Chapter 10
The Stock, Bond, and
Mortgage Markets:
Volatile Asset Prices
©2000 South-Western College Publishing
Common Stock
Equity claims representing
ownership of the net income
and assets of a corporation
that receive a variable
dividend after preferred
stockholders have been paid
and retained earnings have
been put aside
2
Preferred Stock
Equity claims representing
ownership of the net
income and assets of a
corporation that receive a
fixed dividend before
common stockholders are
entitled to anything
3
Program Trading
•Pre-programming of
computers to buy or sell a
large number (basket) of
stocks
•Widely used by institutional
investors
4
Dow Jones Industrial Average
(the Dow)
An index that measures
stock price movements of
30 of the largest companies
traded on the NYSE
5
New York Stock Exchange
(NYSE)
•The world’s largest market
for trading stocks located on
Wall Street in New York
•Trades the stocks of over
3,000 companies
6
Stock Market Indexes
Is the Most Famous the Best?
Dow Jones Industrial Average - 30 stocks
of some of the largest companies in
America, “the blue chip.”
Dow Jones Transportation Average - 20
airline, trucking, and railroad stocks.
Dow Jones 65 Composite Index - all
stocks in the Dow Jones Industrial,
Transportation, and Utility Averages.
Standard & Poor’s 500 - weighted index
of prices of 500 broad based
corporations.
7
New York Composite Index - weighted
average of the market value of all stocks
traded on the NYSE plus four subgroup
indexes representing industrial,
transportation, utility, and finance stocks.
Wilshire Equity Index Value - weighted
index of the value of all stocks listed on the
NYSE, the American Stock Exchange, and
over-the-counter stocks that NASDAQ
members.
NASDAQ Composite Index - a weighted
index that measures changes in prices of
all stock traded by the NASDAQ system.
8
Cracking the Code -- The Stock Market
Below is a typical entry of the stock page
of the Wall Street Journal
52 weeks
HIGH: 67 7/18
LOW: 26 11/18
STOCK: Gap Inc.
SYM: GPS
DIV YLD: .20
%: .3
PE: 41
VOL 100S: 17847
HIGH: 62 3/8
LOW: 59 1/4
NET CHANGE: -3¼
9
The Ten Largest Companies (measured in market value)
Traded on the Big Board, February 1999
Company name
Symbol
Average Number of shares traded
Market Value of Outstanding Stock (billions)
General Electric
Merck & Co., Inc.
Wal-Mart Stores, Inc.
Pfizer Inc.
Exxon Corp.
Coca Cola Co.
International Business
Machines Corp.
AT&T Corp.
American International
Group
Lucent Technologies Inc.
Exhibit 10-1
GE
MRK
WMT
PFE
XON
KO
IBM
T
AIG
LU
$328.7
194.1
194.0
161.8
161.8
157.5
156.7
4,813,547
3,460,742
3,414,326
2,782,958
4,224,258
3,765,753
5,331,253
144.0
138.7
133.9
5,331,253
2,524,947
7,777,063
10
American Stock Exchange
A stock exchange located in
New York that trades the
stock of over 660 companies
11
Over-the-Counter Market
A network of thousands of
securities dealers located
all over the country that
trade stocks of more than
30,000 companies over the
telephone or computer
12
Association of Securities
Dealers Automated Quotation
System (NASDAQ)
An association whose members
trade stocks over an advanced
computer system that provides
immediate information about
prices and the number of
shares being traded
13
The Returns to Stocks and Bonds Over Time
Value of $100 invested in stocks in 1969a
Value of $100 invested in stocks in 1969b
$4,000
3,500
3,000
2,500
2,000
1,500
1,000
500
0
1969
Exhibit 10 -2
1973
1978
1983
1988
1993
1998
14
Open-end and Closed-end
Mutual Funds
•Open-end: continually sells new
shares to the public or buys
outstanding shares from the public at
a price equal to the net asset value
•Closed-end: sells a limited number of
shares and does not buy back
outstanding shares
15
Load
• A sales commission
required to be paid to a
broker to buy into some
mutual funds
• By law, the load cannot
exceed 8.5 percent of the
investment
16
No-Load Mutual Fund
A mutual fund purchased
directly from the company
where the load is avoided
17
A Sample of the Types of
Mutual Funds (Stocks)
Aggressive Growth Funds invest in small
companies with potential for growth
seeking capital appreciation.
Global Equity Funds invest in stocks
from around the world achieving greater
diversification than investing in
comparable stocks from one country.
18
Growth and Income Funds invest in
companies that are expected to grow and
that pay dividends.
Income Equity Funds invest in companies
that are expected to pay high dividends.
Index Funds invest in a market basket of
stocks that replicates the basket included
in a stock market index.
Sector Funds invest in stocks of
particular industries.
Socially Conscious Funds invest in
companies they believe to be ethically
responsible.
19
A Sample of the Types of Mutual
Funds (Bonds)
Corporate Bond Funds invest only in
corporate bonds.
Global Bond Funds invest in bonds
from around the world.
Ginnie Mae Funds invest in Ginnie
Mae mortgage-backed securities.
High Yield Bond Funds invest most of
their portfolio in junk bonds.
20
Long-term Municipal Bond Funds
invest in a broad base of municipal
funds; earnings are exempt from
federal taxes.
State Municipal Bond Funds invest
in municipal bonds from one state;
earnings are exempt from federal
taxes and from state taxes for
investors living in the issuing state.
U.S. Government Income Funds
invest in U.S. government bonds.
21
A Sample of the Types of Mutual Funds
(Stock and Bond Funds)
Balanced Funds invest in some combination of
stocks and bonds to preserve principle,
generate income and achieve long-term
growth.
Flexible Portfolio Funds can vary relative
investments between stocks, bonds, and
money market instruments.
Income Mixed Funds invest in stocks and
bonds to earn high dividend and interest
income.
Convertible Securities Funds invest in
securities that can be converted to common
22
stock.
Mortgage Bonds
Bonds backed by
personal property
23
Collateral Bonds
Bonds backed by
financial assets
24
Debenture Bonds
Bonds with no specific
collateral backing but that
have a general claim on
the other unpledged assets
of the issuer
25
Subordinated Debenture
Bonds
Bonds with no collateral
backing that have a general
claim after debenture
bondholders have been paid
26
Cracking the Code on Corporate Bonds
The Wall Street Journal
Bond
Chg
Cur Yld
Vol
Close
Net
ATT
7.6
43
106 5/8
+1/8
27
Treasury Strips
A type of government
securities that allow investors
to register and trade
ownership of the interest
(coupon) payments and the
principal amount of the
security
28
Inflation-Indexed Bonds
Bonds whose principal
amount is adjusted for
inflation at the time when
coupon payments are made
(usually every six months)
29
General Obligation Bonds
Municipal bonds to be repaid
out of general tax revenues
30
Revenue Bonds
• Municipal bonds to be
repaid out of the revenues
from a specific project that
the bond supports
• Repayment is based on the
success of the specific
project
31
Cracking the Code on Treasury Bonds
The Wall Street Journal
Rate Mo/Yr Bid
Yld
9
Nov. 18 138:12
Asked
Chg
Ask
139:18 +10
5.75
32
Government National Mortgage
Association (GNMA)
Government sponsored
program that guarantees the
timely payment of interest
and principal on bundles of
at least $1 million of
standardized mortgages
33
Mortgage-Backed
Securities
•Securities backed by a
pool of mortgages
•They have a low default
risk
•They provide a steady
stream of income
34