of the U. S. - Dow Jones Wilshire U. S. Small-Cap Growth Price Dow Jones Wilshire U. S. Small-Cap Value Price Wilshire Large Cap 750 - Wilshire Mid Cap 500 Wilshire Small Cap 1750 stock market Designed to represent the performance of all US-headquartered equity securities Contains 4, 972 stocks (beginning of 2006) Wilshire Micro Cap Wilshire All Growth Wilshire All Value Wilshire Large Growth Wilshire Large Value Wilshire Mid Growth Wilshire Mid Value n Dow Jones Wilshire 4500 - Contains the Wilshire 5000 firms less the - Wilshire Small Growth Wilshire Small Value Wilshire Small Cap 250 Price 14 S&P 500 firms Considered a mid-cap index

FIN 432 Vicentiu Covrig Nasdaq Indexes n n Nasdaq Composite Index - All common stocks listed on the Nasdaq Stock Market - 3, 175 firms - Market value-weighted Nasdaq 100 Index - Largest 100 firms on the Nasdaq Stock Market - Large stock index, but technology oriented 15

FIN 432 Vicentiu Covrig Standard & Poor’s S&P 500 n S&P Mid. Cap 400 Index n - 400 firms - Stocks with market caps of $1. 5 to $10 billion n S&P Small. Cap 600 Index - 600 firms - Average market cap of $600 million 16

FIN 432 Vicentiu Covrig Global Stock Indexes n Major Local Stock Market Index - Nikkei, Dax, FTSE n Morgan Stanley Capital International Indexes - Global, regional, and local indexes - Emerging and developed markets 17

FIN 432 Vicentiu Covrig Securities Market Regulation Legislation Important to Investors, Issuers of Securities and Brokers/Dealers Securities Act of 1933 - Applies to firms going public— - Securities Exchange Act of 1934 - Focuses on securities trading - Creates and authorizes issuing new securities Requires firms to register with government Requires firms to provide investors with financial and material information Exempts private placements and small issues - 18 Securities and Exchange Commission (SEC) to enforce statutes, rules, and regulations Protects investors against fraud

FIN 432 Vicentiu Covrig Self-Regulatory Organizations (SROs) n n n SEC delegates regulatory authority National Association of Securities Dealers (NASD) - Regulates Nasdaq and OTC - Monitors sales practices - Administers tests and licenses for individuals - Ensures accurate sales information NYSE, AMEX, CBOE--business practices and market operations Municipal Securities Rulemaking Board Banks—Fed Reserve, Comptroller of Currency, FDIC 19

FIN 432 Vicentiu Covrig Circuit Breakers and Trading Limits n n On Monday, October 19, 1987, the DJIA lost over 22% of its value in a crash. This event lead to the enactment of circuit breakers that pause or close trading during fast moving markets. Breakers are set to 10%, 20%, and 30% of recent DJIA level. - At DJIA 10, 000, the breakers are changes of 1, 000, 2, 000, and 3, 000. - The first breaker halts trading for 30 to 60 minutes. - The 2 nd breaker halts trading for 2 hours and the third breaker stops trading for the day. Collars: restricts index arbitrage when DJIA moves 200 points. - “Curbs” are in 20

FIN 432 Vicentiu Covrig Learning objectives Discuss the trading on NYSE, AMEX and Nasdaq Discuss the other US stock markets Discuss the DJIA and. S&P 500 indices. Know how to calculate the indices. See the example in the slides. Know the Russell and Wilshire indices Discuss the Self Regulatory organizations. Discuss the Circuit Breakers and Trading limits. End of chapter CFA problems 2. 1 and 2. 2 21