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1.
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Study the introduction to this
section above.
Explain what you expect to learn from this section.
Study the vocabulary words
and look for them as you do the readings in this section. You will be tested on these
words.
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The
New York Stock Exchange is a
tangle of telephones, video monitors,
computer screens, and
frantic activity. The
wrong decision may mean the difference
between gaining or losing
thousands of
dollars. This is one of the places where
stock is bought and sold?-and fortunes
are
made and lost. Just what is stock, exactly
how is it traded, and when is it a
good
investment?
Buying Stock
Besides bonds,
corporations can raise funds
by issuing stock, which represents ownership
in the corporation.
Stock is issued in
portions known as shares. By selling shares
of stock, corporations
raise money to start,
run, and expand their businesses. Stocks
are also called equities,
or claims of ownership in the corporation.
| Benefits of
Buying Stock
There are
two ways for stockholders to
make a profit:
• Dividends As you read in
Chapter 8,
many corporations pay out part of their
profits as dividends to their
stockholders.
Dividends are usually paid four times a
year (quarterly). The size of the
dividend
depends on the corporation’s profit. The
higher the profit, the larger the
dividend
per share of stock.
• Capital gains A second way an investor can
earn a profit is to sell the stock for more than he or she paid for it. The difference between the
higher selling price and the lower purchase price is called a capital gain. An investor who
sells a stock at a price lower than the purchase price, however, suffers a capital
loss. | | |
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2.
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Why would a company want to
issue (sell) shares in its company?
a. | because the government forced to to
sell | c. | to limit liability in case of law
suits | b. | to raise money | d. | to be more democratic |
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3.
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Mr. Lopez purchased equities in
the Apple corporation as part of his retirement portfolio. What does that mean?
a. | Mr. Lopez is guaranteed to make a
profit by purchasing equities | c. | Mr. Lopez does not have to pay taxes on the dividends he receives from
Apple. | b. | Mr. Lopez owns part of the Apple corporation | d. | All investors have an equal ownership in the
company |
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4.
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Mr. Lopez is likely to recieve
a dividend check from Apple four times a year. Which statement below is true about the
dividend?
a. | Apple does not have to pay Mr. Lopez
dividends because only owns equities and not shares | c. | The more profits Apple makes the greater the
dividend | b. | The less profit Apple makes the greater the dividend it will have to
pay | d. | The more profit Apple makes the less it will have to pay
in dividends. |
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5.
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Mr. Lopez purchased Apple for
$109.01 per share. The price of apple shares is now 105.1 Mr Lopez made
a. | a capital
gain | c. | a $4.00
dividend | b. | a capital loss | d. | a $4.01 dividend |
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Types of
Stock
Stock may be
classified in several ways, such as whether or not it pays dividends.
• Income stock
This stock pays dividends
at regular times during the year.
• Growth stock
This stock pays few or no dividends. Instead, the issuing company reinvests its earnings in its
business. The business (and its stock) thus increases in value over time. Stock may also be
classified as to whether stockholders have a vote in company policy.
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• Common stock Investors who buy
common stock are voting owners of
the
company. They usually receive one vote
for each share of stock owned. They may
use this
vote, for example, to elect the
company’s board of directors. In some
cases, a relatively
small group of people
may own enough shares to give them
control over the company.
• Preferred stock Investors who buy
preferred stock are nonvoting owners of
the
company. Owners of preferred stock,
however, receive dividends before the
owners of common
stock. If the company
goes out of business, preferred stockholders
get their investments back
before
common stockholders. | | |
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6.
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Mrs. Murphy wants to invest
some money in the stock market and get regular payments from the company that she can use to live on.
What type of stock should she buy??
a. | income
stock | c. | growth
stock | b. | common stock | d. | preferred stock |
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7.
