Stocks, Stock Markets, and Market Efficiency
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Represents the original capital paid into or
invested in the business by its founders
Serves as a security for the creditors of a
business since it cannot be withdrawn to the
detriment of the creditors
Stock prices tell the value of the companies
that issued the stocks
Fluctuate in quality and value
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Shares in a firm’s ownership
Small denominations
Transferable
The shares are registered in the names of
brokerage firms that hold them on investors’
behalf
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Stockholders are paid with dividends
◦ Board of directors decide when to pay out dividends
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Voting right, the shareholders elect the board
of directors
Limited liability: the max loss of shareholders
is their initial investment (the price paid for
the stocks in the first place)
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Preferred stockholders have a greater claim to
a company's assets and earnings
Dividends are paid for preferred stockholders
before common stockholders
◦ Dividends are paid at regular intervals
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No voting right
No election right
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Stock-market indexes
◦ Measuring method of a section of the stock market
◦ Tell how much the value of an average stock has
changed and how much total wealth has gone up or
down
◦ Manager’s performance benchmarks
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World/Global index
◦ MSCI World and S&P Global 100
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National index
◦ The American S&P 500, the Canadian MSCI,
◦ the Japanese Nikkei 225
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Performance of 30 large, publicly owned
companies based in the United States
The average is price-weighted, and to
compensate for the effects of stock splits and
other adjustments
The percentage change in the DJIA overtime
is the percentage change in the sum of the 30
prices
Ex:
 Purchasing of
◦ Stock 1 at $50.00
◦ Stock 2 at $100.00
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An increase of 15% in the first stock
◦ 1st stock price increases to $57.50
◦ Total value in the portfolio: $157.59
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An increase of 15% in the second stock
◦ 2nd stock price increases to $115.00
◦ Total value in the portfolio: $165.00
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Index conducted from the price of many more
stocks
500 firms, the largest firms in the U.S.
economy, trade on either of the 2 largest
American stock market exchanges: the New
York Stock Exchange and the NASDAQ
Value-weighted index
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Nasdaq Composite Index
◦ 5,000 companies traded on the OTC (over-thecounter) market
◦ Value-weighted index
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Wilshire 5000 : covers all publicly traded
stocks in the U.S.
◦ 6,500 companies traded on The New York Stock
Exchange, the American Stock Exchange, and the
OTC
◦ Value-weighted index
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Are contracts that allow people/ investors to
buy or sell a specific type of asset at a specific
time and at a given price
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Futures contract:
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Standardized contract
Clearing house guarantees the transactions
Settlement occurs at the end of the contract
Not delivery
Forwards contract:
◦ Non-standardized (private) contract
◦ Default might happen
◦ Marked-to-market daily, daily changes are settled
day by day until the end of the contract.
◦ Used by hedgers that want to eliminate the volatility
of an asset's price, and delivery of the asset or cash
settlement will usually take place
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Right, not obligation to buy or sell an asset
on or before a particular date
To protect investors from unexpected price
change
Call option:
◦ Purchase at a specific price
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Put option:
◦ Sell at a specific price
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A contract to buy or sell at an agreed to price,
stated dollar amount of T-bills to be sold at
the next weekly auction
Trading starts when BoC announces the size
of the following week’s auction. And ends
before the results of the auction are
announced
P today =[D next year/(1+i)] + [P
year/(1+i)^1]
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next
P today : the purchase price of product
D next year : amount of dividend payment
P next year : sale price at 1 year later
i: interest rate
P today =[D next year/(1+i)] + [D in 2 years/(1+i)²]
+ [P next year/(1+i)²]
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The price today is the present value of the
sum of the dividends plus the present value
of the price at the time the stock is sold 2
years from now
P today = Dividend per share
Discount rate – Dividend
growth rate
P today = D today
i-g
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Stock prices tell the market value of
companies, which guides the allocation of
resources
Stocks are less risky if holding for a long
periods than short periods
Efficient stock markets not reflect the
movement of stock price, caused by
asymmetry of information