Topic 7.3 Stocks

7.3 The Stock Market
Objectives
1. Understand the benefits and risks of buying stock.
2. Describe how stocks are traded.
3. Identify how stock performance is measured.
4. Explain the causes and effects of the Great Crash of 1929.

What is a stock, exactly how is it traded, and when is it a good investment?
Besides selling bonds, companies can sell stock to raise money. But stock represents ownership in a company.

Share – Portion of stock

Dividends – A companies profits paid out to shareholders. This is usually done four times a year.

Capital gain/loss – The difference between a selling price and a purchase price. If the selling price is bigger than the purchase price, it’s a gain. If the selling price is lower than the purchase price, it’s a loss.

Stock Split – The division of a single share of stock into more than one share.

EX: Suppose you own 200 shares of Google at $100 per share. The stock splits and now you have 400 shares at $50.

Companies have stock splits when they feel their stock is too expensive to buy.

Buying stocks can be risky because a company could potentially not make money and not pay dividends. Additionally, the share price could drop.

How Are Stocks Traded
Suppose you want to buy a stock in a company. Do you call up that company, no. You call a stockbroker.

Stockbroker – A person who links buyers and sellers of a stock.

Stock Exchanges – A market for buying and selling stock.

EX: NYSE and NASDAQ

Measuring Stock Performance
Bull Market – A steady rise in the stock market over a period of time.

Bear Market – A steady drop in the stock market over a period of time.

The Dow – An index that show how certain stocks have traded (around 30 stocks)

S&P 500 – An index that shows the price changes of 500 different stocks

The Great Crash of 1929
The 1920s saw a long-term bull market but in 1929 the stock market crashed leading to the Great Depression.

Speculation – The practice of making high-risk investments with borrowed money with the hopes of a big return

7.2 Notes Bonds

7.2 Bonds and Other Financial Assets
Objectives
1. Describe the characteristics of bonds as financial assets
2. Identify different types of bonds
3. Describe the characteristics of other types of financial assets.
4. Explain four different types of financial asset markets.

How do borrowers raise money for investment? One of the most important ways is by selling bonds.

Bond – Certificates sold by a company or government to finance projects or expansion.

EX: War bonds during WWII

Bonds are basically IOUs that the government or companies must pay back to investors with a fixed amount of interest. They are generally considered low-risk investments.
Bonds have three basic components:
Coupon Rate – The interest rate that a bond issuer will pay to a bondholder.

Maturity – The time at which payment to a bondholder is due.

Par Value – The amount that an investor pays to purchase a bond and that will be repaid to the investor at maturity.
Example: Suppose you buy a bond from a new company, Jeans Inc.
Coupon rate: 5%, paid to the bondholder annually
Maturity: 10 years
Par Value: $1,000






Advantages and Disadvantages
The person who buys a bond is called a “holder,” while the person who sells the bond is an “issuer.”
Bonds are desirable to the issuer because
1. The coupon rate on a bond does not go up or down so companies know exactly how much they will have to pay back.
2. Unlike stockholders, bondholders do not own a part of the company. So a company does not have to share its profits if it becomes wealthy.

Bonds are undesirable to the issuer because
1. A company must make interest payments on bonds, even during bad years.

Types of Bonds

Savings Bond – A low-denomination ($50 to $10,000) bond issued by the US government.

Municipal Bond – A bond issued by a state or local government to finance highways, libraries, parks and schools.

Corporate Bonds – A bond that a corporation issues to raise money to expand its business.

Junk Bonds – A lower-rated, potentially higher-paying bond.

Savings and municipal bonds are generally considered low-risk compared corporate bonds, whereas junk bonds are the riskiest.

7.1 Notes

7.1 Saving and Investing

Objectives
1. Understand how investing contributes to the free enterprise system.
2. Explain how the financial system brigs together savers and borrowers.
3. Describe how financial intermediaries link savers and borrowers.
4. Identify the trade-offs among risk, liquidity and return

If you go to school today, you give up your time now so that you will be prepared for a career in the future. If a firm builds a new plant, it spends money today for the sake of earning more money in the future. These actions represent investments.

Investment – The act of redirecting resources from being consumed today so that they may create benefits in the future.

Investment promotes economic growth
EX: You put money in bank, the bank lends it to a business, the business invests the money in a new plant, and the plant hires people and produces better products.

