Stock market

p> 4.5 Options

An option is a piece of paper that gives you the right to buy or sell a given security at a specified price for a specified period of time. A
"call" is an option to buy, a "put" is an option to sell. In simplest form, these have become an extremely popular way to speculate on the expectation that the price of a stock will go up or down. In recent years a new type of option has become extremely popular: options related to the various stock market averages, which let you speculate on the direction of the whole market rather than on individual stocks. Many trading techniques used by expert investors are built around options; some of these techniques are intended to reduce risks rather than for speculation.

4.6 Rights

When a corporation wants to sell new securities to raise additional capital, it often gives its stockholders rights to buy the new securities
(most often additional shares of stock) at an attractive price. The right is in the nature of an option to buy, with a very short life. The holder can use ("exercise") the right or can sell it to someone else. When rights are issued, they are usually traded (for the short period until they expire) on the same exchange as the stock or other security to which they apply.

4.7 Warrants

A warrant resembles a right in that it is issued by a company and gives the holder the option of buying the stock (or other security) of the company from the company itself for a specified price. But a warrant has a longer life—often several years, sometimes without limit As with rights, warrants are negotiable (meaning that they can be sold by the owner to someone else), and several warrants are traded on the major exchanges.

4.8 Commodities and Financial Futures

The commodity markets, where foodstuffs and industrial commodities are traded in vast quantities, are outside the scope of this text. But because the commodity markets deal in "futures"—that is, contracts for delivery of a certain good at a specified future date— they have also become the center of trading for "financial futures", which, by any logical definition, are not commodities at all.

Financial futures are relatively new, but they have rapidly zoomed in importance and in trading activity. Like options, the futures can be used for protective purposes as well as for speculation. Making the most headlines have been stock index futures, which permit investors to speculate on the future direction of the stock market averages. Two other types of financial futures are also of great importance: interest rate futures, which are based primarily on the prices of U.S. Treasury bonds, notes, and bills, and which fluctuate according to the level of interest rates; and foreign currency futures, which are based on the exchange rates between foreign currencies and the U.S. dollar. Although, futures can be used for protective purposes, they are generally a highly speculative area intended for professionals and other expert investors.

5. STOCK MARKET AVERAGES READING THE NEWSPAPER QUOTATIONS

The financial pages of the newspaper are mystery to many people. But dramatic movements in the stock market often make the front page. In newspaper headlines, TV news summaries, and elsewhere, almost everyone has been exposed to the stock market averages.

In a brokerage firm office, it’s common to hear the question “How’s the market?” and answer, “Up five dollars”, or “Down a dollar”. With 1500 common stocks listed on the NYSE, there has to be some easy way to express the price trend of the day. Market averages are a way of summarizing that information.

Despite all competition, the popularity crown still does to an average that has some of the qualities of an antique–the Dow Jones Industrial
Average, an average of 30 prominent stocks dating back to the 1890s. This average is named for Charles Dow–one of the earliest stock market theorists, and a founder of Dow Jones & Company, a leading financial news service and publisher of the Wall Street Journal.

In the days before computers, an average of 30 stocks was perhaps as much as anyone could calculate on a practical basis at intervals throughout the day. Now, the Standard & Poor’s 500 Stock Index (500 leading stocks) and the New York Stock Exchange Composite Index (all stocks on the NYSE) provide a much more accurate picture of the total market. The professionals are likely to focus their attention on these “broad” market indexes. But old habits die slowly, and someone calls out, “How’s the market?” and someone else answers, “Up five dollars,” or “Up five”–it’s still the Dow
Jones Industrial Average (the “Dow” for short) that they’re talking about.

The importance of daily changes in the averages will be clear if you view them in percentage terms. When the market is not changing rapidly, the normal daily change is less than Ѕ of 1%. A change of Ѕ% is still moderate;
1% is large but not extraordinary; 2% is dramatic. From the market averages, it’s a short step to the thousands of detailed listings of stock prices and related data that you’ll find in the daily newspaper financial tables. These tables include complete reports on the previous day’s trading on the NYSE and other leading exchanges. They can also give you a surprising amount of extra information.

