SouthUral State University
The Department of Economic and Management
Work on subject
The Student: Velichko O.S.
Group: E&M-263
The Tutor: Sergeeva L.M.
Chelyabinsk
1998
Contents
1. Market place
2. Trading on the stock exchange floor
3. Securities. Categories of common stock
1. Growth stocks
2. Cyclical stocks
3. Special situations
4. Preferred stocks
1. Bonds-corporate
2. Bonds-U.S. government
3. Bonds-municipal
4. Convertible securities
5. Option
6. Rights
7. Warrants
8. Commodities and financial futures
5. Stock market averages reading the newspaper quotations
1. The price-earnings ratio
6. European stock markets–general trend
1. New ways for old
2. Europe, meet electronics
7. New issues
8. Mutual funds. A different approach
1. Advantages of mutual funds
2. Load vs. No-load
3. Common stock funds
4. Other types of mutual funds
5. The daily mutual fund prices
6. Choosing a mutual fund
1. MARKET PLACE
The stock market. To some it’s a puzzle. To others it’s a source of
profit and endless fascination. The stock market is the financial nerve
center of any country. It reflects any change in the economy. It is
sensitive to interest rates, inflation and political events. In a very real
sense, it has its fingers on the pulse of the entire world.
Taken in its broadest sense, the stock market is also a control center.
It is the market place where businesses and governments come to raise money
so that they can continue and expend their operations. It is the market
place where giant businesses and institutions come to make and change their
financial commitments. The stock market is also a place of individual
opportunity.
The phrase “the stock market” means many things. In the narrowest
sense, a stock market is a place where stocks are traded – that is bought
and sold. The phrase “the stock market” is often used to refer to the
biggest and most important stock market in the world, the New York Stock
Exchange, which is as well the oldest in the US. It was founded in 1792.
NYSE is located at 11 Wall Street in New York City. It is also known as the
Big Board and the Exchange. In the mid-1980s NYSE-listed shares made up
approximately 60% of the total shares traded on organized national
exchanges in the United States.
AMEX stands for the American Stock Exchange. It has the second biggest
volume of trading in the US. Located at 86 Trinity Place in downtown
Manhattan, the AMEX was known until 1921 as the Curb Exchange, and it is
still referred to as the Curb today. Early traders gathered near Wall
Street. Nothing could stop those outdoor brokers. Even in the snow and rain
they put up lists of stocks for sale. The gathering place became known as
the outdoor curb market, hence the name the Curb. In 1921 the Curb finally
moved indoors. For the most part, the stocks and bonds traded on the AMEX
are those of small to medium-size companies, as contrasted with the huge
companies whose shares are traded on the New York Stock Exchange.
The Exchange is non-for-profit corporation run by a board of directors.
Its member firm are subject to a strict and detailed self-regulatory code.
Self-regulation is a matter of self-interest for stock exchange members. It
has built public confidence in the Exchange. It also required by law. The
US Securities and Exchange Commission (SEC) administers the federal
securities laws and supervises all securities exchange in the country.
Whenever self-regulation doesn’t do the job, the SEC is likely to step in
directly. The Exchange doesn’t buy, sell or own any securities nor does it
set stock prices. The Exchange merely is the market place where the public,
acting through member brokers, can buy and sell at prices set by supply and
demand.
It costs money it become an Exchange member. There are about 650
memberships or “seats” on the NYSE, owned by large and small firms and in
some cases by individuals. These seats can be bought and sold; in 1986 the
price of a seat averaged around $600,000. Before you are permitted to buy a
seat you must pass a test that strictly scrutinizes your knowledge of the
securities industry as well as a check of experience and character.
Apart from the NYSE and the AMEX there are also “regional” exchange in
the US, of which the best known are the Pacific, Midwest, Boston and
Philadelphia exchange.
There is one more market place in which the volume of common stock
trading begins to approach that of the NYSE. It is trading of common stock
“over-the-counter” or “OTC”–that is not on any organized exchange. Most
securities other than common stocks are traded over-the-counter. For
example, the vast market in US Government securities is an over-the-counter
market. So is the money market–the market in which all sorts of short-term
debt obligations are traded daily in tremendous quantities. Like-wise the
market for long-and short-term borrowing by state and local governments.
And the bulk of trading in corporate bonds also is accomplished over-the-
counter.
While most of the common stocks traded over-the-counter are those of
smaller companies, many sizable corporations continue to be found on the
“OTC” list, including a large number of banks and insurance companies.
