FIN3244 EXAM 2 Investment Information and Securities Transactions CH9 Understanding Market Averages and Indexes o o A group of preselected securities usually chosen for some shared characteristic s Purpose Measure general market movement or conditions Track price and or volume changes through time Compare portfolio s performance to that of a large diversified market portfolio serves as a benchmark reference chart Forecast future market behavior through the study of market cycles trends and behaviors o How to Use o How to Interpret Appropriate index Keep time periods identical Compare by the percent of change NOT the dollar amount Key Point Gives us a general idea as to how the market is performing in order for us to compare it to our company and see how it s performing When reflecting a sustainable upward trend in prices over time a bull market is said to exist When reflecting a sustainable downward trend in prices over time a bear market is said to exist Stock Market Averages and Indexes o Measure the general behavior of stock prices over time Average 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 the standard cite is the closing price of the day o The Dow Jones Averages track the general behavior of component firms Equally weighted averages percent change in higher priced components have a greater impact on the average I E Stock 1 50 goes up 10 goes up 5 points Stock 2 200 goes up 10 up 20 points o Stock 2 goes up by a higher amount due to it s higher price Doesn t consider size of a company only looks at price Divisor measures the return excluding dividends on a portfolio that holds one share of each stock Maintains comparative relationships overtime to help predict the future time series Adjusts for any stock splits company changes or other events that have occurred over time Multiple Dow Jones Averages Dow Jones Industrial Average DIJA the average is made up of 30 stocks selected for total market value and broad public ownership each stock is of high quality to ensure the behavior as believed reflect overall market activity o DIJA closing share price of STK1 closing SP of STK2 closing SP of STK30 DIJA DIVISOR o Most popular and largest companies in appropriate industries o Intention is to give a broad overview of what s going on in the U S economy Dow Jones Transportation Average based on 20 stocks including railroads airlines freight forwarders and mixed transportation companies Leading indicator of future events I E an influx of transportation during Christmas due to getting presents from Point A to Point B Dow Jones Utility Average computed using 15 public utility stocks Extremely regulated Behaves more like bonds than stocks Dow Jones Composite Average sum of all indexes market weighted index o o o 1 o Companies with large total market values have the most effect on the index s movement Key Point There are many averages available depending upon what you want to measure and what you re looking at You need to use the appropriate index even though indexes can sometimes be used to measure multiple things For example you wouldn t want to use an industrial one with utilities Standard Poor s Indexes calculates each business day by substituting the closing market value closing price x number of shares outstanding of each stock into the following equation o Current closing market value of STK1 CCMV of STK2 CCMV of STK30 Base period closing MV of STK1 BPCMV of STK2 BPCM of STK30 X 10 Size of company is taken into consideration Generally considered a more accurate reflection of the U S economy than DJIA 500 stock composite index much more broad than DJIA Firm that selects index components of US firms with global exposure Finance is global money travels globally Almost 50 of the production sales and profits of U S firms come from overseas business o Hence if you invest with S P500 then you have at least a little involved globally o The amount paid in foreign tax is greater than the amount paid in US tax o Nasdaq Composite Index all 3000 stocks in market High concentration of technological and growth firms Because of the high concentration in biotech and computer technology it is questionable as to whether or not having more firms really makes it more broad than DJIA or S P500 General o o The Market refers to 1 DJIA OR 2 S P500 Generally both move in the same direction A Mixed Market refers to 1 DJIA 2 S P500 AND 3 NASDAQ Either two are moving up while one is moving down OR one is moving up while two are moving down Not all moving in the same direction o Most asset types move in the same direction Most stocks on a good day will move up Individual firms can vary one move up and another down Sensitivity to the market varies between each individual firm Investment Banks Mutual Funds Hedge Funds and the Shadow Banking System CH5 Investment Banking o o Commercial Banking is taking in deposits and making loans Investment Banking is mainly concerned with the following activities Providing advice on new security issues Key Point The 1st three activities are central to investment banking while the last three emerged recently I E how to raise funds by issuing stocks or bonds or taking out loans Investment banks have information about the current willingness of investors to buy different types of securities AND on the prices investors are likely to require Underwriting new security issues Investment banks unlock capital markets by knowing the ins and outs of financial markets Use derivate contacts and design new securities to help corporations manage risk Underwriting an activity in which an investment bank guarantees to issuing corporation the price of a new security and then resells the security for profit o Can lower information costs between lenders and borrowers because investment banks put their reputations behind the firms they underwrite Initial public offering IPO the first time a firm sells stock to the public 6 8 kept in equity expensive going public Seasoned Equity Offerings sale of brand new never before traded stocks or bonds of existing companies 2 4 kept in equity Syndicate a group of investment banks that jointly underwrite a large security issue 2 Providing advice and financing for mergers and acquisitions Investment banks can estimate the value of firms lead negotiations and
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