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Mr. Magna wants to purchase
stock in Qualcomm and is interested in voting on the people who will run the company. Which type of
stock should Mr. Magna purchase that will give one vote for each share he owns?
a. | income
stock | c. | common
stock | b. | growth stock | d. | preferred stock |
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8.
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You want to start saving for
your retirement and have enough money to live on. What type of stock should you purchase that will
grow in value over time thus increasing the value of your portfolio?
a. | income
stock | c. | growth
stock | b. | preferred stock | d. | common stock |
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Stock
Splits
Owners of common
stock may sometimes
vote on whether to initiate a stock split. A
stock split means that
each single share of
stock splits into more than one share. A
company may seek to split a stock
when
the price of stock becomes so high that it
discourages potential investors from
buying
it.
For example, suppose you own 200
shares in a sporting goods company called
Ultimate
Sports. Each share is worth $100.
After the split, you own two shares of
Ultimate Sports stock
for every single share
you owned, so that you now own 400
shares. Because the price is divided
along
with the stock, however, each share is now
worth only $50. Although the split has
not
immediately resulted in any financial gain,
shareholders like stock splits because
prices
tend to rise afterward.
| Risks of Buying
Stock
Purchasing stock
is risky because the firm
selling the stock may earn lower profits
than expected, or it may
lose money. If so,
the dividends will be smaller than expected
or nothing at all, and the
market price of
the stock will probably decrease. If the
price of the stock decreases,
investors who
choose to sell their stock will get less than
they paid for it, experiencing a
capital loss.
How do the risk and rate of return on
stocks compare to the risk and rate
of
return on bonds? As you have read,
investors expect higher rates of return
when they take
on greater risk. Because of
the laws governing bankruptcy, stocks
are more risky than bonds.
When a firm
goes bankrupt, it sells its assets (such as
land and equipment) and then pays
its
creditors, including bondholders, first.
Stockholders receive dividends only if
there is
money left over after bondholders
are paid. As you might expect, because
stocks are riskier
than bonds, the returns
on stocks are generally higher.
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9.
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You are the owner of a popular
restaurant chain listed on the NY Stock Exchange. Your business is doing really well. The value and
price or your stock has increases dramatically. In fact, the price of you stock is so high people are
not buying as much as they did in the past. What is one solution you could take to encourage buyers
to purchase your stock.
a. | Sell lots of your stock so people
would think your stock is not as valuable as it was in the past. | c. | Sell half of the company so people would be buying half a
share when they bought. | b. | Split the stock, thereby lowering the price. | d. | Take your company private by removing it from the Stock
Exchange |
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10.
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In the example above you have
200 shares of Ultimate Sports in your stock portfolio at $100 a share. What happens to the value of
your portfolio if the stock splits?
a. | The value of your portfolio
decreases | c. | The value of your
portfolio increases | b. | The value of your portfolio stays the same | d. | Your portfolio is worth half as much as it did before the
split |
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11.
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Marisa wants to invest part of
her money for retirement. She is a frugal saver and does not like to take risks with her cash. Which
investment below would be best for her?
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12.
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Sean is a risk taker. He also
wants to save for his retirement but wants a higher return on his investments and doesn’t mind
a little risk. What investment would be best for Sean?
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13.
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Which two statements below are
true? (pick 2)
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How Stocks
Are Traded
Suppose you
decide that you want to buy
stock. Do you call up the company and
place an order? Probably not,
because very
few companies sell stock directly. Instead,
you would contact a stockbroker,
a person
who links buyers and sellers of stock.
Stockbrokers usually work with
individual
investors, advising them to buy or sell
particular stocks.
Stockbrokers work
for brokerage firms,
or businesses that specialize in trading
stocks. Stockbrokers and
brokerage firms
cover their costs and earn a profit by
charging a commission, or fee, on
each
stock transaction. Sometimes they also act
as dealers of stock, meaning that they
buy
shares at a lower price and sell them to
investors at a slightly higher price,
profiting
from the difference, or “spread.”
