Basic information• Course web site:www.econ.ucsc.edu/faculty/elbaum• Bernard Elbaum, Economics Dept.,Engineering 2, Room 431, ext. 9-4248,email [email protected]• Office hours, Tu Th 1-2Econ 80H: Introduction• Why take this course?– Fear– Greed– Desire for knowledge requisite to financialdecision-making and self-reliance– Self-reliance is much cheaper than payingothers for advice and suffering losses from theirconflicts of interestSome Advice• Do course reading on time & come to class• There is a large volume of course material• Much new vocabulary• Some basic statistics• If you’re familiar with the stock market,that’s a big advantage• If not, your mind may be buzzing soonHow to learn the course material• Seek multiple sources of reinforcement• Do the reading• Come to lecture• Go to section• Do homework exercises• Read newspapers & magazines aboutfinanceDon’t skimp• My mother-in-law clips coupons– She saves a few dollars that way– If she paid more attention to her portfolioinstead, she’d earn thousands more per year• Buy the textbooks and read them– The returns to learning the material are huge– The book costs are paltry by comparison– If you have liquidity constraints, find a solutionFurther Advice• Read as much as can about finance• Benefit of reading additional media– The more you know, the more valuable yourinformation is likely to be– It will help you in this course– It may help you get a job– It will help you understand the world– It will eventually help you make investment decisionsworth far, far more than the cost of buying the mediaRead other media• For example, I’ll pass around a signup form forthe Wall St. Journal which I’ll fax in• Or subscribe to The Economist magazine• I know high schoolers who read it weekly• 12-weeks for only $19.95• 25-weeks for only $39.90• 51-weeks for only $77.00• Go to www.economistacademic.com• For instructor code, enter 4173• Best short source of international & financial news2 Views of stock prices• Psychological--crowdpsychology/castles in the air• FundamentalistWhy this course• Gain understanding of financial markets that rulemuch of modern life--a worthy part of liberal artseducation• Prepare for a career in finance– Better advised if an econ major to take upper divisioncourses 133 & 135• This is rare course that helps you understand theworld and also relates directly to your life• No single course is likely to matter more to yourfinancial well being than this one.Psychological View• Leads to chartism and markettiming approaches• Try to predict marketstatistically based on pasttrading volumes and prices• Published prediction schemesgenerally fail empiricaltestsGains from saving• Well considered frugality does pay• Those who have saved and invested well inthe US have reaped terrific gains• If you invested $2000 per year each year for40 years, you wound up with nearly $1million• Don’t save on reading matter. But do saveand invest once you start earning.Psychological View• What about unpublished schemes?• If you had a scheme that seemed to work,would you publish it?• There is evidence that some statistical,technical trading rules worked in the past.• Will the same rules work in the future?Would you bet your money on it?Fundamentalist View• Market prices reflect genuineearnings capacity of companyin the future• Also reflect current companywealth--the value of assetsowned by the company• Fundamentalism must be truein long runMarket Efficiency• Efficiency says that stock price reflectsavailable information about fundamentals• Everyone agrees that market is fairlyefficient in the long run• But things are much less clear in the shortrunMarket Efficiency• The idea is that the market must be efficientor else there would be easy money sitting onthe table for someone to just pick up• Too many smart people are looking for easymoney for there to be any aroundMarket Efficiency• Who would you rather trust to invest yourmoney?• Very highly paid and highly educatedprofessionals who work as fund managerson Wall St. and wear expensive suits• Or baboons throwing darts at the WallStreet Journal?Market Efficiency• The evidence suggests that you’re better offwith the baboons• The professionals don’t like be comparedunfavorably to bare-assed apes.• But the comparison does not say that theapes are smarter• It says there are too many smartprofessionals for anyone to beat the averageMarket Efficiency• If it is hard to beat the average, the bestadvice is to ignore the professionals• Don’t pay hefty fees to the pros so they cantry and fail to beat the market• Instead pay low fees to an index fund whichwill get you the average, guaranteed.What is a stock?• A share of ownership in a publicly heldcompany that enjoys limited liability• What does “publicly held” mean?• What does “limited liability” mean?Publicly held• Publicly held means that the company’sshares are held by anyone in the investingpublic who buys them• They are not held privately• There is a market for them where shares canbe boughtLimited Liability• Limited Liability means that shareownersare not liable for the company’s debts• The most you can lose as a stock purchaseris 100% of the amount that you invest inbuying stock• Limited liability companies are known ascorporationsRights of stock ownership• You technically have the right to vote oncorporate issues at their annual meetings ofshareholders.• One share = one vote• You have rights to receive dividendsDividends• What are dividends?• A dollar amount that a corporation pays pershare• Usually paid quarterly, though there can bespecial one-time dividends• Companies generally maintain a givendividend level for years with infrequent cutsor increasesDividends• Dividends are paid out of company profitsor earnings• Whatever companies don’t pay out asdividends, they are free to reinvest incompany operations• As an alternative to paying dividends,companies can buy shares back fromstockholdersStock returnsHow do you earn returns on stock?From dividends.And from increases in stock price thatrepresent what we call capital gainsStock price movementsWhy does stock price go up or down?In theory, stock price reflects the present value of thefuture dividends expected by investorsDividends reflect profitsProfits reflect the business share of