As there is no physical trading floor, over-the-counter trading is
accomplished through vast telephone and other electronic networks that link
traders as closely as if they were seated in the same room. With the help
of computers, price quotations from dealers in Seattle, San Diego, Atlanta
and Philadelphia can be flashed on a single screen. Dedicated telephone
lines link the more active traders. Confirmations are delivered
electronically rather than through the mail. Dealers thousands of miles
apart who are complete strangers execute trades in the thousands or even
millions of dollars based on thirty seconds of telephone conversation and
the knowledge that each is a securities dealer registered with the National
Association of Securities Dealers (NASD), the industry self-regulatory
organization that supervises OTC trading. No matter which way market prices
move subsequently, each knows that the trade will be honoured.
2. TRADING ON THE STOCK EXCHANGE FLOOR
When an individual wants to place an order to buy or sell shares, he
contacts a brokerage firm that is a member of the Exchange. A registered
representative or “RR” will take his order. He or she is a trained
professional who has passed an examination on many matters including
Exchange rules and producers.
The individual’s order is relayed to a telephone clerk on the floor of
the Exchange and by the telephone clerk to the floor broker. The floor
broker who actually executes the order on the trading floor has an
exhausting and high-pressure job. The trading floor is a larger than half
the size of football field. It is dotted with multiple locations called
“trading posts”. The floor broker proceeds to the post where this or that
particular stock is traded and finds out which other brokers have orders
from clients to buy or sell the stock, and at what prices. If the order the
individual placed is a “market order”–which means an order to buy or sell
without delay at the best price available–the broker size up the market,
decides whether to bargain for a better price or to accept one of the
orders being shown, and executes the trade–all this happens in a matter of
seconds. Usually shares are traded in round lots on securities exchanges. A
round lot is generally 100 shares, called a unit of trading, anything less
is called an odd lot.
When you first see the trading floor, you might assume all brokers are
the same, but they aren’t. There are five categories of market
professionals active on the trading floor.
Commission Brokers, usually floor brokers, work for member firms. They
use their experience, judgment and execution skill to buy and sell for the
firm’s customer for a commission.
Independent Floor Brokers are individual entrepreneurs who act for a
variety of clients. They execute orders for other floor brokers who have
more volume than they can handle, or for firms whose exchange members are
not on the floor.
Registered Competitive Market Makers have specific obligations to trade
for their own or their firm’s accounts–when called upon by an Exchange
official–by making a bid or offer that will narrow the existing quote
spread or improve the depth of an existing quote.
Competitive Traders trade for their own accounts, under strict rules
designed to assure that their activities contribute to market liquidity.
[pic]
And last, but not least, come Stock Specialists. The Exchange tries to
preserve price continuity– which means that if a stock has been trading at,
say, 35, the next buyer or seller should be able to an order within a
fraction of that price. But what if a buyer comes in when no other broker
wants to sell close to the last price? Or vice versa for a seller? How is
price continuity preserved? At this point enters the Specialist. The
specialist is charged with a special function, that of maintaining
continuity in the price of specific stocks. The specialist does this by
standing ready to buy shares at a price reasonably close to the last
recorded sale price when someone wants to sell and there is a lack of
buyers, and to sell when there is a lack of sellers and someone wants to
buy. For each listed stock, there are one or more specialist firms assigned
to perform this stabilizing function. The specialist also acts as a broker,
executing public orders for the stock, and keeping a record of limit orders
to be executed if the price of the stock reaches a specified level. Some of
the specialist firms are large and assigned to many different stocks. The
Exchange and the SEC are particularly interested in the specialist
function, and trading by the specialists is closely monitored to make sure
that they are giving precedence to public orders and helping to stabilize
the markets, not merely trying to make profits for themselves. Since a
specialist may at any time be called on to buy and hold substantial amounts
of stock, the specialist firms must be well capitalized.
In today's markets, where multi-million-dollar trades by institutions
(i. e. banks, pension funds, mutual funds, etc.) have become common, the
specialist can no longer absorb all of the large blocks of stock offered
for sale, nor supply the large blocks being sought by institutional buyers.
