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What Causes Stock Prices to Change?
Lesson Summary
What Causes Stock Prices to Change? explores the influences that affect stock prices.
Lesson Objectives
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Analyze and interpret market indices, which influence change in the price of stock.
Discuss the various ways stock prices are influenced.
Evaluate the ways investors can be affected by the change in market prices when
choosing to buy, sell, or hold.
Interpret charts and graphs to better understand the growth and change in stock
prices.
NCTM Standards
1A - Understand numbers, ways of representing numbers, relationships among numbers, and
number systems.
5A - Formulate questions that can be addressed with data and collect, organize, and display
relevant data to answer them.
5B - Select and use appropriate statistical methods to analyze data.
5C - Develop and evaluate inferences and predictions that are based on data.
5D - Understand and apply basic concepts of probability.
7B - Make and investigate mathematical conjectures.
7C - Develop and evaluate mathematical arguments and proofs.
8A - Organize and consolidate mathematical thinking through communication.
8B - Communicate mathematical thinking coherently and clearly to peers, teachers, and
others.
8C - Analyze and evaluate the mathematical thinking and strategies of others.
8D - Use the language of mathematics to express mathematical ideas precisely.
9C - Recognize and apply mathematics in contexts outside of mathematics.
10A - Create and use representations to organize, record, and communicate mathematical
ideas.
Mathematical Strands
Thinking
Algebraically
Interpreting
Statistics
Communicating
Quantitative
Information
Tackling
Complex
Problems
Students calculate Price/Earnings Ratios as well as solve
for stock prices and earnings-per-share values.
Students examine the trajectories of two stocks after
Hurricane Katrina, write about the information
presented, and hypothesize why certain sectors did
poorly after this event while others gained.
Students will write a brief description of events that
might make a company perform the way shown in the
graph.
Students use announcements from the Federal Reserve
to predict market activity.
66
THINKING ALGEBRAICALLY
Calculating Price/Earnings (P/E) Ratios
A P/E ratio is the quotient of a share’s current price to the company’s earnings per outstanding
share.
P/E ratio =
Pr ice _ per _ Share
Earnings _ per _ Share
Use this information to answer each problem.
1. If the company’s earnings per share are $1.75, and the current share price is $14.50, what is
the P/E ratio?
2. A company’s earnings per share are $0.80, and the current share price is $40.95. What is
the P/E ratio for this company?
3. A stock is trading at $53.28 while the company’s earnings per share are $1.39. What is the
P/E ratio for this stock?
4. If a company’s earnings per share are $2.01 and its stock is currently valued at $21.70, what
is the stock’s P/E ratio?
5. If a company’s stock is trading at $38.42, and its P/E ratio is 25.69, what are its earnings
per share?
6. A company has a P/E ratio of 17.51 and a stock value of $42.80. What are its earnings per
share?
7. A company’s earnings per share are $2.04 and its P/E ratio is 29.55. What is the value of
the company’s stock?
8. If the P/E ratio of a stock is 1.49 and its earnings per share are $1.17, how much would it
cost to buy 550 shares of its stock?
What Causes Stock Prices to Change?
67
INTERPRETING STATISTICS
Shocks to the Stock Market
Hurricane Katrina, one of the deadliest hurricanes in American history, struck the Gulf Coast
in late August of 2005. This tragedy also affected the stock market because investors knew
that companies would be influenced differently by this event.
The graphs below show two different industries’ performances over the same time period.
One of the trend lines shows the performance of companies that owned lumber businesses,
while the other trend line tracks the performance of residential insurance companies.
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1. Which trend line, the dotted or solid, do you think belongs to the lumber businesses
and which belongs to the residential insurance companies? Explain your answer.
2. The two sectors either rise or drop suddenly right around the time of Hurricane
Katrina, and then begin to recover from the initial shock. Where in the graph do you
see this recovery?
3. What is another example of an industry that would have experienced great losses after
Hurricane Katrina? Sketch a trend line for this industry on the graph above.
-.
4. What is an example of an industry that would have experienced gains after Hurricane
Katrina? Sketch a trend line for this industry on the graph above.
What Causes Stock Prices to Change?
68
COMMUNICATING QUANTITATIVE INFORMATION
Looking at the Effect of World Events
Below is a graph of the Dow Jones Industrial Average from January 2000 to April 2007.
Dow Jones Industrial Average
13,000.00
12,000.00
11,000.00
10,000.00
9,000.00
8,000.00
7,000.00
6,000.00
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Use the graph to identify where each historical event occurred and what happened to the
market.