Some newspapers provide more extensive tables, some less. Since the
Wall Street Journal is available world wide, we’ll use it as a source of convenient examples. You’ll find a prominent page headed “New York Stock
Exchange Composite Transactions”. This table covers the day’s trading for all stocks listed on the NYSE. “Composite” means that it also includes trades in those same stocks on certain other exchanges (Pacific, Midwest, etc.) where the stocks are “dually listed”. Here are some sample entries:

|52 Weeks | | |Yld |P-E |Sales | | | |Net |
|High |Low |Stock |Div |% |Ratio|100s |High |Low |Close |Chg. |
|52 |37 5/8|Cons Ed |2.68 |5.4 |12 |909 |49 |48 7/8|49 1/4|+1/4 |
|7/8 | | | | | | |3/8 | | | |
|91 |66 1/2|Gen El |2.52 |2.8 |17 |11924 |91 |89 5/8|90 |-1 |
|1/8 | | | | | | |3/8 | | | |
|41 |26 1/4|Mobil |2.20 |5.4 |10 |15713 |41 |40 1/2|40 7/8|+5/8 |
|3/8 | | | | | | | | | | |

Some of the abbreviated company names in the listings can be a considerable puzzle, but you will get used to them.

While some of the columns contain longer-term information about the stocks and the companies, we'll look first at the columns that actually report on the day's trading. Near the center of the table you will see a column headed "Sales 100s". Stock trading generally takes place in units of
100 shares and is tabulated that way; the figures mean, for example, that
90,900 shares of Consolidated Edison, 1,192,400 shares of General Electric, and 1,571,300 shares of Mobil traded on January 8. (Mobil actually was the
12th "most active" stock on the NYSE that day, meaning that it ranked 12th in number of shares traded.)

The next three columns show the highest price for the day, the lowest, and the last or "closing" price. The "Net Chg." (net change) column to the far right shows how the closing price differed from the previous day's close—in this case, January 7.

Prices are traditionally calibrated in eighths of a dollar. In case you aren't familiar with the equivalents, they are:

1/8 =$.125

1/4=$.25

3/8 =$.375

1/2 =$.50

5/8 =$.625

3/4=$.75

7/8 =$.875

Con Edison traded on January 8 at a high of $49.375 per share and a low of $48 875, it closed at $49.25, which was a gain of $0.25 from the day before. General Electric closed down $1.00 per share at $90 00, but it earned a "u" notation by trading during the day at $91 375, which was a new high price for the stock during the most recent 52 weeks (a new low price would have been denoted by a "d").

The two columns to the far left show the high and low prices recorded in the latest 52 weeks, not including the latest day. (Note that the high for General Electric is shown as 91 1/8, not 91 3/8.) You will note that while neither Con Edison nor Mobil reached a new high on January 8, each was near the top of its "price range" for the latest 52 weeks. (Individual stock price charts, which are published by several financial services, would show the price history of each stock in detail.)

The other three columns in the table give you information of use in making judgments about stocks as investments. Just to the right of the name, the "Div." (dividend) column shows the current annual dividend rate on the stock — or, if there's no clear regular rate, then the actual dividend total for the latest 12 months. The dividend rates shown here are
$2.68 annually for Con Edison, $2.52 for GE, and $2.20 for Mobil. (Most companies that pay regular dividends pay them quarterly: it's actually
$0.67 quarterly for Con Edison, etc.) The "Yid." (Yield) column relates tie annual dividend to the latest stock price. In the case of Con Edison, for example, $2.68 (annual dividend)/$49.25 (stock price) ==5.4%, which represents the current yield on the stock.

5.1 The Price-Earnings Ratio

Finally, we have the "P-E ratio", or price-earnings ratio, which represents a key figure in judging the value of a stock. The price-earnings ratio—also referred to as the "price-earnings multiple", or sometimes simply as the "multiple"—is the ratio of the price of a stock to the earnings per share behind the stock.

This concept is important. In simplest terms (and without taking possible complicating factors into account), "earnings per share" of a company are calculated by taking the company's net profits for the year, and dividing by the number of shares outstanding. The result is, in a very real sense, what each share earned in the business for the year — not to be confused with the dividends that the company may or may not have paid out.
The board of directors of the company may decide to plow the earnings back into the business, or to pay them out to shareholders as dividends, or
(more likely) a combination of both; but in any case, it is the earnings that are usually considered as the key measure of the company's success and the value of the stock.

The price-earnings ratio tells you a great deal about how investors view a stock. Investors will bid a stock price up to a higher multiple if a company's earnings are expected to grow rapidly in the future. The multiple may look too high in relation to current earnings, but not in relation to expected future earnings. On the other hand, if a company's future looks uninteresting, and earnings are not expected to grow substantially, the market price will decline to a point where the multiple is low.

Multiples also change with the broad cycles of the stock market, as investors become willing to pay more or less for certain values and potentials. Between 1966 and 1972, a period of enthusiasm and speculation, the average multiple was usually 15 or higher. In the late 1970s, when investors were generally cautious and skeptical, the average multiple was below 10. However, note that these figures refer to average multiples–whatever the average multiple is at any given time, the multiples on individual stocks will range above and below it.