Over the last several years, there has been a rapid growth in block trading
by large brokerage firms and other firms in the securities industry. If an
institution wants to sell a large block of stock, these firms will conduct
an expert and rapid search for possible buyers; if not enough buying
interest is found, the block trading firm will fill the gap by buying
shares itself, taking the risk of owning the shares and being able to
dispose of them subsequently at a profit. If the institution wants to buy
rather than sell, the process is reversed. In a sense, these firms are
fulfilling the same function as the specialist, but on a much larger scale.
They are stepping in to buy and own stock temporarily when offerings exceed
demand, and vice versa.
So the specialists and the block traders perform similar stabilizing
functions, though the block traders have no official role and have no
motive other than to make a profit.
3. SECURITIES. CATEGORIES OF COMMON STOCK
There is a lot to be said about securities. Security is an instrument
that signifies (1) an ownership position in a corporation (a stock), (2) a
creditor relationship with a corporation or governmental body (a bond), or
(3) rights to ownership such as those represented by an option, subsription
right, and subsription warrant.
People who own stocks and bonds are referred to as investors or,
respectively, stockholders (shareholders) and bondholders. In other words a
share of stock is a share of a business. When you hold a stock in a
corporation you are part owner of the corporation. As a proof of ownership
you may ask for a certificate with your name and the number of shares you
hold. By law, no one under 21 can buy or sell stock. But minors can own
stock if kept in trust for them by an adult. A bond represents a promise by
the company or government to pay back a loan plus a certain amount of
interest over a definite period of time.
We have said that common stocks are shares of ownership in
corporations. A corporation is a separate legal entity that is responsible
for its own debts and obligations. The individual owners of the corporation
are not liable for the corporation's obligations. This concept, known as
limited liability, has made possible the growth of giant corporations. It
has allowed millions of stockholders to feel secure in their position as
corporate owners. All that they have risked is what they paid for their
shares.
A stockholder (owner) of a corporation has certain basic rights in
proportion to the number of shares he or she owns. A stockholder has the
right to vote for the election of directors, who control the company and
appoint management. If the company makes profits and the directors decide
to pay part of these profits to shareholders as dividends, a stockholder
has a right to receive his proportionate share. And if the corporation is
sold or liquidates, he has a right to his proportionate share of the
proceeds.
What type of stocks can be found on stock exchanges? The question can
be answered in different ways. One way is by industry groupings. There are
companies in every industry, from aerospace to wholesale distributers. The
oil and gas companies, telephone companies, computer companies,
autocompanies and electric utilities are among the biggest groupings in
terms of total earnings and market value. Perhaps a more useful way to
distinguish stocks is according to the qualities and values investors want.
3.1 Growth Stocks.
The phrase "growth stock" is widely used as a term to describe what
many investors are looking for. People who are willing to take greater-than-
average risks often invest in what is often called "high-growth"
stocks—stocks of companies that are clearly growing much faster than
average and where the stock commands a premium price in the market. The
rationale is that the company's earnings will continue to grow rapidly for
at least a few more years to a level that justifies the premium price. An
investor should keep in mind that only a small minority of companies really
succeed in making earnings grow rapidly and consistently over any long
period. The potential rewards are high, but the stocks can drop in price at
incredible rates when earnings don't grow as expected. For example, the
companies in the video game industry boomed in the early 1980s, when it
appeared that the whole world was about to turn into one vast video arcade.
But when public interest shifted to personal computers, the companies found
themselves stuck with hundreds of millions of dollars in video game
inventories, and the stock collapsed.
There is less glamour, but also less risk, in what we will call—for
lack of a better phrase—"moderate-growth" stocks. Typically, these might be
stocks that do not sell at premium, but where it appears that the company's
earnings will grow at a faster-than-average rate for its industry. The
trick, of course, is in forecasting which companies really will show better-
than-average growth; but even if the forecast is wrong, the risk should not
be great, assuming that the price was fair to begin with.
There's a broad category of stocks that has no particular name but that
is attractive to many investors, especially those who prefer to stay on the
conservative side. These are stocks of companies that are not glamorous,
but that grow in line with the economy. Some examples are food companies,
beverage companies, paper and packaging manufacturers, retail stores, and
many companies in assorted consumer fields.
As long as the economy is healthy and growing, these companies are
perfectly reasonable investments; and at certain times when everyone is
interested in "glamour" stocks, these "non-glamour" issues may be neglected
and available at bargain prices. Their growth may not be rapid, but it
usually is reasonably consistent. Also, since these companies generally do
not need to plow all their earnings back into the business, they tend to
pay sizable dividends to their stockholders. In addition to the real growth
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