Lesson 3
HOW FINANCIAL MARKETS WORK
CHAPTER OBJECTIVES
A financial market is a place where firms and individuals enter into contracts to sell or buy a specific product such as a stock, bond or futures contract. Buyers seek to buy at the LOWEST available price and sellers seek to sell at the HIGHEST available price. (Markets provide a meeting place for buyers and sellers where prices are determined.)
Securities markets deal primarily with stocks and bonds. The purpose of a securities market is primarily for business to acquire investment capital. Examples of securities markets include the New York Stock Exchange (NYSE) and the Nasdaq Stock Market (Nasdaq).
The Nasdaq Stock Market is computer-based versus the NYSE, which is floor-based. A screen-based market like the Nasdaq enables participants to trade stocks with each other through a telecommunications network: they access the market on their desktop terminals anywhere they happen to be while a mainframe computer processes the trade. A traditional floor-based market, like the NYSE, operates in a specific building where brokers representing investors must be present to trade stocks. In 1997, 163.9 billion shares were traded on Nasdaq and 133.3 billion on the NYSE.
Futures markets trade on the future price of commodities and financial products. The purpose of a futures market is to provide businesses with a way to manage price risk. Examples of futures markets are the Chicago and the New York Mercantile Exchanges and the Chicago Board of Trade.
How Securities are Bought and Sold
New issues of stock must be registered with the U.S. Securities and Exchange Commission (SEC) and, in some cases, the Maine Securities Division. A prospectus, giving details about a company’s operation and the stock to be issued, is printed and distributed to interested parties. Investment bankers or brokerage houses buy large quantities of the stock from the company, then resell the stocks to individual and institutional investors. This is how the company receives the money it seeks.
Stock certificates are issued in the name of the purchaser of the stock. Corporations have many different stockholders and must keep a record of their names and addresses. The stock certificate of ownership of a publicly held corporation may be transferred from one owner to another since a stock certificate is a negotiable instrument. Certificates may be held by brokerage houses in street name (broker firm’s name) on behalf of the investor.
The potential buyer places an order with a broker for the stock he or she wishes to purchase. A broker is a licensed professional who is employed by a brokerage firm and who specializes in buying and selling securities. The broker puts in the buy order to the appropriate exchange. When someone who owns the desired stock is willing to sell at the price the buyer is willing to pay, the transaction takes place. Computer technology and telephones are used to execute the sale.
Trading on line is much cheaper. Some companies, like "DATEK" online trading, charges $8 a trade. If you understand the market and how it works you can avoid the commissions you would pay a broker.
FACTORS THAT AFFECT PRICE
Few investors can consistently predict the ups and downs of the market or even of an individual investment. Yet investors who are aware of the factors that affect market price are more likely to make sound investment decisions than are less informed investors.
Actions of investors. Individual investors, institutional investors and mutual fund managers all affect the price by their actions in buying or selling. For example, when large numbers of individual investors believe that the nation is heading into a recession, their actions can influence the health of the market.
Business Conditions. Profits earned, an increase in volume of sales and expansion of plants of the corporation all affect investor interest and, consequently, price. Health of the economy, business conditions in general and the business cycle also affect the price.
Government action. Government decisions regarding issues such as interest rates, taxes, trade policy and budget deficits have an impact on prices.
Economic indicators. Published figures on personal income levels, employment, consumer spending patterns, business inventories and interest rates all effect one industry or another and subsequently stock, bond and future prices.
Because investment markets have international linkages, investments can be purchased around the clock. When the market opens in New York, the Tokyo market has just closed for the day and the London market is halfway through its trading day. When prices go down in Japan, there often is a ripple effect that sends British and U.S. markets down.
YOUR ASSIGNMENT FOR THE NEXT THREE WEEKS IS TO WATCH TV. IN THE MORNING AT 6:30 AM, WHILE YOU ARE HAVING BREAKFAST, I WANT YOU TO TUNE INTO BLOOMBERGS ON MPBN. IT IS A HALF HOUR SHOW WITH EXCELLENT INFORMATION ON INVESTING. WHEN YOU GET HOME FROM SCHOOL, I WOULD LIKE FOR YOU TO WATCH CNBC IF YOU HAVE SATELITE. IT IS ANOTHER EXCELLENT SHOW. MOST OF THE DAY, DURING THE WEEKDAYS, IT PERTAINS TO BUSINESS AND INVESTING. NOTICE THE CHARTS ON SOME OF THE STOCKS THEY RECOMMEND. YOU MAY WANT TO ADD SOME OF THESE STOCKS TO YOUR INVESTMENT PORTFOLIO. ALSO, NOTICE THE TICKER TAPE AT THE BOTTOM OF THE SCREEN. IF THE STOCK SYMBOL IS IN GOLD, THAT MEANS THAT IT IS TRADING AFTER HOURS.
I WANT YOU TO START TO WATCH THESE PROGRAMS ON A REGULAR BASIS. YOU WILL GAIN MUCH KNOWLEDGE TO USE WITH YOUR INVESTMENT PORTFOLIO. YOU CAN START IT NOW. EACH OF YOU STUDENTS HAVE $250,000 TO INVEST IN STOCKS. BUY AT THE CLOSE PRICE OF THE DAY. IF YOU SELL, SELL AT THE CLOSE PRICE. DISREGARD COMMISSIONS. GOOD LUCK!! IT WILL BE INTERESTING TO SEE IF YOU MAKE MONEY OR LOSE MONEY. IF YOU HAVE ANY QUESTIONS, PLEASE E-MAIL ME. I WILL GET BACK TO YOU PROMPTLY.
A COUPLE OTHER THINGS. 1. IF YOU CANNOT WATCH THESE PROGRAMS, HAVE SOMEONE TAPE THEM WITH A VCR. IT CAN BE DONE AT MOST SCHOOLS. YOU MAY HAVE TO PROVIDE YOUR OWN TAPES. 2. START TO READ THE FINANCIAL PAGES OF NEWSPAPERS. YOUR LIBARARY WILL HAVE THE NEWSPAPERS ON HAND. THE WALL STREET JOURNAL IS GREAT. IT ALSO GIVES YOU SOME STOCK SYMBOLS TO RESEARCH ON THE INTERNET. I WOULD USE www.cnnfn.com and www.cnbc.com. WHEN YOU GET ON THESE TWO INTERNET SITES YOU CAN GET STOCK QUOTES, CHARTS, RESEARCH, ETC. THAT WILL BE HELPFUL WITH YOUR PERSONAL INVESTMENT PORTFOLIO. REMEMBER, E-MAIL ME IF YOU HAVE ANY QUESTIONS.
DO NOT GET BOGGED DOWN WITH ALL THE INFORMATION. JUST ABSORB WHAT YOU CAN.