In order for investment to take place an economy must have a financial system.
Financial System – The system that allows the transfer of money between savers and borrowers.


Financial Intermediary – An institution that helps channel funds from savers to borrowers.

EX: Banks, saving & loan associations, credit unions, and mutual funds.

Mutual Fund – A fund that pools the savings of many individuals and invest this money in a variety of stocks, bonds and other assets.

Savers give their money to financial intermediaries, who give it to investors. Why don’t savers deal with investors directly? There are three reasons:

1. Diversification – Spreading out investments to reduce risk.

EX: Putting your money in a bank or a mutual fund allows you to pool your money with other people, which is then invested in a variety of places.



2. Financial intermediaries provide information to savers. For example, mutual fund managers are knowledgeable about how the stocks in their portfolios are performing.

Portfolio – A collection of financial assets.

Intermediaries also provide a prospectus to savers.

Prospectus – An investment report to potential investors.

And finally intermediaries provide liquidity.

3. Liquidity – The ease with which people can convert and asset into cash.

EX: You can sell your shares in a mutual fund easily but if you had invested in a piece of art, it might be hard to sell.


Investors must make choices between return on an investment, its risk and how liquid it is.

Return – The money an investor receives above and beyond the sum of money initially invested.

Topic 6.1 combining supply and demand

6.1: Combining Supply and Demand
Objectives
1. Explain how supply and demand create balance in the marketplace.
2. Compare a market in equilibrium with a market in disequilibrium.
3. Identify how the government sometimes intervenes in markets to control prices.
4. Analyze the effects of price ceilings and price floors.

Buyers always want to pay the lowest possible price, while sellers hope to sell at the highest possible price. With buyers and sellers at odds, how can a market system satisfy both groups? In a free market system, supply and demand work together. The result is a price that both sides can agree on.

Price of a slice of pizza ($) Quantity Demanded Quantity Supplied Result
.50 300 100 Shortage from
1.00 250 150 excess demand
1.50 200 200
Equilibrium

2.00 150 250 Surplus from excess
2.50 100 300 supply
3.00 50 350












Equilibrium – The point at which quantity demanded and quantity supplied are equal.

What is the equilibrium price in the example above?

Disequilibrium – describes any price or quantity not at equilibrium; when quantity supplied is not equal to quantity demanded.


Excess Demand (Shortage )– When quantity demanded is more than quantity supplied.

Excess Supply (Surplus) – When quantity supplied is more than quantity demanded.

Excess Demand Excess Supply













Suppliers will raise or lower their prices to meet consumers’ wishes. And in the process, restore the market to equilibrium.

Government Intervention

The government can purposefully make a market in disequilibrium in two ways: price floors and price ceilings.

Price Ceiling – A maximum price that can be legally charged for a good or service.

EX: Rent control













Pros/Cons




Price Floor – a minimum price for a good or service.

EX: Minimum wage












Pros/Cons

Topic 4.3 Elasticity

3.3 Elasticity of Demand
Objectives
1. Explain how to calculate elasticity of demand.
2. Determine elasticity of demand from a demand schedule and a demand curve.
3. Identify factors that affect elasticity.

Are there some goods that you would buy no matter the price? Are there other goods that you would not buy if the price changed a little?

Elasticity of Demand – A measure of how consumers react to a change in price.

Inelastic – Describes demand that is NOT sensitive to a change in price.

EX: Gas, medicine, milk

Elastic – Describes demand that is very sensitive to a change in price.

EX: Restaurant meals, foreign travel, specific brands of toothpaste and pizza slices, potato chips





Graphic Examples
Elastic Demand (Chips) Inelastic demand (Gas)







Calculating elasticity of demand

Elasticity of demand = Percentage change in quantity demanded
Percentage change in price

Percentage change = Original number – New number
Original number



Calculation:
If the elasticity is greater than 1, then it is elastic
If the elasticity is less than 1, then it is inelastic
If elasticity is equal to 1, then it is called unitary elastic

Elastic Demand
% change in Qd = 10-20 = 1
10

% change in P = 4-3 = (1/4)
4

Elasticity = % change in Qd = 1 = 4, which is greater than one so gas is inelastic
% change in P (1/4)

Inelastic Demand
% change in Qd = 10-15 = (5/10) = (1/2)
10


% change in P = 6-2 = (4/6) =(2/3)
6

Elasticity = % change in Qd = (1/2) = (3/4)
% change in P (2/3)

(3/4) is less than one so chips are elastic

Four Factors Affecting Elasticity of Demand
1. Availability of substitutes - If there are few subs for a good, then if the price rises greatly, you still might buy it.

