ECON 0110 1st Edition Lecture 11EXAMPLES:FIDELITY MAGELLANBuys stock of high growth companiesLots of buying and selling to “beat the market” = high expensesVANGUARD 500Buys shares of the 500 largest corporations sold on the New York Stock Exchange(NYSE)No attempt to “beat the market” = low expensesVanguard 500 is an INDEX FUNDNEW YORK STOCK EXCHANGE:Located on WALL STREET Location where shares of several thousand major corporations are bought andsoldNo new shares of stock are being traded on the NYSEDOW JONES INDUSTRIAL AVERAGEAdjusted average price of shares of stock in 30 major “industrial” corporationsDollar weightedTO SEE HISTORICAL DATA ON THE DOW JONES INDUSTRIAL AVERAGEhttp://stockcharts.com/freecharts/historical/djia1900.htmlSTANDARD & POOR’S 500 INDEXAdjusted average price of shares of stock in 500 major U.S. corporationsMarket capitalization weightedTO SEE HISTORICAL DATA ON THE S&P 500http://finance.yahoo.com/q/hp?s=%5EGSPC&a=00&b=3&c=1950&d=11&e=29&f=2014&g=m1PROSPECTUSOfficial description of a corporation for purposes of selling new shares of stockANNUAL REPORTDescribes activities of a corporation during the last yearProvides financial information: sales revenue, profits, etc.2345BRIEF DESCRIPTION OF HOW THE DOW JONES INDUSTRIAL AVERAGE (DJIA) ISCALCULATEDFirst note that most of the corporations currently included in the DJIA are not“industrial” corporations. Some are banking, some are pharmaceuticals, etc.SIMPLE EXAMPLE USING 3 COMPANIES:To keep things simple, let’s use 3 companies rather than 30 companies. Back in1896, suppose the stock of the 3 corporations stock sold for $50, $100, and $150.The initial calculation of the DJIA would be($50 + $100 + $150)/ 3 = $100Now assume each stock increased in price to, say, $800. The new calculation ofthe DJIA would be($800 + $800 + $800)/3 = $800Now comes the tricky part!Assume each corporation believes that a price of $800 per share is too high toentice investors. They need to lower the price somehow. For simplicity, assumeeach corporation decides to have an 8 for 1 stock split. That is, if you owned 1share previously, now you will own 8 shares. If each share was originally worth$800, then each new share would become worth $100.Nothing has changed in the economy, so we need the value of the DJIA to be$800, just as it was before the split. But now, we have three stocks selling for$100 each. The average price of these three stocks is $100. But the DJIA needsto be $800.What we do is change the DENOMINATOR.We need ($100 +$100 + $100)/D = $800We obtain D = $300/$800 = .375Now suppose each of the stocks increase in price to $300. The new DJIA wouldbe (300 + 300 + 300)/.375 = 900/.375 = 2,400Note that the DJIA = 2,400 and this is NOT the average price of the three stocks(which is 300).Now suppose these three companies become irrelevant in the economy. DowJones replaces these three companies by three modern companies whose stockprices are $100, $100 and $100. Nothing has happened in the economy, so thenew DJIA should remain at $2,400.6Once again, we need to change the DENOMINATOR.We need ($100 +$100 + $100)/D = $2,400We obtain D = $300/$2400 = .125Note that the DJIA = 2,400 and this is NOT the average price of the three newstocks (which is