lhe StocK Market: A Gase Stucly
How does the stock market work and how can we understand what happened in lg4g?
lmagine that a group of your friends want to form a new company to produce athletic
shoes. They need to buy the materials, rent a factory, pay manufacturers, hire a sales
stafi, and pay for advertising. They estimate that they need 9100, 000 to start the
company.
How could they raise the money? They could use all of their savings, borrow money
from the bank, ask for a government loan, or raise money by selling stocks in the
company. In this last case, they get people to invest in the company by buying stocks.
lf they sold 10,000 siocks at $10 each, they would have the $100,000 they need to start
their company. Each stock represents a share of the business. The stoikholder,
therefore, owns part of the business and shares in the company's success or failure. As
proof of his or her investment in the business, the stockholder is given a paper calfed a
stock certificate.
Suppose you decide the Athletic Shoe Company is going to be vastly successful and
you decide to buy stocks in it. First, you would visit a stockbroker, whose job it is to
buy and sell stocks in a kind of marketplace known as the stock exchange. (Both the act
of buying and selling stocks, and the place in which this is done, are called the stock
market). The stockbroker places your order and carries out the details of your
transaction. Whether you buy or sell, you pay your stockbroker a smallfee for handling
the business for you.
The stocks represent your share in the ownership of the company. lf there are 10,000
shares in the company and you own 1 of them, you own ilto,oob of the company,s
shares. lf you own 10 shares, then you own 1/1,ooo of the company's shares.
People buy shares in companies to make money. Suppose you buy 100 shares in
the
Athletic shoe company. you pay g25 per share. youi totaiinvestment is
$2s00. A few
months later, the value of the stock rlses to $35 per share. Business is booming your
Athletic shoes are the latest fad. At this point, you sell your 100 stocks at
3s$ per share.
You paid $2500, but get back $3500. This oifference in"price is called r proiit
or capital
gain.
Stocks can also make money for you in another way. Companies
usually divide some of
the-p-rofits among the shareholders. These payments to shareholders
are called
dividends. Since you own 1/100 of the stocks in the Athletics Snoe Comprny, yo,
entitled to receive 11100 of the amount the company pays out in dividends.
"ru
The prices of stocks go up and down almost every day. There are many complicated
reasons for this. One important reason is demand. lfpeople wish to buy a certain
stock,
prices will go up because they are willing to pay the price. lf nobody
*untr a particular
stock, or if several people wish to setl it, the price on the Markey wili probably'fall.
The Stock Market: Kev Terms
Term
Stock
Stockhof der
$tock certificate
Stockbroker
Stock market
rroilvcaprtal gain
Dividends
Definition
lnvestment activitv
Situation 1.
You are a stockbroker. You hear about a new company that you want to invest in
but you have no extra money. You expect to double your money if you invest in this
company. What do you do?
a) don't invest
b) Take money out of your other investments which are doing very well
c) Borrow money the from the bank an pay back the loan with a small fee
Situation 2
You are looking to buy a new car. You do not have any money right now but you
have a great job. What do you do?
a) buy the car and pay it off one month at a time
b) wait until you save enough money, then buy it outright
Situation 3
You want to go on vacation with your friends but your boss won't let you. He will
Iire you if you leave. However, you are a good stockbroker and can probably find
an even better job the second you get back
a) Go on vacation
b) Keep your job
Situation 4
You own a very big business. If you buy another small company, there is a very
small chance that you will go broke. But there is a greater chance that you will
make a lot of money.
a) buy the small company
b) don't buy it
Situation 5
You are a stockbroker. You see all the other stockbrokers selling their stocks. You
ask them why and they say. "I think these stocks are no good and I want to sell
them while they are still worth something" You own the same stocks and you notice
that their price has fallen during the day. You have lost money on that stock and
are getting scared. What do you do?
a) sell the stock now and be safe
b) keep the stock and risk losing more money
Situation 6
There is a stock that everybody wants to sell. No one will buy it. It's price has
dropped from $100 to $65. Someone offers to sell it to you at $60.
a) do you follow what everyone else is doing and reject the offer
b) take a risk and buy a stock that nobody else want