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ECONOMICS 179
ECONOMICS OF THE STOCK MARKET
Professor Thornton
T, Th, 11:00-12:15
Winter 2001
Pray-Harrold 407
Office and Phone: Pray-Harrold 707-F, 487-0080
Office Hours: T, Th, 12:15 – 4:15, and by appointment.
Texts: John M. Dalton, How the Stock Market Works, Second Edition, 1993.
Burton G. Malkiel, A Random Walk Down Wall Street, Fourth Edition, 1999.
One of the most visible and important markets in the U.S. economy is the stock market.
The stock market plays a pivotal role in the social organization of economic activity, and
the outcomes of interactions that take place in this market have important consequences
for the wealth and prosperity of individuals, firms, and the nation as a whole. Recent
developments in the commercial internet and information technology have made the
stock market increasingly accessible to anyone who wants to participate. Financial data
and news is now readily available to the general public as well as Wall Street
professionals, and many individuals are taking an active role in managing their own stock
portfolios and retirement accounts. In this changing environment, it is important for
ordinary individuals to have a basic knowledge of the stock market and the skills
necessary to assimilate financial information and make educated investment decisions.
The objective of this course is to provide you with a fundamental understanding of how
the stock market works, how investment decisions are made, and recent changes that are
transforming the stock market and making it accessible to the general public. You will
also learn how to use the internet to access information about the stock market.
Your grade in the class will be based on two exams, a midterm and a final, several
homework/internet assignments, and participation in a simulated stock market game. The
weights are as follows.
Exams:
50%
Homeworks:
40%
Stock Market Game: 10%
There are currently more that 8,000 Web sites that provide a vast array of information on
the stock market and investing. The homework/internet assignments are designed to help
you become acquainted with accessing and interpreting this information. During the
semester, you will also play a simulated stock market game. This game will be played on
the VirtualStockExchange Web site, which was founded by alumni from Stanford and
Cornell University as an educational tool to teach students about investing in the stock
market. It is a simulated online brokerage firm that lets you do mock trading of all
securities listed on the major stock exchanges in the U.S. Thus, you will be buying and
selling stocks on the internet just like you would if you had an account at an online
broker. The only requirement is that you play the game, and submit periodic updates of
your portfolio holdings.
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The following books are recommended for students who wish to do additional reading on
topics related to the stock market. These books are not required for this class.
Jeremy Siegel, Stocks for the Long-Run, Second Edition, McGraw-Hill, 1998.
Robert Shiller, Irrational Exuberance, Princeton University Press, 2000.
Richard Tewles and Edward Bradley, The Stock Market, Seventh Edition, John Wiley
and Sons, 1998.
Thomas Bass, The Predictors, Henry Holt and Company, 1999.
John Bogle, John Bogel on Investing: The First 50 Years, McGraw-Hill, 2001.
Peter Lynch, One Up on Wall Street, Simon and Schuster, 2000.
Investors Business Daily, Guide to the Stock Market, John Wiley and Sons, 1996.
Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital
Management, 2000.
Jonathan Burton, Investment Titans: Investment Insights from the Minds That Move Wall
Street, McGraw Hill, 2001.
Nicholas Teebagy, The Math Behind Wall Street, Four Walls Eight Windows, 2000.
Robert W. Kolb, Financial Derivatives, New York Institute of Finance, 1993.
OUTLINE OF TOPICS AND ASSIGNMENTS
1. Economics and Markets
What is economics? How do economists view the economy? What is a market? Why do
economists study markets and complex exchange processes? How do economists
organize their thinking about markets? Why study the stock market?
Dates: Tuesday 1/9.
Assignment: None.
2. Firms, Corporations, Stocks and Bonds
What is the objective of a firm? How are firms legally organized? What is a
corporation? What do corporations do with the profits that they make? What is the
difference between common stock and preferred stock? What are preemptive rights,
stock warrants, and stock options? Why are these financial instruments called
derivatives?
Dates: Thursday 1/11, Tuesday, 1/16.
Assignment: Dalton, chapter 1, chapter 9.
3. Investment Returns, Stock Reports, and Stock Indexes
What is the difference between total return and rate of return on an investment? Do
stocks or bonds have higher historical returns? How do you read a stock report? What is
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a stock index? What is the difference between the Dow Jones Industrial Average,
Standard and Poor’s 500 Index, Wilshire 5000 Index, and the Russell Indexes?
