FIN432 Vicentiu Covrig 1 Equity Markets (chapter 2)

FIN432Vicentiu Covrig

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Equity MarketsEquity Markets(chapter 2)(chapter 2)


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Equity MarketsEquity Markets

New York Stock Exchange

- An Agency Auction Market Market in which brokers represent buyers

and sellers and prices are determined by supply and demand.

- Trading All trading in a specific stock is done at the post where that stock

is assigned on the NYSE floor.Trading is managed by the specialist.

www.nyse.com

2005

NYSE Average Daily Stock Volume (millions) 1,604

NYSE Average Trade Size per Sale (in shares) 334

Number of NYSE Non-US Stocks 453

NYSE Dollar Value of Trading Activity (billions of dollars) $56.1

Programs as % of Total NYSE 56.9%

Companies Listed on the NYSE 2,779


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AMEX is also a specialist auction market Lower listing standards than NYSE More than 1,000 listings

- 140+ Exchange Traded Funds

- 15+ HOLDRs

- 350+ structured products

www.amex.com

American Stock Exchange


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Electronic market Negotiated market

- Market makers are dealers

- Price determination through bargaining

3,600+ issues- more technology firms

- Dell, Microsoft, Intel

www.nasdaq.com

Nasdaq


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Other U.S. stock marketsOther U.S. stock markets

Nasdaq SmallCap Market- 800 small firms seeking Nasdaq market maker sponsorship

- No penny stocks (price < $1)

Over-the-Counter Bulletin Board- 3,000+ securities offered by 300+ market makers

- Penny stocks traded here

Electronic Communication Networks (ECNs)- Electronic market for institutional investors to trade with each

other


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Dow AveragesDow Averages

Charles Dow and Edward Davis Jones- Credited with inventing the stock index

- First stock index created in 188411 firmsMostly railroad companiesAdded up the stock prices and divided by 11. (price average index)

- DJIA was started in 1896 with 12 stocks

DJUA, DJTA


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Dow Jones Industrial AverageDow Jones Industrial Average

30 companies- Most important and largest firms- Selected by the editors of the Wall Street Journal

Formula

While originally 30, the divisor has been steadily reduced to account for stock splits. At the beginning of 2006 the divisor was 0.12493117.

Note that a $1 change in a stock’s price causes the DJIA to change by 8 (=1/ 0.12493117)

divisorDJIA

PDJIA

30

1iit

t


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Problems with price-weighted averagesProblems with price-weighted averages

Stock splits require changes in the divisor Larger priced stocks move the index more

than smaller priced stocks for the same % price move.- A $100 stock that increases 10% changes by

$10. A $10 stock that increases 10% changes by $1. A change of $10 moves the DJIA ten times more than a $1 change.

Difficult to index to a price-weighted average.

3M Co.

Alcoa Inc.

Altria Group Inc.

American Express Co.

American International Group Inc.

Boeing Co.

Caterpillar Inc.

Citigroup Inc.

Coca-Cola Co.

E.I. DuPont de Nemours & Co.

Exxon Mobil Corp.

General Electric Co.

General Motors Corp.

Hewlett-Packard Co.

Home Depot Inc.

Honeywell International Inc.

Intel Corp.

International Business Machines Corp.

Johnson & Johnson

JPMorgan Chase & Co.

McDonald's Corp.

Merck & Co. Inc.

Microsoft Corp.

Pfizer Inc.

Procter & Gamble Co.

SBC Communications Inc.

United Technologies Corp.

Verizon Communications Inc.

Wal-Mart Stores Inc.

Walt Disney Co.


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Standard & Poor’s 500 IndexStandard & Poor’s 500 Index The 500-firm index started in 1957

- Value weighted indexDetermine market capitalization of each firm (stock price × shares

outstanding)Add up the market capitalization for all 500 firmsScale (Index Base set to 10)

- Generally the largest 500 firms in the U.S.However, it is designed to match the sectors weights of the overall

market composition.

valuebaseIndexQP

QPindexweightedValue tt

00


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Index ExampleIndex Example Consider 3 stocks.

- Stock A is $40 and has 300 shares outstanding

- Stock B sells for $60, outstanding shares of 200

- Stock C costs $80 and has 100 shares. Consider two indices

- Price-weighted average, divisor=2.5

- Value-weighted averageBase index value = 100The stock originally sold for $30, $50, and $60 with

outstanding shares of 300, 100, and 100, respectively


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What is the value of each index?What is the value of each index?

Price-weighed average

(40 + 60 + 80) / 2.5 = 72.00

Value-weighted index

{($40X300 + $60X200 + $80X100) / ($30X300 + $50X100 + $60X100)} × 100

=

{32,000 / 25,000} × 100 = 128.00


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What is the value of each index after the $40 What is the value of each index after the $40 stock changes to $45?stock changes to $45?

