Stock market

SouthUral State University

The Department of Economic and Management

Work on subject

The Student: Velichko O.S.

Group: E&M-263

The Tutor: Sergeeva L.M.

Chelyabinsk

1998

Contents

1.   Market place

2.   Trading on the stock exchange floor

3.   Securities. Categories of common stock

3.1  Growth stocks

3.2  Cyclical stocks

3.3  Special situations

4.   Preferred stocks

4.1  Bonds-corporate

4.2  Bonds-U.S. government

4.3  Bonds-municipal

4.4  Convertible securities

4.5  Option

4.6  Rights

4.7  Warrants

4.8  Commodities and financial futures

5.   Stock market averages reading the newspaper quotations

5.1  The price-earnings ratio

6.   European stock markets–general trend

6.1  New ways for old

6.2  Europe, meet electronics

7.   New issues

8.   Mutual funds. A different approach

8.1  Advantages of mutual funds

8.2  Load vs. No-load

8.3  Common stock funds

8.4  Other types of mutual funds

8.5  The daily mutual fund prices

8.6  Choosing a mutual fund

1. MARKET PLACE

The stock market. To some it’s a puzzle. To others it’s a source of profit and endless fascination. The stock market is the financial nerve center of any country. It reflects any change in the economy. It is sensitive to interest rates, inflation and political events. In a very real sense, it has its fingers on the pulse of the entire world.

Taken in its broadest sense, the stock market is also a control center. It is the market place where businesses and governments come to raise money so that they can continue and expend their operations. It is the market place where giant businesses and institutions come to make and change their financial commitments. The stock market is also a place of individual opportunity.

The phrase “the stock market” means many things. In the narrowest sense, a stock market is a place where stocks are traded – that is bought and sold. The phrase “the stock market” is often used to refer to the biggest and most important stock market in the world, the New York Stock Exchange, which is as well the oldest in the US. It was founded in 1792. NYSE is located at 11 Wall Street in New York City. It is also known as the Big Board and the Exchange. In the mid-1980s NYSE-listed shares made up approximately 60% of the total shares traded on organized national exchanges in the United States.

AMEX stands for the American Stock Exchange. It has the second biggest volume of trading in the US. Located at 86 Trinity Place in downtown Manhattan, the AMEX was known until 1921 as the Curb Exchange, and it is still referred to as the Curb today. Early traders gathered near Wall Street. Nothing could stop those outdoor brokers. Even in the snow and rain they put up lists of stocks for sale. The gathering place became known as the outdoor curb market, hence the name the Curb. In 1921 the Curb finally moved indoors. For the most part, the stocks and bonds traded on the AMEX are those of small to medium-size companies, as contrasted with the huge companies whose shares are traded on the New York Stock Exchange.

The Exchange is non-for-profit corporation run by a board of directors. Its member firm are subject to a strict and detailed self-regulatory code. Self-regulation is a matter of self-interest for stock exchange members. It has built public confidence in the Exchange. It also required by law. The US Securities and Exchange Commission (SEC) administers the federal securities laws and supervises all securities exchange in the country. Whenever self-regulation doesn’t do the job, the SEC is likely to step in directly. The Exchange doesn’t buy, sell or own any securities nor does it set stock prices. The Exchange merely is the market place where the public, acting through member brokers, can buy and sell at prices set by supply and demand.

It costs money it become an Exchange member. There are about 650 memberships or “seats” on the NYSE, owned by large and small firms and in some cases by individuals. These seats can be bought and sold; in 1986 the price of a seat averaged around $600,000. Before you are permitted to buy a seat you must pass a test that strictly scrutinizes your knowledge of the securities industry as well as a check of experience and character.

Apart from the NYSE and the AMEX there are also “regional” exchange in the US, of which the best known are the Pacific, Midwest, Boston and Philadelphia exchange.

There is one more market place in which the volume of common stock trading begins to approach that of the NYSE. It is trading of common stock “over-the-counter” or “OTC”–that is not on any organized exchange. Most securities other than common stocks are traded over-the-counter. For example, the vast market in US Government securities is an over-the-counter market. So is the money market–the market in which all sorts of short-term debt obligations are traded daily in tremendous quantities. Like-wise the market for long-and short-term borrowing by state and local governments. And the bulk of trading in corporate bonds also is accomplished over-the-counter.

While most of the common stocks traded over-the-counter are those of smaller companies, many sizable corporations continue to be found on the “OTC” list, including a large number of banks and insurance companies.

As there is no physical trading floor, over-the-counter trading is accomplished through vast telephone and other electronic networks that link traders as closely as if they were seated in the same room. With the help of computers, price quotations from dealers in Seattle, San Diego, Atlanta and Philadelphia can be flashed on a single screen. Dedicated telephone lines link the more active traders. Confirmations are delivered electronically rather than through the mail. Dealers thousands of miles apart who are complete strangers execute trades in the thousands or even millions of dollars based on thirty seconds of telephone conversation and the knowledge that each is a securities dealer registered with the National Association of Securities Dealers (NASD), the industry self-regulatory organization that supervises OTC trading. No matter which way market prices move subsequently, each knows that the trade will be honoured.

2. TRADING ON THE STOCK EXCHANGE FLOOR

When an individual wants to place an order to buy or sell shares, he contacts a brokerage firm that is a member of the Exchange. A registered representative or “RR” will take his order. He or she is a trained professional who has passed an examination on many matters including Exchange rules and producers.

