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					• An Introduction
• Essential Characteristics of Common Stock
• Measuring the Level of the Stock Market
• Valuing Stocks
• Fundamental Value and the Dividend-Discount Model
• Investing in Stocks for the Long Run
• The Stock Market’s Role in the Economy
Stocks: An Introduction
 Stocks provide a key instrument for holding
  personal wealth as well as a way to diversify,
  spreading and reducing the risks that we face
 For companies, they are one of several ways to
  obtain financing.
 Additionally, Stocks and stock markets are one
  of the central links between the financial world
  and the real economy.
 They indicate the value of the companies that
  issued the stocks and, They allocate scarce
  investment resources
 Stocks: An Introduction
 The firms deemed most valuable in the marketplace for
  stocks are the ones that will be able to obtain financing
  for growth. When resources flow to their most valued
  uses, the economy operates more efficiently
 Most people see stock market as a place where fortunes
  are easily made or lost, and they recoil at its
  unfathomable booms and busts.
 Great American Depression (1929)
 Post-September 11, 2001 scenario
 Pakistan stock market on roller-coaster-ride (March
       Essential Characteristics of Common Stock
 Stocks, also known as common stock or equity, are shares
    in a firm’s ownership
   From their early days, stocks had two important
    characteristics : The shares are issued in small
    denominations and The shares are transferable
   Until recently, stockowners received a certificate from the
    issuing company, but now it is a computerized process
    where the shares are registered in the names of brokerage
    firms that hold them on the owner’s behalf
   The ownership of common stock conveys a number of
    A stockholder is entitled to participate in the shares of
    the enterprise, but this is a residual claim i.e. meaning the
    leftovers after all other creditors have been paid.
    Essential Characteristics of Common Stock
 Stockholders also have limited liability
 Even if a company fails, the maximum amount that the
    stockholder can lose is the initial investment
   Stockholders are entitled to vote at the firm’s annual
    meeting including voting to elect (or remove) the firm’s
    board of directors
   Prices of individual shares are low, allowing individuals to
    make relatively small investments
   Because of limited liability, investor’s losses cannot
    exceed the price they paid for the stock; and
   Shareholders can replace managers who are doing a
    bad job
  Measuring the Level of the Stock Market
 Stocks are one way in which we choose to hold our
  wealth, so when stock values rise we get richer and
  when they fall we get poorer
 These changes affect our consumption and saving
  patterns, causing general economic activity to
 Stock market indexes are designed to give us a sense
  of the extent to which stock prices are going up or
 Tell us both how much the value of an average stock
  has changed, and how much total wealth has gone
  up or down
Measuring the Level of the Stock Market
 Every major country in the world has a stock market, and
    each of these markets has an index
   The Dow Jones Industrial Average
   The Standard & Poor's 500 Index
   NASDAQ Composite index
   Financial Times Stock Exchange 100 Index
   Hang Seng 100
   Nikkei 225
   The KSE100
                     VALUING STOCKS
 People differ in their opinions of how stocks should
  be valued
 Chartists believe that they can predict changes in a
  stock’s price by looking at patterns in its past price
 Behaviorists estimate the value of stocks based on their
  perceptions of investor psychology and behavior
 Others estimate are based on a detailed study of the
  fundamentals, which can be analyzed by examining the
  firm’s financial statements.
 In this view the value of a firm’s stock depends both on
  its current assets and estimates of its future profitability
Fundamental Value and the Dividend-Discount Model
 As with all financial instruments, a stock represents a
  promise to make monetary payments on future dates,
  under certain circumstances
 With stocks the payments are in the form of dividends,
  or distributions of the firm’s profits
 The price of a stock today is equal to the present value of
  the payments the investor will receive from holding the
 This is equal to: The selling price of the stock in one
  year’s time plus The dividend payment received in the
Fundamental Value and the Dividend-Discount Model

  Thus the current price is the present value of next
   year’s price plus the dividend
  If Ptoday is the purchase price of stock, Pnext year is
   the sales price one year later and Dnext year is the
   size of the dividend payment, we can say:
Fundamental Value and the Dividend-Discount Model
Fundamental Value and the Dividend-Discount Model
Fundamental Value and the Dividend-Discount Model
        Investing in Stocks for the Long Run

 Stocks appear to be risky, and yet many people
  hold substantial proportions of their wealth in
  the form of stock
 This is due to the difference between the short
  term and the long term;
 Investing in stocks is risky only if you hold them
  for a short time
 In fact, when held for the long term, stocks are
  less risky than bonds.
       The Stock Market’s Role in the Economy
 The stock market plays a crucial role in every modern
  capitalist economy.
 The prices determined there tell us the market value of
  companies, which determines the allocation of
 Firms with a high stock market value are the ones
  investors’ prize, so they have an easier time garnering
  the resources they need to grow.
 In contrast, firms whose stock value is low have
  difficulty financing their operations
 So long as stock prices accurately reflect fundamental
  values, this resource allocation mechanism works well.
       The Stock Market’s Role in the Economy
 Shifts in investor psychology may distort prices;
  both euphoria and depression are contagious
 When investors become unjustifiably exuberant
  about the market’s future prospects, prices rise
  regardless of the fundamentals, and such mass
  enthusiasm creates bubbles.
 Bubbles are persistent and expanding gaps
  between actual stock prices and those warranted
  by the fundamentals.
 These bubbles inevitably burst, creating
     The Stock Market’s Role in the Economy
 They affect all of us because they distort the
  economic decisions companies and consumers
 If bubbles result in real investment that is
 both excessive and inefficiently distributed,
 crashes do the opposite; the shift to excessive
 pessimism causes a collapse in investment and
 economic growth
 When bubbles grow large enough and result in
 crashes the stock market can destabilize the
 real economy

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