Dates: Thursday 1/18, Tuesday 1/23.
Assignment: Dalton, chapter 2.
4. Primary Market for Stocks and Initial Public Offerings
What is the primary market for stocks? Who are the major players in this market? What
role do investors, corporations, brokers, and dealers play in this market? What is the
difference between a private placement of stock and a public offering of stock? How
does an initial public offering (IPO) of stock work? Can investors become wealthy by
buying stock issued by corporations in an initial public offering?
Dates: Thursday 1/25, Tuesday 1/30.
Assignment: Dalton, chapter 3.
5. Secondary Market for Stocks: How Stocks Are Bought and Sold
What is the secondary market for stocks? Who are the major players in this market?
What role do investors, brokers and dealers play in this market? What is the difference
between an organized exchange and an over-the-counter market? What are the major
types of brokerage firms? What is the difference between cash and margin brokerage
accounts? How does a cash stock transaction differ from a margin stock transaction?
What does it mean to sell a stock short? What is the difference between market, limit, and
stop orders? How are stocks traded on the New York Stock Exchange? What role do
specialists play on the exchange? How are stocks traded on the over-the-counter market?
Will Electronic Communications Networks eventually replace organized exchanges and
the existing over-the-counter market?
Dates: Thursday 2/1, Tuesday 2/6, Thursday 2/8, Tuesday 2/13.
Assignment: Dalton, chapters 4,5,6,7,10.
6. What Determines Stock Prices: Fundamentals or Psychology?
What is the firm foundation theory of stock valuation? How does a rational investor
determine the price she is willing to pay for a stock? What factors determine the intrinsic
value of a share of stock? What are undervalued and overvalued stocks? What is the
market psychology theory of stock valuation? How does an emotional investor determine
the price she is willing to pay for a stock? What determines the psychic value of a stock?
What is a speculative bubble? What is the price/earnings ratio, and how does it measure
the value of a stock? Does the stock market have rational underpinnings, or is it just a big
casino?
Dates: Thursday 2/15, Tuesday 2/20, Thursday 2/22, Tuesday 2/27.
Assignment: Malkiel, chapters 1,2,3,4;
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Midterm Exam: Thursday 3/1
Winter Vacation: 3/6, 3/8
7. Stock Market Analysis and Investment Strategies: Are Stock Prices Predicable?
What is fundamental analysis? What is technical analysis? Can investors and stock
market analysts make big profits using these investment strategies? What is the random
walk theory and the efficient market hypothesis? Do they suggest that investing in the
stock market is a pure gamble?
Dates: Tuesday 2/13, Thursday 2/15.
Assignment: Malkiel, chapters 5,6,10 (pages 240 – 258); Dalton, chapter 11.
8. Mutual Funds: Can Professional Portfolio Managers Beat the Market?
What is a mutual fund? What different types of mutual funds exist? How are mutual fund
shares priced? What is a load, expense ratio, 12b-1 fee, and turnover ratio? How do you
judge the performance of a mutual fund? How does an index fund differ from an actively
managed fund? Can mutual fund portfolio managers consistently beat the market?
Dates: Tuesday 3/20, Thursday 3/22.
Assignment: Dalton, chapter 8; Malkiel, chapter 7, 10 (pages 259 – 270), 14.
9. Stock Market Reaction to News
What impact does economic, political, and other news have on the stock market? Why is
expected news not news? Does the market react to news in a predictable fashion? Why
do stock market participants hate uncertainty? To what extent does new affect stock
prices?
Dates: Tuesday 3/27.
10. Stock Market Performance: 1982 – Present
What factors have caused the dramatic increase in the stock market since 1982? What
role have fundamental factors played in the rising stock market? What role have
psychological factors played in the rising stock market? Is the stock market fairly valued,
overvalued, or undervalued? Why did the stock market “crash” in 1987? How might the
stock market perform in the near future?
Dates: Thursday 3/29, Tuesday 4/3, Thursday 4/5, Tuesday 4/10.
Assignments: Dalton, chapter 14.
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11. Principles of Modern Portfolio Theory: How to Construct a Portfolio of Stocks
What is modern portfolio theory? How is risk defined and measured? How can investors
reduce risk? How can modern portfolio theory be used as a guide to choosing a stock
portfolio?
Dates: Thursday 4/12, Tuesday 4/17, Thursday 4/19.
Assignments: Malkeil, chapters 8,9.
Final Exam: Thursday, April 26, 11:00 – 12:30
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