1. Terrorists attacked the United States in September 2001.
2. President Bush was re-elected in November 2004.
3. The Euro was introduced in January 2002.
4. The merger between AOL and Time Warner was approved in February 2001.
Find another dramatic rise or drop in the market, and research what was happening in
financial and world news at that time.
What Causes Stock Prices to Change?
69
TACKLING COMPLEX PROBLEMS
Looking to the Federal Reserve
Investors listen to the announcements made by the Federal Reserve (Fed) to determine
whether the stock market will rise or fall.
If the Fed thinks that the economy is doing well, the stock market tends to rally. If the Fed
thinks that inflation (how much the prices of goods rise over time) is under control, the stock
market also tends to rally.
For the following statements, summarize what the Federal Reserve has said, and then predict
what the market would do after each announcement.
1. “Recent indicators have suggested somewhat firmer economic growth, and some
tentative signs of stabilization have appeared in the housing market. Overall, the
economy seems likely to expand at a moderate pace over the coming quarters.”
(January 31, 2007)
2. “Readings on core inflation have improved modestly in recent months, and inflation
pressures seem likely to moderate over time. However, the high level of resource
utilization has the potential to sustain inflation pressures.” (January 31, 2007)
3. The Federal Reserve Open Market Committee judges that some further policy firming
might be needed to address inflation risks.
Answer these questions based on information about actions by the Federal Reserve.
4. After an announcement from the Fed, the stock market dropped .064%. If a major
market index was previously at a value of 11,230, what would you predict to be the
value of the index after the announcement?
5. If an announcement from the Fed caused a major index to jump from 12,843 to 13,006,
how big was this jump as a percentage?
What Causes Stock Prices to Change?
70
THINKING ALGEBRAICALLY
What Causes Stock Prices to Change?
ANSWER KEY
Please Note: 1. Prices included in lesson are not representative of actual market data and are for instructional
purposes only. 2. Discrepancies may occur between student responses and the answer keys as a result of how
far calculations were taken past the decimal point. In most instances, numbers were rounded from the thousandth or
ten thousandth place.
Calculating Price/Earnings (P/E) Ratios
A P/E ratio is the quotient of a share’s current price to the company’s earnings per outstanding
share.
P/E ratio =
Price_per_Share
Earnings_per_Share
Use this information to answer each problem.
1. If the company’s earnings per share are $1.75, and the current share price is $14.50, what is
the P/E ratio?
Answer: $14.50 ÷ $1.75 = P/E of 8.29
2. A company’s earnings per share are $0.80, and the current share price is $40.95. What is
the P/E ratio for this company?
Answer: $40.95 ÷ $0.80 = P/E of 51.19
3. A stock is trading at $53.28 while the company’s earnings per share are $1.39. What is the
P/E ratio for this stock?
Answer: $53.28 ÷ $1.39 = P/E of 38.33.
4. If a company’s earnings per share are $2.01 and its stock is currently valued at $21.70, what
is the stock’s P/E ratio?
Answer: $21.70 ÷ $2.01 = P/E of 10.80
5. If a company’s stock is trading at $38.42, and its P/E ratio is 25.69, what are its earnings
per share?
Answer: EPS = $38.42 ÷ 25.69 = $1.50.
6. A company has a P/E ratio of 17.51 and a stock value of $42.80. What are its earnings per
share?
Answer: EPS = $42.80 ÷ 17.51 = $2.44.
7. A company’s earnings per share are $2.04 and its P/E ratio is 29.55. What is the value of
the company’s stock?
Answer: Price = ($2.04) (29.55) = $60.28.
8. If the P/E ratio of a stock is 1.49 and its earnings per share are $1.17, how much would it
cost to buy 550 shares of its stock?
Answer: Total Cost = (1.49) ($1.17) (550) = $958.82
What Causes Stock Prices to Change?
Answer Key
62
INTERPRETING STATISTICS
Shocks to the Stock Market
Hurricane Katrina, one of the deadliest hurricanes in American history, struck the Gulf Coast
in late August of 2005. This tragedy also affected the stock market because investors knew
that companies would be influenced differently by this event.
The graphs below show two different industries’ performances over the same time period.
One of the trend lines shows the performance of companies that owned lumber businesses,
while the other trend line tracks the performance of residential insurance companies.
1. Which trend line, the dotted or solid, do you think belongs to the lumber businesses
and which belongs to the residential insurance companies? Explain your answer.