Stock Exchanges
Stock is bought and sold on
stock
exchanges, or markets for buying and
selling stock. These markets act
as
secondary markets for stocks and bonds.
Most newspapers publish data on transactions
in
major stock exchanges. (See Figure
11.7 to learn how to read a newspaper
stock market
report.)
Major United States stock exchanges
include the New York Stock Exchange
(NYSE)
and Nasdaq. In addition, a large
number of people trade stocks on the
Internet. (See Skills for
Life on page 284 to
learn more about reading a stock market
report on the
Internet.)
| The New York Stock
Exchange
The New York
Stock Exchange (NYSE) is
the country’s largest and most powerful
exchange. The NYSE began
in 1792 as an
informal, outdoor exchange under a now famous buttonwood tree in New
York’s
financial district. Over time, as the financial
market developed and the demand to
buy
and sell financial assets grew, the exchange
moved indoors and became restricted to
a
limited number of members, who buy
“seats” allowing them to trade on
the
exchange. Today, new technologies make
trading so fast that a transaction takes only
an
instant.
The NYSE handles stock and bond
transactions for only the largest and
most
established companies in the country. The
largest and best-known companies listed on the
NYSE are referred to as blue chip
companies. Blue chip stocks are often in
high demand because
investors expect the
companies to continue to do business profitably for a long
time.
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14.
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If you wanted to invest in the
stock market, who would you call?
a. | stock
broker | c. | government stock
service | b. | finance company | d. | New York Stock Exchange |
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15.
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What do brokerage firms
do?
a. | They employ stock brokers who help
you to invest in the stock market and charge you a fee for their service | c. | They make sure investors do not go “broke,”
thus the name brokerage firm. | b. | They are employed by the government to make sure your investments in the stock
market are safe. | d. | They provide insurance much like the
FDIC to protect investros from loosing their money |
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16.
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What is the New York Stock
Exchange?
a. | A bank that consumers can use to get
credit cards, such as Visa and American Express | c. | A New York State agency that allows people to exchange cash for goods and
services | b. | It is the main ATM outlet in New York | d. | A place where brokers can go to buy and sell
stocks |
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The OTC
Market
Despite the
importance of organized stock
exchanges like the New York Stock
Exchange, many stocks, as well
as bonds,
are not traded on the floor of stock
exchanges. Instead, they are traded on
the
OTC market, that is, over-the-counter, or
electronically. Investors may buy
directly
from a dealer or from a broker who will
search the market for the best
price.
| Nasdaq
Nasdaq (the National Association of
Securities Dealers Automated
Quotations)
is the American market for over-the-counter
securities. Nasdaq was created in 1971
to
help solve the problem of fragmentation in
the OTC market by using automation. By
the
1990s, it had grown into the second
largest securities market in the United States
and the
third largest in the world, linking
markets in the United States, Asia, and
Europe. Because it
does not have a trading
floor, Nasdaq’s trading information is
simultaneously broadcast
to some
360,000 computer terminals
throughout the world.
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17.
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If Mario wanted to use his
computer to buy and sell stock directly, which service would he use?
a. | Nasdaq | c. | America Online | b. | His local ISP | d. | An OTC firm |
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18.
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Because millions of people use
their computers to trade stocks and bonds electronically, there has to be a way to show what the
current price of stocks and bonds are. As people trade online during the day the prices are
constantly changing. What company performs this service?
a. | Moody’s | c. | NYSE | b. | Standard and Poors | d. | Nasdaq |
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Futures and
Options
Futures
are contracts to buy or sell
commodities at a specific date in the future at a price specified
today. For example, a buyer and seller might agree today on a price of $4.50 for a bushel of soybeans
six or nine months in the future. The buyer would pay some portion of the money today, and the seller
would deliver the goods in the future. Many of the markets in which futures are
bought and sold
are associated with grain and livestock exchanges. These markets include
the New York Mercantile
Exchange and the Chicago Board of Trade.
