Macroeconomics
4 Buying & Selling
Selling stock is one of the ways that companies raise money, and once a
company is owned by shareholders, protecting the price of that stock
becomes a main focus of the company. Bonds are another way that
companies raise money—by taking loans, not from banks, but from people
who would like to finance a company over a period of time.
This section corresponds to Chapter 11: Sections 3 & 4.
OBJECTIVES
53. Explain what stocks are and why people trade stocks.
54.
are
55.
56.
Discuss how stocks are traded, explaining how the performance of stocks
measured.
Identify different kinds of bonds and the factors that affect bond trading.
Outline investment options other than stocks and bonds.
LIII. The Stock Market
 KEY CONCEPTS
o Initial Public Offering (IPO)—stock sold to investment bankers
in the primary market
o Stock exchange—secondary market where securities resold
and bought buyers expect stock price to rise, so they can
resell for a profit
o Capital gains—profit made from sale of stock
o Common stock—gives shareholders voting rights, share of
profits
o Preferred stock—gives shareholders share of profits, no
voting rights
A. Why Buy Stock?
1. Investors may buy stock to earn dividends—a share of the
company’s profits. ★
2. Also, investors may buy stock to earn capital gains through
resale of stock. This goal is for investors who want growth; they
look for the potential for capital gains.
3. Investing in stock has a higher risk than most other
investments, but gives the biggest upside for high returns.
Companies do not guarantee dividends or that the value of the
stock will rise, but stock investors think it is worth the risk.
B. There are essentially two kinds of stock.
1. Common stock—gives shareholders voting rights and a share
of profits. Owners get one vote per share owned to elect people
on the board of directors. ★
2. Preferred stock—gives shareholders share of profits but no
voting rights. Preferred investors are paid before common
shareholders, and are paid off first if the company closes. These
dividends are basically guaranteed, but the dividends do not
increase if the stock increases in value.
LIV. The Business of Stock Trading

KEY CONCEPTS
o Future—contract to buy or sell a stock on specific future date
at preset price
o Option—contract giving right to buy, sell in future at preset
price. The investor pays small fraction of stock’s current price.
o Bull market—prices rise steadily over a relatively long period
o Bear market—prices decline steadily over a relatively long
period
A. When people believe that a company’s value is going to increase,
demand for that stock rises and its stock price goes up. As the price
rises, ★
B. Trading Stock
1. Organized Stock Exchanges: New York Stock Exchange
(NYSE) on Wall Street is the oldest and largest in the USA.
Traditionally, each stock was auctioned from a trading post on
the exchange floor. Today, computers are used to execute many
trades.
2. Electronic Markets: Over-the-counter (OTC) market is for
stocks not traded on NYSE. The NASDAQ is centralized computer
system for OTC trading; it is the second largest exchange in
world in number of companies and shares traded. NASDAQ
companies are from many sectors of U.S. economy, but mostly
in technology.
3. Futures and Options Markets: Most investors do not trade
futures and options; ★
C. Measuring How Stocks Perform: About half of U.S. households own
stocks. A stock index
1. Stock Indexes measure and report the change in the prices of
a set of stocks. ★
a. U.S. indexes: Dow Jones Industrial Average, Standard &
Poor’s 500, NASDAQ Composite. Since 1896, DJIA changed
with U.S. economy. It includes the most successful
companies in the most important economic sectors. It uses
points to measure changes in prices at which stocks
traded.
b. Global indexes: Hang Seng, DAX, Nikkei 225, TSE 300,
FTSE 100
2. Tracking the Dow: 1972 to 2000 was the longest bull market
in history; most last two to three years. Many factors affect the
Dow’s performance. It is affected by its previous close, the
Federal Reserve, foreign indexes, and the US trade balance.
LV. Bonds and Other Financial Instruments
 KEY CONCEPTS
o Par value—amount issuer must pay buyer at maturity
o Maturity—date when bond is due to be repaid
o Coupon rate—interest rate bondholder gets every year until
maturity
o Yield—annual rate of return on a bond
A. Why Buy Bonds?
1. Bonds are issued by companies and governments to borrow
money and repay it on a fixed schedule. Investors buy bonds for
the interest paid and for any gains made by selling the bond
before its maturity. If the bond is sold at par value, its yield is
the same as coupon rate. If it is sold for less, the yield is higher;
if sold for more, the yield is lower. Bonds with longer maturity
dates have higher yields than bonds with shorter dates, ★
2. Types of Bonds: There are different types of bonds with
different risks and different yields.
a. The U.S. government issues a variety of instruments
with different maturity dates. Treasury bonds (>10 years),
Treasury notes (2-10 years), and Treasury bills (<1 year).
They are considered very safe investments, but provide a
very low yield. All governments do it; ★
b. State, local governments issue bonds, too. These bonds
are usually used to finance construction costs of a public
good, such as bridges, schools, roads, or sports facilities.
They usually earn no federal income tax, so are desirable
to investors ★
c. Corporate bonds are a higher risk investment than
government bonds, but they pay a higher coupon rate. The
riskiest kind of bond is called a “Junk bond”; they pay ★
B. Buying Bonds
1. Most bond-buyers want guaranteed interest income, For those
investors, the yield is the most important factor. Investors who
want to sell before the bond comes to maturity want to make a
profit on their sale.
2. Market interest rates are also an important consideration. As
market interest rates rise, the price of bonds with lower rates
falls, because people think they can make more money on other
types of investments ★
3. The main risk to investors is that the borrowers will default on
their obligations. To minimize that risk, governments and
companies get evaluated by credit-rating companies to
determine how likely they are to default. It is similar to a
person’s credit-score, but for businesses (and somewhat less
scientific—W).
LVI. Other Financial Instruments
A. Certificates of Deposit
1. CDs are offered primarily by banking institutions; they have a
maturity date at which time the investor can reclaim their
deposit and interest.
2. They pay fixed or variable interest (usually fixed—W), and are
reinvested for compound interest. Because they have longer
maturity dates, ★
3. The federal government insures CD funds up to $250,000.
The biggest risk to the investor is that they will lose their
interest, and maybe some principal, if the funds withdrawn early.
It makes their wealth non-liquid.
B. Money Market Mutual Funds
1. MMMFs are when a person’s financial assets are invested in
Mutual Funds of the stock market for a fixed amount of time. ★
2. MMMFs give a higher yield than savings accounts with similar
liquidity. Investors can redeem their shares by check, phone, or
electronic transfer.
3. The funds are not insured, but they are tightly regulated, so
the investor’s principal is usually considered safe. Their yield
varies based on yield of assets in fund.