Special Topics in Economics Special Topics in Economics Econ. 491Econ. 491

Chapter 10:Chapter 10:Stock Exchange MarketStock Exchange Market

I. Stock Market OverviewI. Stock Market Overview Stock is a share in the ownership of a company. Stock

represents a claim on the company's assets and earnings.

Holding a company's stock means that you are one of the many owners (shareholders) of a company and, as such, you have a claim (albeit usually very small) to everything the company owns.

A stock is represented by a stock certificate. In the past, when a person wanted to sell his or her shares, that person physically took the certificates down to the brokerage. But now is easier.

What is the difference between the stock and What is the difference between the stock and bond?bond?

(1) Bond Market(1) Bond Market- - Corporations and Gov’s are able to borrow to finance Corporations and Gov’s are able to borrow to finance

their activities.their activities.- Bond is a dept security that promises to make Bond is a dept security that promises to make

payments on a period basis at a specific period of payments on a period basis at a specific period of time.time.

(2) Stock Exchange Market(2) Stock Exchange Market- - Claims on the earnings of corporations are tradedClaims on the earnings of corporations are traded- Stock is a share of ownership in a corporation.- Stock is a share of ownership in a corporation.

II. Types of StocksII. Types of Stocks There are two main types of stocks: common stock There are two main types of stocks: common stock

and preferred stock.and preferred stock. Common stock is common. When people talk about Common stock is common. When people talk about

stocks they are usually referring to this type. In fact, stocks they are usually referring to this type. In fact, the majority of stock is issued is in this form.the majority of stock is issued is in this form.

Preferred stock represents some degree of ownership Preferred stock represents some degree of ownership in a company but usually doesn't come with the same in a company but usually doesn't come with the same voting rights. (This may vary depending on the voting rights. (This may vary depending on the company.) company.)

With preferred shares, investors are usually With preferred shares, investors are usually guaranteed a fixed dividend forever.guaranteed a fixed dividend forever.

III. Traded StocksIII. Traded Stocks A primary marketA primary market is a financial market (stock market) is a financial market (stock market)

in which new issues of a security are sold to initial in which new issues of a security are sold to initial buyers.buyers.

A secondary marketA secondary market is a financial market (stock is a financial market (stock market) in which securities that have been previously market) in which securities that have been previously issued are resold.issued are resold.

  Secondary markets serve two Secondary markets serve two functionsfunctions::A.A. They make financial instruments more liquid They make financial instruments more liquid( cash ( cash generated from flows of money through more sellers & generated from flows of money through more sellers & buyersbuyers).).B.B. They determine the price of the security They determine the price of the security (through (through supply and demand).supply and demand).

Thus;Thus; There are many stock exchanges located in just about There are many stock exchanges located in just about

every country around the world.every country around the world.

Most stocks are traded on exchanges, which are places Most stocks are traded on exchanges, which are places where buyers and sellers meet and decide on a price.where buyers and sellers meet and decide on a price.

The purpose of a stock market is to facilitate the The purpose of a stock market is to facilitate the exchange of securities between buyers and sellers, exchange of securities between buyers and sellers, reducing the risks of investing.reducing the risks of investing.

A stock market is nothing more than a super-A stock market is nothing more than a super-sophisticated farmers' market linking buyers and sophisticated farmers' market linking buyers and sellers. sellers.

IV. Price of StockIV. Price of Stock Stock prices change every day as a result of market Stock prices change every day as a result of market

forces.forces.

Share prices change because of supply and demand.Share prices change because of supply and demand.

Understanding supply and demand is easy. Understanding supply and demand is easy.

But what makes people like a particular stock and But what makes people like a particular stock and

dislike another stock. dislike another stock.

This comes down to figuring out what news is positive This comes down to figuring out what news is positive

for a company and what news is negative.for a company and what news is negative.

So mainly, at the most fundamental level, supply and So mainly, at the most fundamental level, supply and demand in the market determines stock price.demand in the market determines stock price.

Also what affects the stock price is company’s earning Also what affects the stock price is company’s earning which affects investors' valuation of a company, which affects investors' valuation of a company,

However, there are other indicators that investors use to However, there are other indicators that investors use to predict stock price. Remember, it is investors' sentiments, predict stock price. Remember, it is investors' sentiments, attitudes and expectations that ultimately affect stock attitudes and expectations that ultimately affect stock prices.prices.

IIV. IIV. Stock Market IndexStock Market Index

Stock index or stock market index is a method of Stock index or stock market index is a method of measuring the value of a section of the stock market.measuring the value of a section of the stock market.

It is computed from the prices of selected stocks It is computed from the prices of selected stocks (typically a weighted average).(typically a weighted average).

Thus, it is a statistical measure of change in a securities market.

V. V. Economy Reaction Economy Reaction

financial markets play an important role in contributing financial markets play an important role in contributing to the health and efficiency of an economy.to the health and efficiency of an economy.

There is a strong positive relationship between There is a strong positive relationship between financial market development and economic growth.financial market development and economic growth.

Financial markets help to efficiently direct the flow of Financial markets help to efficiently direct the flow of savings and investment in the economy in ways that savings and investment in the economy in ways that facilitate the accumulation of capital and the facilitate the accumulation of capital and the production of goods and services.production of goods and services..