Price-weighed average

(45 + 60 + 80) / 2.5 = 74.00 a 2.78% change

Value-weighted index

{($45X300 + $60X200 + $80X100) / ($30X300 + $50X100 + $60X100)} × 100

=

{33,500 / 25,000} × 100 = 134.00 a 4.69% change


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More Popular IndicesMore Popular Indices Russell Indexes

- Russell 3000 uses the 3,000 largest U.S. companiesRepresents 98% of the investable US equity

- Russell 1000 uses the 1,000 largest U.S. companiesRepresents 92% of the investable US equity

- Russell 2000 uses the 2,000 smallest companies n the Russell 3000Considered a small cap index.


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Dow Jones WilshireDow Jones Wilshire

Dow Jones Wilshire 5000 Composite Index- Most comprehensive measure of the

U.S. stock market- Designed to represent the performance

of all US-headquartered equity securities- Contains 4,972 stocks (beginning of

2006)

Dow Jones Wilshire 4500- Contains the Wilshire 5000 firms less

the S&P 500 firms- Considered a mid-cap index

Dow Jones Wilshire 5000 (Full Cap) Price

Dow Jones Wilshire 4500 (Full Cap) Price

Dow Jones Wilshire 2500 Price

Dow Jones Wilshire U.S. Large-Cap Price

Dow Jones Wilshire U.S. Mid-Cap Price

Dow Jones Wilshire U.S. Small-Cap Price

Dow Jones Wilshire U.S. Micro-Cap Price

Dow Jones Wilshire U.S. Large-Cap Growth Price

Dow Jones Wilshire U.S. Large-Cap Value Price

Dow Jones Wilshire U.S. Mid-Cap Growth Price

Dow Jones Wilshire U.S. Mid-Cap Value Price

Dow Jones Wilshire U.S. Small-Cap Growth Price

Dow Jones Wilshire U.S. Small-Cap Value Price

Wilshire Large Cap 750

Wilshire Mid Cap 500

Wilshire Small Cap 1750

Wilshire Micro Cap

Wilshire All Growth

Wilshire All Value

Wilshire Large Growth

Wilshire Large Value

Wilshire Mid Growth

Wilshire Mid Value

Wilshire Small Growth

Wilshire Small Value

Wilshire Small Cap 250

Wilshire Small Cap 250 Price


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Nasdaq IndexesNasdaq Indexes Nasdaq Composite Index

- All common stocks listed on the Nasdaq Stock Market

- 3,175 firms

- Market value-weighted

Nasdaq 100 Index- Largest 100 firms on the Nasdaq Stock Market

- Large stock index, but technology oriented


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Standard & Poor’sStandard & Poor’s

S&P 500 S&P MidCap 400 Index

- 400 firms

- Stocks with market caps of $1.5 to $10 billion S&P SmallCap 600 Index

- 600 firms

- Average market cap of $600 million


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Global Stock IndexesGlobal Stock Indexes Major Local Stock Market Index

- Nikkei, Dax, FTSE

Morgan Stanley Capital International Indexes- Global, regional, and local indexes

- Emerging and developed markets


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Securities Act of 1933- Applies to firms going public—

issuing new securities

- Requires firms to register with government

- Requires firms to provide investors with financial and material information

- Exempts private placements and small issues

Securities Exchange Act of 1934- Focuses on securities trading

- Creates and authorizes Securities and Exchange Commission (SEC) to enforce statutes, rules, and regulations

- Protects investors against fraud

Securities Market RegulationSecurities Market RegulationLegislation Important to Investors, Issuers of Securities and Legislation Important to Investors, Issuers of Securities and

Brokers/DealersBrokers/Dealers


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SEC delegates regulatory authority National Association of Securities Dealers (NASD)

- Regulates Nasdaq and OTC- Monitors sales practices- Administers tests and licenses for individuals- Ensures accurate sales information

NYSE, AMEX, CBOE--business practices and market operations

Municipal Securities Rulemaking Board Banks—Fed Reserve, Comptroller of Currency, FDIC

Self-Regulatory Self-Regulatory Organizations (SROs)Organizations (SROs)


2020

On Monday, October 19, 1987, the DJIA lost over 22% of its value in a crash.

This event lead to the enactment of circuit breakers that pause or close trading during fast moving markets.

Breakers are set to 10%, 20%, and 30% of recent DJIA level. - At DJIA 10,000, the breakers are changes of 1,000,

2,000, and 3,000.- The first breaker halts trading for 30 to 60 minutes.- The 2nd breaker halts trading for 2 hours and the third

breaker stops trading for the day. Collars: restricts index arbitrage when DJIA moves 200

points.- “Curbs” are in

Circuit Breakers and Trading LimitsCircuit Breakers and Trading Limits


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Learning objectivesLearning objectives

Discuss the trading on NYSE, AMEX and Nasdaq Discuss the other US stock marketsDiscuss the DJIA andS&P500 indices.Know how to calculate the indices. See the example in the slides.Know the Russell and Wilshire indicesDiscuss the Self Regulatory organizations.Discuss the Circuit Breakers and Trading limits.End of chapter CFA problems 2.1 and 2.2

Documents

FIN432 Vicentiu Covrig 1 Equity Markets (chapter 2)