Download Equities and Indexes

Equities and Indexes
Common Stock
Preferred Stock
Equity Index
Bond Index
Common Stock
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Definition
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Ownership shares in public companies
Characteristics
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Voting rights
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Residual Claims
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Shareholder can vote for company issues, e.g., executive
compensation, board of directors, auditing firm, etc.
Last in line of all claimants on the company, e.g., owns
whatever is left after workers, suppliers, bondholders are
paid off.
Limited Liability
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Investments 3
Lose no more than original investment, e.g., you pay $90
for a share of IBM, you’ll lose no more than that.
2
Common Stock

A quote from WSJ (or YAHOO these days)
52 Weeks
Hi
Lo Stock (SYM) DIV YLD% P/E Volume Hi
17.52
5.73
GenElec (GE) 0.40 2.43 14.68 74,123,574 16.75 16.35 16.44 -0.26
$0.10/Quarter
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A few questions
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Net
Lo Close
Chg
0.40
 100
16.44
How much do you have to pay for a share at
close?
What is last year’s earning?
Is the stock boring?
Investments 3
3
Preferred Stock

Definition
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Characteristics
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Non-voting share in a corporation
Fixed dividend stream (like bond coupon)
Dividend may be skipped yet cumulative
Dividend fully taxable
How different is it from a bond?
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4
Indexes: Equity and Bond

What are they?
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Why do we need them?
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
An indicator of average security prices
Tracking market returns
Benchmarking fund manager performance
Bases for derivatives, e.g., index options
Factors affecting an index
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Representative?
Weighting of components?
Investments 3
5
Equity Indexes
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DJIA
S&P 500, S&P Mid Cap.
NASDAQ 100
Nikkei 225 (Tokyo Stock Exchange)
FTSE 100 (London)
Wilshire 5000
MSCI-EAFE Index

Morgan Stanley Capital International Europe,
Australia, Far East Index (including 21
developed countries outside North America)
Investments 3
6
Equity Indexes: DJIA

Some facts
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30 industrial stock price-weighted average.
Oldest and best-known in the U.S.
Used to representing about a quarter of the
market value of the NYSE stocks.
Quantitatively
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Divisor changes when stock splits or stock is
replaced by another
Investments 3
7
Equity Indexes: DJIA

Construction
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Suppose DJIA has two stocks
Stocks
Shares
Price
Name Outstanding Yesterday Today
A
20
$30
$25
B
5
$40
$50
Divisor
DJIA
2
35
37.5
Investments 3
8
Equity Indexes: DJIA

What happens when a stock splits?

At market close today, B has a 2-for-1 split
Stocks
Shares
Price
Name Outstanding Yesterday Today
A
20
$30
$25
B
5
$40
$50
Divisor
DJIA
2
35
37.5
B
10
$25
DJIA
1.3333
37.5
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Where does the new divisor come from?
$25  $25
 $37.5
new divisor
Investments 3
$25  $25
 new divisor 
 1.3333
$37.5
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Equity Indexes: S&P 500

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Including 500 NYSE, Amex, NASDAQ stocks
Considered to be a much broader index of
the U.S. market than the DJIA
Numerous financial products derived from the
index
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Mutual funds indexed to the S&P 500 Index
S&P Depository Receipts (SPDR)
S&P 500 Index Options and Futures
Market value-weighted index – larger
companies have more weight in S&P 500
S&P 500 is float-adjusted since Sep 16, 2005
Investments 3
10
Equity Indexes: S&P 500

Market value-weighted index - Calculation
Stocks
Shares
Price
Name Outstanding Yesterday Today
A
20
$30
$25
B
5
$40
$50
S&P
8
100 93.75
Investments 3
11
Equity Indexes: S&P 500
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When does the divisor change?
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NOT for stock split
YES for stock replacement in the index
E.g., C replaces B in the index
Stocks
Shares
Price
20  25  40  60 Name Outstanding Yesterday Today
93.75 
new divisor
A
20
$30
$25
20  25  40  60
B
5
$40
$50
new divisor 
Divisor
S&P
8
100 93.75
93.75
C
40
$50
$60
 30.9333
S&P
30.9333
93.75
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Example: Amazon.com joining S&P 500
Amazon.com Stock Price
50
48
46
AMZN joins
S&P 500 on
Nov 18, 2005
Announcement
is made after
market closing
on Nov 14, 2005
44
42
40
11/1/05
11/8/05
11/15/05
11/22/05
11/29/05
Amazon.com Trading Volume
60000000
40000000
20000000
0
11/1/05
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11/8/05
11/15/05
11/22/05
11/29/05
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Equity Indexes
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Equally Weighted Stock Indexes
Equally weighted stock indexes place
equal weight on each stock return, and call
for a portfolio strategy that places equal
dollar values in each stock.
E.g., Stock A has a return of 2% and stock B
has a return of 1%. An equally weighted
index of A and B has a return of
0.5*2% + 0.5*1% = 1.5%

Constant portfolio rebalancing is
required to track such an index
Investments 3
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Bond Indexes
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An indicator for bond market returns
# of Issues
Maturity
Excluded Issues
Weighting
Reinvestment
Bond Indexes
Lehman Brothers* Merrill Lynch
> 6,500
> 5,000
>= 1 year
>= 1 year
High Yield
High Yield
Convertible
Convertible
Floating Rate
Market Value
Market Value
No
Yes*
*specific bond
Salomon Brothers
> 5,000
>= 1 year
High Yield
Convertible
Floating Rate
Market Value
Yes**
** 30-day T-bill
* Now Barclays Capital Aggregate Bond Index
Investments 3
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Wrap-up
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What are stocks and preferred stocks?
What are stock indexes for?
What are commonly used indexes?
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DJIA: price-weighted - Old and Faithful
S&P: float value weighted - good “market” proxy
NASDAQ: new and dynamic
Less followed
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Bond indexes: professionals pay more attention to it
Investments 3
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