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Answer: The dotted line belongs to the residential insurance companies. The
solid line belongs to the lumber companies. After Hurricane Katrina, there was a
lot of destruction causing billions of dollars worth of damage to homes which
resulted in a lot of insurance claims. The lumber companies had more business
because of the damaged and destroyed homes.
What Causes Stock Prices to Change?
Answer Key
63
INTERPRETING STATISTICS
2. The two sectors either rise or drop suddenly right around the time of Hurricane
Katrina, and then begin to recover from the initial shock. Where in the graph do you
see this recovery?
Answer: The recovery began at the end of October and continued through
November.
3. What is another example of an industry that would have experienced great losses after
Hurricane Katrina? Sketch a trend line for this industry on the graph above.
Possible answers might include: auto insurance companies, tourism, and local
farming.
4. What is an example of an industry that would have experienced gains after Hurricane
Katrina? Sketch a trend line for this industry on the graph above.
Possible answers might include: roofing supplies and auto sales.
What Causes Stock Prices to Change?
Answer Key
64
COMMUNICATING QUANTITATIVE INFORMATION
Looking at the Effect of World Events
Below is a graph of the Dow Jones Industrial Average from January 2000 to April 2007.
Dow Jones Industrial Average
13,000.00
12,000.00
11,000.00
10,000.00
9,000.00
8,000.00
7,000.00
6,000.00
Jan-00
Jan-01
Jan-02
Jan-03
Jan-04
Jan-05
Jan-06
Jan-07
Jan-08
Jan-09
Jan-10
Use the graph to identify where each historical event occurred and what happened to the
market.
1. Terrorists attacked the United States in September 2001.
Answer: The DJIA went down sharply but finished the year strong.
2. President Bush was re-elected in November 2004.
Answer: The DJIA increased after President Bush was re-elected.
3. The Euro was introduced in January 2002.
Answer: The DJIA dipped a little but increased through February and March,
after the introduction of the Euro.
4. The merger between AOL and Time Warner was approved in February 2001.
Answer: The DJIA dropped after the merger.
Find another dramatic rise or drop in the market, and research what was happening in
financial and world news at that time.
What Causes Stock Prices to Change?
Answer Key
65
TACKLING COMPLEX PROBLEMS
Looking to the Federal Reserve
Investors listen to the announcements made by the Federal Reserve (Fed) to determine
whether the stock market will rise or fall.
If the Fed thinks that the economy is doing well, the stock market tends to rally. If the Fed
thinks that inflation (how much the prices of goods rise over time) is under control, the stock
market also tends to rally.
For the following statements, summarize what the Federal Reserve has said, and then predict
what the market would do after each announcement.
1. “Recent indicators have suggested somewhat firmer economic growth, and some
tentative signs of stabilization have appeared in the housing market. Overall, the
economy seems likely to expand at a moderate pace over the coming quarters.”
(January 31, 2007)
Answers will vary. With recent economic growth and signs of a stabilizing
housing market, we should be headed toward moderate economic growth in the
coming quarter. This is good news for the stock market and probably will bring
about improvement in that market.
2. “Readings on core inflation have improved modestly in recent months, and inflation
pressures seem likely to moderate over time. However, the high level of resource
utilization has the potential to sustain inflation pressures.” (January 31, 2007)
Answers will vary. There is still some uncertainty about inflation. On one hand,
there seems to be some reduction in inflationary pressures. On the other hand,
there are still some inflation worries. This uncertainty about inflation probably
will keep the stock market from improving significantly as investors will worry
about future actions by the Fed to curtail inflation.
3. The Federal Reserve Open Market Committee judges that some further policy firming
might be needed to address inflation risks.
Answer: There are still some concerns about inflation which need to be
addressed. Investors should expect the Fed to increase interest rates in an
attempt to reduce inflation. This expectation probably will slow down the stock
market.
Answer these questions based on information about actions by the Federal Reserve.
4. After an announcement from the Fed, the stock market dropped .064%. If a major
market index was previously at a value of 11,230, what would you predict to be the
value of the index after the announcement?
Answer: The value of the index would be (11,230) – (11,230) (0.0064)
= (11,230) (1 - 0.0064) = 11,158.13
5. If an announcement from the Fed caused a major index to jump from 12,843 to 13,006,
how big was this jump as a percentage?
Answer: The increase = [(13,006 - 12,843) ÷ 12,843] x 100
= 0.012691 x 100 = 1.27%
What Causes Stock Prices to Change?
Answer Key
66