Similarly, options are contracts that
give
investors the choice to buy or sell stock and
other financial assets. Investors may buy
or
sell a particular stock at a particular price
up until a certain time in the
future—usually three to six months. The option to buy shares of stock at a specified time in
the future is known as a call option.
For example, you may pay $10 per share today for
a call option. The call option gives you the right, but not the obligation, to purchase a certain
stock at a price of, say, $100 per share. If at the end of six months, the price has gone up to $115
per share, your option still allows you to purchase the stock for the agreedupon $100. You thus earn
$5 per share ($15 minus the $10 you paid for the call option). If, on the other hand, the price has
dropped to $80, you can throw away the option and buy the stock at the going
rate.
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The option to sell shares of stock at a specified time in the future is
called a put
option. Suppose
that you, as the seller, pay
$5 for the right to sell a particular stock that you do not yet own
at $50 per share. If the price per share falls to $40, you can buy the share at that price and
require the contracted buyer to pay the agreed-upon $50. You would then make $5 on the sale ($10
minus the $5 you paid for the put option). If the price rises to $60, however, you can throw away the
option and sell the stock for $60.
Daytrading
Most people who buy stock hold their
investment for
a period of time—sometimes
many years—with the expectation that it will grow in value.
Recently, however, a different type of stock trading, called daytrading, has become popular.
Daytraders try to predict minute-byminute price changes based on computer programs that tell the
trader when to buy and sell. These traders might make dozens of trades a day in hopes of making
a
profit. Unfortunately, daytrading is a risky
business in which traders can lose a
great
deal of money.
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19.
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The current price for a bushel
of corn is $5.00 Daniel believes that six months from now the price will be $10.00 If Daniel can buy
today at $5.00 and sell for $10.00 six months from now he will make a good profit. What is this
transaction called?
a. | Over The Counter
Trading | c. | Day
Trading | b. | Buying Futures | d. | Dealing in Mutual Funds |
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20.
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The option to
buy shares of stock at a
specified time in the future is known as a/an
a. | OTC
option | c. | call
option | b. | sell | d. | put
option |
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21.
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The option to sell shares of
stock at a specified time in the future is called a/an
a. | OTC
option | c. | call | b. | sell | d. | put |
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22.
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Computers allow people to see
the minute by minute changes in stock prices over the internet. Michael Palomata likes to sit at his
computer and buy and sell stocks on a minute by minute basis. Michael is engaging
in
a. | OTC
trading | c. | Futures
Trading | b. | Day Trading | d. | Put Options |
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Measuring
Stock Performance
You
may have heard newscasters speak of a
“bull” or “bear” market or of the
market
rising or falling. What do these terms mean
and how are increases and decreases in
the
sale of stocks measured?
Bull and Bear
Markets
When the stock market rises steadily over a
period of time, a bull market
exists. On the
other hand, when the stock market falls for
a period of time, people call it
a bear market.
In a bull market, investors expect an
increase in profits and thus buy
stock.
During a bear market, investors sell stock
in expectation of lower profits. The
1980s
and 1990s brought the longest sustained
bull market in the nation? ’s history. A
multiyear bear market began in 2000.
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The Dow Jones
Industrial Average
The Dow (The Dow Jones Industrial
Average) has shown how certain
stocks
have traded daily since 1896. To make sure
that the stocks remain representative of
the
stock market as a whole, over the years the
companies on the Dow have changed.
Today,
the stocks on the Dow represent 30
large companies in various industries, such
as food,
entertainment, and technology.
S & P 500
The
S & P 500 (Standard & Poor’s 500) gives a broader picture of stock performance.
It tracks the price changes of 500 different
stocks as a measure of overall stock
market
performance. The S&P 500 reports mainly
on stocks listed on the NYSE, but some
of
its stocks are traded on the Nasdaq and
OTC markets. | | |
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23.