EX: Your favorite concert group and Aquafresh toothpaste

2. Relative importance - What percentage of your budget do you spend on goods and services?

EX: ½ your budget goes to clothes or the increase of price in toothpicks

3. Necessities vs. luxuries
i. Necessities tend to inelastic
EX: milk and medicine

ii. Luxuries tend to be elastic
EX: Steak and lobster dinners

4. Change over time - You need time to find subs for goods/services. So demand in short-run maybe inelastic and more elastic in long-run

EX: gas in the Summer of 2008

4.2 Notes Shifts in Demand

Topic 4.2 Shifts in the Demand Curve
Objectives
1. Understand the difference between a change in quantity demanded and a shift in the demand curve.
2. Identify several factors that determine demand and can cause a shift in the demand curve.
3. Explain how the change in the price of good can affect demand for a related good.

The demand schedule only took prices into account, while keeping all other factors the same, or constant. What if a government report came out that stated eating tomato sauce is the best way to cure a cold? What would happen to the demand of pizza?





Graphing Changes in Demand

Change in Quantity Demanded Demand shifting to left














Demand shift to right














Factors that cause the demand curve to shift

1. Income

Normal Good – A good that consumers demand more of when their incomes increase.

EX: New clothing, Roast beef sandwiches

Inferior Good – A good that consumers demand less of when their incomes increase.

EX: Used clothing, “mystery meat” sandwiches



Shift in Demand when your income increases

Used Clothing New Clothing













2. Consumer Expectations – Our expectations about the future affect are buying decisions now.

EX: A salesman tells you a bike you want will go on sale in one week so your demand for the bike now falls.

Demand for Bikes













3. Population
EX: After the baby boom, demand for bottles and baby food increased.

Demand for baby products after baby boom






4. Consumer Tastes and Advertising
EX: Nike pumps shoes, light up shoes (LA Lights), shoes with wheels.

Demand for Pumps after people thought they were not cool anymore













5. Price of Complements – Two goods that are bought and used together.
EX: Basketballs and basketball shoes

Demand for Basketballs after the price for basketball shoes goes up drastically












6. Price of Substitutes – Goods used in place of one another.
EX: Coffee and tea

Demand for coffee if the price of tea goes down

Topic 4.1 Demand schedule

4.1 Understanding Demand
Objectives
1. Explain the law of demand.
2. Understand how the substitution effect and the income effect influence decisions.
3. Create a demand schedule for an individual and a market.
4. Analyze the information presented in a demand curve.

Buyers demand goods, sellers supply those goods, and the interactions between the two groups lead to an agreement on the price and the amount traded.

Law of Demand – Consumers buy more of a good when its price decrease and less when its price increases.

Price Increase Quantity Demanded Decrease

Price Decrease Quantity Demanded Increase

The law of demand is explained by two patterns

Substitution Effect – When consumers react to an increase in a good’s price by consuming less of that good and more of other goods.

EX: The price of school pizza goes up so you eat bagels instead.

Income Effect – The change in consumption resulting from a change in real income.

EX: When the price of movie tickets goes up, it makes you feel poorer, so you buy fewer movie tickets.

You only demand goods that you can afford to buy. You may want a Lamborghini, but if you cannot afford one then you don’t demand it.

Demand Schedule – A table that lists the quantity of a good a person will but each different price.

Market Demand Schedule – A table that lists the quantity of a good all consumers in a market will buy at each different price.




Individual Demand
Price of a slice
of pizza ($) Quantity demanded
per day
.50 6
1.00 4
1.50 3
2.00 1
2.50 1
3.00 0

Market Demand (everyone in the classroom added together)
Price of a slice
of pizza ($) Quantity demanded
per day
.50 95
1.00 72
1.50 60
2.00 32
2.50 15
3.00 8

Graphing
Individual Demand Curve Market Demand Curve

Price on y-axis
Quantity Demanded on x-axis
Draw demand for both












The demand curve tells how quantity demanded will be affected by a change in price.