The individual’s order is relayed to a telephone clerk on the floor of the Exchange and by the telephone clerk to the floor broker. The floor broker who actually executes the order on the trading floor has an exhausting and high-pressure job. The trading floor is a larger than half the size of football field. It is dotted with multiple locations called “trading posts”. The floor broker proceeds to the post where this or that particular stock is traded and finds out which other brokers have orders from clients to buy or sell the stock, and at what prices. If the order the individual placed is a “market order”–which means an order to buy or sell without delay at the best price available–the broker size up the market, decides whether to bargain for a better price or to accept one of the orders being shown, and executes the trade–all this happens in a matter of seconds. Usually shares are traded in round lots on securities exchanges. A round lot is generally 100 shares, called a unit of trading, anything less is called an odd lot.

When you first see the trading floor, you might assume all brokers are the same, but they aren’t. There are five categories of market professionals active on the trading floor.

Commission Brokers, usually floor brokers, work for member firms. They use their experience, judgment and execution skill to buy and sell for the firm’s customer for a commission.

Independent Floor Brokers are individual entrepreneurs who act for a variety of clients. They execute orders for other floor brokers who have more volume than they can handle, or for firms whose exchange members are not on the floor.

Registered Competitive Market Makers have specific obligations to trade for their own or their firm’s accounts–when called upon by an Exchange official–by making a bid or offer that will narrow the existing quote spread or improve the depth of an existing quote.

Competitive Traders trade for their own accounts, under strict rules designed to assure that their activities contribute to market liquidity.

And last, but not least, come Stock Specialists. The Exchange tries to preserve price continuity– which means that if a stock has been trading at, say, 35, the next buyer or seller should be able to an order within a fraction of that price. But what if a buyer comes in when no other broker wants to sell close to the last price? Or vice versa for a seller? How is price continuity preserved? At this point enters the Specialist. The specialist is charged with a special function, that of maintaining continuity in the price of specific stocks. The specialist does this by standing ready to buy shares at a price reasonably close to the last recorded sale price when someone wants to sell and there is a lack of buyers, and to sell when there is a lack of sellers and someone wants to buy. For each listed stock, there are one or more specialist firms assigned to perform this stabilizing function. The specialist also acts as a broker, executing public orders for the stock, and keeping a record of limit orders to be executed if the price of the stock reaches a specified level. Some of the specialist firms are large and assigned to many different stocks. The Exchange and the SEC are particularly interested in the specialist function, and trading by the specialists is closely monitored to make sure that they are giving precedence to public orders and helping to stabilize the markets, not merely trying to make profits for themselves. Since a specialist may at any time be called on to buy and hold substantial amounts of stock, the specialist firms must be well capitalized.

In today's markets, where multi-million-dollar trades by institutions (i. e. banks, pension funds, mutual funds, etc.) have become common, the specialist can no longer absorb all of the large blocks of stock offered for sale, nor supply the large blocks being sought by institutional buyers. Over the last several years, there has been a rapid growth in block trading by large brokerage firms and other firms in the securities industry. If an institution wants to sell a large block of stock, these firms will conduct an expert and rapid search for possible buyers; if not enough buying interest is found, the block trading firm will fill the gap by buying shares itself, taking the risk of owning the shares and being able to dispose of them subsequently at a profit. If the institution wants to buy rather than sell, the process is reversed. In a sense, these firms are fulfilling the same function as the specialist, but on a much larger scale. They are stepping in to buy and own stock temporarily when offerings exceed demand, and vice versa.

So the specialists and the block traders perform similar stabilizing functions, though the block traders have no official role and have no motive other than to make a profit.

3. SECURITIES. CATEGORIES OF COMMON STOCK

There is a lot to be said about securities. Security is an instrument that signifies (1) an ownership position in a corporation (a stock), (2) a creditor relationship with a corporation or governmental body (a bond), or (3) rights to ownership such as those represented by an option, subsription right, and subsription warrant.

People who own stocks and bonds are referred to as investors or, respectively, stockholders (shareholders) and bondholders. In other words a share of stock is a share of a business. When you hold a stock in a corporation you are part owner of the corporation. As a proof of ownership you may ask for a certificate with your name and the number of shares you hold. By law, no one under 21 can buy or sell stock. But minors can own stock if kept in trust for them by an adult. A bond represents a promise by the company or government to pay back a loan plus a certain amount of interest over a definite period of time.

We have said that common stocks are shares of ownership in corporations. A corporation is a separate legal entity that is responsible for its own debts and obligations. The individual owners of the corporation are not liable for the corporation's obligations. This concept, known as limited liability, has made possible the growth of giant corporations. It has allowed millions of stockholders to feel secure in their position as corporate owners. All that they have risked is what they paid for their shares.

A stockholder (owner) of a corporation has certain basic rights in proportion to the number of shares he or she owns. A stockholder has the right to vote for the election of directors, who control the company and appoint management. If the company makes profits and the directors decide to pay part of these profits to shareholders as dividends, a stockholder has a right to receive his proportionate share. And if the corporation is sold or liquidates, he has a right to his proportionate share of the proceeds.

What type of stocks can be found on stock exchanges? The question can be answered in different ways. One way is by industry groupings. There are companies in every industry, from aerospace to wholesale distributers. The oil and gas companies, telephone com­panies, computer companies, autocompanies and electric utilities are among the biggest groupings in terms of total earnings and market value. Perhaps a more useful way to distinguish stocks is according to the qualities and values investors want.