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When times are good and stock
prices are rising it is called a _____ market. When times are bad and stock prices are falling it is
called a _____ market
a. | bull -
bear | c. | steady -
periodic | b. | bear - bull | d. | full - half |
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24.
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They cant take an average of
all the companies in the stock market because there are too many. Therefore, they take the average of
30 large companies that represent the market as a whole and publish it in the newspapers each day.
What is this average called?
a. | Standard and Poors
average | c. | The
DOW | b. | NYSE average | d. | The Nasdaq |
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25.
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What is the difference between
the DOW and the S&P 500?
a. | The DOW only includes technology
companies | c. | The DOW is
published daily while the S&P 500 is published monthly | b. | The S&P 500 includes a broader range of financials in
its average | d. | There is no
difference |
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The Great
Crash of 1929
Like the
1980s and 1990s, the 1920s saw a
long-term bull market. Unfortunately, this
period ended in a
horrifying collapse of the
stock market known as the Great Crash. The
causes of this
collapse contain important
lessons for investors today.
Signs of Trouble
Despite widespread optimism about continuing
prosperity, there were signs of trouble. A relatively small number of companies and families held
much of the nation’s wealth. Many farmers and workers, on the other hand, were suffering
financially. In addition, many ordinary people went into debt buying consumer goods such as
refrigerators and radios—new and exciting inventions at the time—on credit. Finally,
industries were
producing more goods than consumers could buy. As a result, some industries,
including the important automobile industry, developed large surpluses of goods, and prices began to
slump.
Another economic danger sign was the debt that investors were piling up by playing the
stock market. The dizzying climb of stock prices encouraged widespread speculation, the
practice of making high-risk investments with borrowed money in hopes of getting a big return. To
make matters worse, before World War I, only the wealthy had bought and sold
shares in the stock
market. Now, however, the press was reporting stories of ordinary people making fortunes in the stock
market. Small investors thus began speculating in stocks, often with their life savings.
To
attract less-wealthy investors, stockbrokers encouraged a practice called buying on margin. Buying on
margin allowed investors to purchase a stock for only a fraction of its price and borrow the rest
from the brokerage firm. Brokers’ loans to these investors went from about $5 million in
mid-1928 to $850 million in September 1929. The Hoover administration did little to discourage such
borrowing. | The Crash
By Monday, October 28, 1929, the value
of shares of
stock were dropping to a fraction of what people had paid for them. Investors all over the country
were therefore racing to get what was left of their money out of the stock market. On October 29,
1929, known as Black
Tuesday, a record 16.4 million shares were
sold, compared with the average
4 to 8 million shares per day earlier in the year. The Great Crash had begun.
The Aftermath of the Crash
During the bull market that led up
to the Crash, about 4 million people had invested
in the stock market. Although they were
the
first to feel the effects of the Crash, eventually the whole country was affected.
The Crash
contributed to the Great Depression, in which millions of Americans
lost their jobs, homes, and
farms.
Mistakes in monetary policy slowed the nation’s recovery. In 1929, the Fed had
begun limiting the money supply in order to discourage excessive lending. With too little money in
circulation, individuals and businesses could not spend enough to help
the economy
improve.
After the Depression, many people saw stocks as risky investments to be avoided. In
1980, only about 2.5 percent of American households held stock. Gradually, however,
attitudes
began to change. The development of mutual funds also made it easy to own a wide range of stocks.
Americans became more comfortable with stock ownership.
After a period of very strong growth,
stocks crashed again on “Black Monday,” October
18, 1987. The Dow Jones lost 22.6% of
its value that day—nearly twice the one-day loss that began the Crash of 1929. This time the
market rebounded on each of the next two days, and impact on the economy was much less severe. The
Fed moved quickly to add
liquidity and reduce interest rates to stimulate
economic growth.
Within two years, the Dow returned to pre-crash levels. | | |
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26.