Now we can return to the table. The P-E ratio for each stock is based on the latest price of the stock and on earnings for the latest reported 12 months. The multiples, as you can see, were 12 for Con Edison, 17 for GE, and 10 for Mobil. In January 1987, the average multiple for all stocks was very roughly around 15. Con Edison is viewed by investors as a relatively good-quality utility company, but one that by the nature if its business cannot grow much more rapidly that the economy as a whole. GE, on the other hand, is generally given a premium rating as a company that is expected to outpace the economy.

You can't buy a stock on the P-E ratio alone, but the ratio tells you much that is useful. For stocks where no P-E ratio is shown, it often means that the company showed a loss for the latest 12 months, and that no P-E ratio can be calculated. Somewhere near the main NYSE table, you'll find a few small tables that also relate to the day's NYSE-Composite trading.
There's the table showing the 15 stocks that traded the greatest number of shares for the day (the "most active" list), a table of the stocks that showed the greatest percentage of gains or declines (low-priced stocks generally predominate here); and one showing stocks that made new price highs or lows relative to the latest 52 weeks.

You'll find a large table of "American Stock Exchange Composite
Transactions", which does for stocks listed on the AMEX just what the NYSE-
Composite table does for NYSE-listed stocks. There are smaller tables covering the Pacific Stock Exchange, Boston Exchange, and other regional exchanges.

The tables showing over-the-counter stock trading are generally divided into two or three sections. For the major over-the-counter stocks covered by the NASDAQ quotation and reporting system, actual sales for the day are reported and tabulated just as for stocks on the NYSE and AMEX. For less active over-the-counter stocks, the paper lists only "bid" and "asked" prices, as reported by dealers to the NASD.

It is worth becoming familiar with the daily table of prices of U.S.
Treasury and agency securities. The Treasury issues are shown not only in terms of price, but in terms of the yield represented by the current price.
This is the simplest way to get a bird's-eye view of the current interest rate situation—you can see at a glance the current rates on long-term
Treasury bonds, intermediate-term notes, and short-term bills.

Elsewhere in the paper you will also find a large table showing prices of corporate bonds traded on the NYSE, and a small table of selected tax- exempt bonds (traded OTC). But unless you have a specific interest in any of these issues, the table of Treasury prices is the best way to follow the bond market.

There are other tables listed. These are generally for more experienced investors and those interested in taking higher risks. For example, there are tables showing the trading on several different exchanges in listed options—primarily options to buy or sell common stocks (call options and put options). There are futures prices— commodity futures and also interest rate futures, foreign currency futures, and stock index futures. There are also options relating to interest rates and options relating to the stock index futures.

6. EUROPEAN STOCKMARKETS–GENERAL TREND

Competition among Europe’s securities exchanges is fierce. Yet most investors and companies would prefer fewer, bigger markets. If the exchanges do not get together to provide them, electronic usurpers will.

How many stock exchanges does a Europe with a single capital market need? Nobody knows. But a part-answer is clear: fewer than it has today.
America has eight stock exchanges, and seven futures and options exchanges.
Of these only the New York Stock Exchange, the American Stock Exchange,
NASDAQ (the over-the-counter market), and the two Chicago futures exchanges have substantial turnover and nationwide pretensions.

The 12 member countries of the European Community (EC), in contrast, boast 32 stock exchanges and 23 futures and options exchanges. Of these, the market in London, Frankfurt, Paris, Amsterdam, Milan and Madrid–at least–aspire to significant roles on the European and world stages. And the number of exchanges is growing. Recent arrivals include exchanges in Italy and Spain. In eastern Germany, Leipzig wants to reopen the stock exchange that was closed in 1945.

Admittedly, the EC is not as integrated as the United States. Most intermediaries, investors and companies are still national rather than pan-
European in character. So is the job of regulating securities markets; there is no European equivalent of America’s Securities and Exchange
Commission (SEC). Taxes, company law and accounting practices vary widely.
Several regulatory barriers to cross-border investment, for instance by pension funds, remain in place. Recent turmoil in Europe’s exchange rate mechanics has reminded cross0border investors about currency risk. Despite the Maastricht treaty, talk of a common currency is little more than that

Yet the local loyalties that sustain so many European exchanges look increasingly out-of-date. Countries that once had regional stock exchanges have seen them merged into one. A single European market for financial services is on its way. The EC's investment services directive, which should come into force in 1996, will permit cross-border stockbroking without the need to set up local subsidiaries. Jean-Francois Theodore, chairman of the Paris Bourse, says this will lead to another European Big
Bang. And finance is the multinational business par excellence: electronics and the end of most capital controls mean that securities traders roam not just Europe but the globe in search of the best returns.

