Chapter 9 Stock Market Averages and Indexes Measure the general behavior of stock prices over time Averages reflects the arithmetic average price behavior of a representative group of stocks at a given point in time Indexes Measure the current price behavior of a representative group of stocks in relation to a base value set at an earlier point in time Dow Jones Industrial Averages Tracks general behavior of component firms The average is composed of 30 stocks selected for total market value and broad public ownership These 30 stocks are believed to be high quality stocks whose behavior reflects the overall market Value of the DJIA A sum of closing share prices of the 30 stocks divided by a divisor The purpose of the divisor is to adjust for any stock splits company changes or other stock altering events The divisor calculation is very complex Dow Jones Transportation Average similar to the industrial average a composition of 20 stocks including railroads airlines freight forwarders and mixed transportation companies Dow Jones Utility Average computed using 15 public utility stocks Dow Jones 65 Stocks Composite Average made up of all 30 industrial 20 transportation and 15 utility stock indexes Dow Jones US Total Stock Market Index Market Weighted index that measures the performance of all equity securities issued by U S companies that have readily available price data Market Weighted means that companies with large total market values have the most effect on the indexes movement Standard Poor s Indexes Similar to the DJIA in that it is a publisher of major common stock indexes Some key differences between the S P and the DJIA are S P is based on market values rather than share prices Many investors feel that S P indexes provide more broad based and representative measures of general market conditions Similarly to the DJIA S P indexes are only meaningful when compared in other time periods or to their respective base period value The DJIA and S P indexes tend to behave in similar fashion over time however their day to day magnitude and direction up or down can differ significantly because of the differences in how the indexes are constructed DJIA equally weighted S P Market Value Weighted Other S P indexes The S P 500 index comprised of 500 large sized companies The S P 100 Index comprised of 100 large sized companies with individual stock options required for each constituent The Industrial Index made up of the common stock of 400 industrial firms The S P 400 MidCap Index comprised of 400 medium sized companies The S P 600 SmallCap Index comprised of 600 small sized companies The 1500 SuperComp Index comprised of all stocks in the S P 500 400 MidCap and 600 SmallCap indexes Bond Market Indicators there are fewer indicators of overall bond market behavior than of stock market behavior Bond Yield the return an investor would receive in a bond if it were purchased and held to maturity These are reported as annual rates of return Bond Indexes a method of measuring the value of a section of the bond market It is computed from the prices of selected bonds typically a weighted average It is a tool used by investors and financial managers to describe the market and to compare the return on specific investments Stockbrokers act as intermediaries between buyers and sellers of securities by executing the buy sell orders at the best possible price Brokers are typically paid off commission Churning is the illegal and unethical practice of excessive trading by a broker on a clients account to generate commission This practice violates SEC rules and securities laws Brokers must be licensed by both the SEC and the securities exchanges on which they place orders Remember that in a broker v dealer market brokers buy and sell securities on behalf of their client s while dealers buy and trade on their own behalf Dealer markets use Market Makers dealers who assume the risk of holding a certain number of shares of a particular security to facilitate trading in their own name Four Brokerage Services Route clients buy and sell orders be executed at the best possible price to marker venues where they will Brokerage firms typically hold their clients security certificates for safekeeping The brokerage house will issue the securities in its own name Street Name and holds them in trust for their client Because of this the firm can transfer the securities at the time of sale without the client s signature Firms provide free information about investments The firm typically has a research staff that periodically reports on economic market industry or company behaviors and makes recommendations regarding buying selling or holding certain securities Firms will also invest surplus cash left in a clients account into a money market mutual fund allowing the client to earn interest that helps the investor earn as much as possible on temporarily idle funds Basic Types of Orders investors use different types of orders to make securities transactions The type placed normally depends on the investor s goals and expectations Market Order An order to buy or sell stock at the best price available at the time the investor places the order This is the quickest way to fill orders with definite execution because market orders are generally executed as soon as they reach the exchange floor Disadvantage in fast moving markets the price can be significantly different than what you expect price uncertainty Limit Order an order to buy at or below a specified price limit buy order or sell at or above a specified price limit sell order Most effective when the price of a stock fluctuates greatly Fill or Kill order is cancelled if not immediately executed Day Order order is cancelled if not executed by the end of the day Good til Cancelled GTC Order order generally remains in effect for 6 months unless executed cancelled or renewed Disadvantages Can keep you from making profitable transactions When the stock price closely reaches but does not attain the sale price limit before dropping substantially missing the market Execution uncertainty Stop Loss Order The broker sells a stock when its market price reaches or drops below a certain level Stop Loss orders are suspended orders activated if and when the stock reaches a certain price Typically day or GTC orders Once activated the order becomes a market order where the security will be sold at the best available price Investors use Stop loss orders to protect themselves against the
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