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What is the main idea of the
reading above?
a. | There were many reasons for the
Great Crash of 1929 but those reasons do not apply to today’s
market | c. | There were many reasons for the
Great Crash of 1929 that contain lessons for investors today | b. | The Crash of 1929 proved that Socialism is prefereable to
Capitalism | d. | People should not buy on credit,
whether it be stocks or consumer goods |
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27.
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Which statement below is
true?
a. | Greedy speculation in the stock
market caused the Great Depression | c. | The stock market contributed to the Great Depression but was not the only
factor | b. | Rich people caused the Great Depression | d. | If more people had bought stocks on margin the Great Depression might not have
happened |
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The Market
Today
During the second
half of the 1990s, stock
prices rose dramatically. Many people
bought stock for the first time
or invested
in new technology companies. At the end
of the 1990s, almost half of
American
households owned mutual funds.
By 2000, however, investors had
become worried
that most companies
could not make enough money to justify
their high stock prices. Stocks
fell, and
many investors lost most or all of their
prior gains. The following year,
an
economic recession and terrorist attacks
further battered the stock
market.
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In 2002, several large corporations,
including Enron and WorldCom,
declared
bankruptcy and revealed that they had
issued false financial reports for
several
years. Stock prices fell even more as
investors questioned how much they really
knew
about the companies they had
invested in. The federal government introduced new rules for
corporations to restore confidence in the market. The stock market
recovered, but it remained
below the peak
values reached during the bull market of
the 1990s.
In 1990 the DOW was
about 2,750, today it is around 17,000 | | |
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28.
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What does the reading above
suggest?
a. | Over time the stock market is a good
place to invest your money | c. | The stock market has too many ups and downs to be
safe | b. | The stock market is a dangerous place to invest your retirement
savings | d. | Hitler was right, Socialism is better than
Capitalism |
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29.
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Refer to the graphic above.
Which company paid the highest dividend on this day?
a. | Disney | c. | DoleFoods | b. | DOWChem | d. | DominRes |
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30.
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Which stock performed
worst during the day shown on
the chart above?
a. | Disney | c. | DonnaKm | b. | DoleFood | d. | DowChem |
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31.
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Which company traded the most
shares during the day?
a. | Disney | c. | DoleFood | b. | DowChem | d. | Donnely A |
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a. | capital
gain | f. | stockbroker | b. | share | g. | stock exchange
| c. | brokerage firm
| h. | capital loss | d. | Nasdaq | i. | OTC market | e. | equities | j. | stock split |
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32.
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an electronic marketplace for
stocks and bonds
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33.
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a person who links buyers and sellers of
stock
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34.
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portion of stock
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35.
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a market for buying and
selling stock
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36.
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the difference between a lower selling price and a higher
purchase price resulting in a financial
loss to the seller
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37.
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claims of ownership in a corporation
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38.
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American market for OTC
securities
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39.
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a business that specializes in
trading stocks
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40.
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the difference between a higher selling price and a lower
purchase price, resulting in a financial gain for the seller
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41.
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the division of a single share of stock into more than one
share
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a. | bear
market | f. | put
option | b. | futures | g. | S & P 500 | c. | Great Crash | h. | options | d. | The Dow | i. | speculation | e. | call option | j. | bull market |
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42.
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the option to sell shares of stock at a specified time in
the future
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43.
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index that shows the price
changes of 500 different stocks
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44.
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contracts to buy or sell at a specific date in the future
at a price specified today
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45.
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a steady drop in the stock market over a period of
time
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46.
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a steady rise in the stock market over a period of
time
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47.
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the practice of making high-risk investments with borrowed
money in hopes of getting a big return
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48.
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contracts that give investors the choice to buy or sell
stock and other financial assets
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|
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49.
|
the collapse of the stock market in
1929
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50.
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the option to buy shares of stock at a specified time in
the future
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51.
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index that shows how certain
stocks have traded
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