This affects more than just stock exchanges. Investors want financial market that are cheap, accessible and of high liquidity (the ability to buy or sell shares without moving the price). Businesses, large and small, need a capital market in which they can raise finance at the lowest possible cost If European exchanges do not meet these requirements, Europe's economy suffers.

In the past few years the favoured way of shaking up bourses has been competition. The event that triggered this was London's Big Bang in October
1986, which opened its stock exchange to banks and foreigners, and introduced a screen-plus-telephone system of securities trading known as
SEAQ. Within weeks the trading floor had been abandoned. At the time, other
European bourses saw Big Bang as a British eccentricity. Their markets matched buy and sell orders (order-driven trading), whereas London is a market in which dealers quote firm prices for trades (quote-driven trading). Yet many continental markets soon found themselves forced to copy
London's example.

That was because Big Bang had strengthened London's grip on international equity-trading. SEAQ's international arm quickly grabbed chunks of European business. Today the London exchange reckons to handle around 95% of all European cross-border share-trading It claims to handle three-quarters of the trading in blue-chip shares based in Holland, half of those in France and Italy and a quarter of those in Germany—though, as will become clear, there is some dispute about these figures.

London's market-making tradition and the presence of many international fund managers helped it to win this business. So did three other factors.
One was stamp duties on share deals done in their home countries, which
SEAQ usually avoided. Another was the shortness of trading hours on continental bourses. The third was the ability of SEAQ, with market-makers quoting two-way prices for business in large amounts, to handle trades in big blocks of stock that can be fed through order-driven markets only when they find counterparts.

A similar tussle for business has been seen among the exchanges that trade futures and options. Here, the market which first trades a given product tends to corner the business in it. The European Options Exchange
(EOE) in Amsterdam was the first derivatives exchange in Europe; today it is the only one to trade a European equity-index option. London's LIFFE, which opened in 1982 and is now Europe's biggest derivatives exchange, has kept a two-to-one lead in German government-bond futures (its most active contract) over Frankfurt's DTB, which opened only in 1990. LIFFE competes with several other European exchanges, not always successfully: it lost the market in ecu-bond futures to Paris's MATIF.

European exchanges armoured themselves for this battle in three ways.
The first was to fend off foreign competition with rules. In three years of wrangling over the EC's investment-services directive, several member- countries pushed for rules that would require securities to be traded only on a recognized exchange. They also demanded rules for the disclosure of trades and prices that would have hamstrung SEAQ's quote-driven trading system. They were beaten off in the eventual compromise, partly because governments realized they risked driving business outside the EC. But residual attempts to stifle competition remain. Italy passed a law in 1991 requiring trades in Italian shares to be conducted through a firm based in
Italy. Under pressure from the European Commission, it may have to repeal it.

6.1 New Ways for Old

The second response to competition has been frantic efforts by bourses to modernize systems, improve services and cut costs. This has meant investing in new trading systems, improving the way deals are settled, and pressing governments to scrap stamp duties. It has also increasingly meant trying to beat London at its own game, for instance by searching for ways of matching London's prowess in block trading.

Paris, which galvanized itself in 1988, is a good example. Its bourse is now open to outsiders. It has a computerized trading system based on continuous auctions, and settlement of most of its deals is computerized.
Efforts to set up a block-trading mechanism continue, although slowly.
Meanwhile, MATIF, the French futures exchange, has become the continent's biggest. It is especially proud of its ecu-bond contract, which should grow in importance if and when monetary union looms.

Frankfurt, the continent's biggest stock-market, has moved more ponderously, partly because Germany's federal system has kept regional stock exchange in being, and left much of the regulation of its markets at
Land (state) level. Since January 1st 1993 all German exchanges (including the DTB) have been grouped under a firm called Deutsche Borse AG, chaired by Rolf Breuer, a member of Deutsche Bank’s board. But there is still some way to go in centralizing German share-trading. German floor brokers continue to resist the inroads made by the bank’s screen-based IBIS trading system. A law to set up a federal securities regulator (and make insider- dealing illegal) still lies becalmed in Bonn.

Other bourses are moving too. Milan is pushing forward with screen- based trading and speeding up its settlement. Spain and Belgium are reforming their stock-markets and launching new futures exchanges.
Amsterdam plans an especially determined attack on SEAQ. It is implementing a McKinsey report that recommended a screen-based system for wholesale deals, a special mechanism for big block trades and a bigger market-making role for brokers.

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