CH4 - Chapter 8 Stocks, Stock Markets, and Market...

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Chapter 8 Stocks, Stock Markets, and Market Efficiency Chapter Overview The goal of this chapter is to try to make sense of the stock market, to show what fluctuations in stock value mean for individuals and for the economy as a whole, and to look at a critical connection between the financial system and the real economy. The chapter will also explain how it is that things sometimes go awry, resulting in bubbles and crashes. Reading this chapter will prepare students to: Describe stocks and stock markets. Explain how to value stocks. Assess the risks involved in buying stock. Important Points of the Chapter For individuals, stocks are a key instrument for holding wealth; for companies, they are one of several ways to obtain financing. Beyond that, stocks and stock markets are one of the central links between the financial world and the real economy. Contrary to popular mythology, stock prices tend to rise steadily and slowly, collapsing only on those rare occasions when normal market mechanisms are out of alignment. The danger is that if we are preoccupied with the potential short-term losses associated with crashes, we lose sight of the gains we could realize if we took a longer-term view. Application of Core Principles Principle #4: Markets (page 176) We need to understand the dynamics of the stock market, both to manage our personal finances and to see the connections between stock values and economic conditions. Principle #1: Time (page 181) Present value analysis can be used to find the value of a stock. The price of the stock today should be equal to the present value of the selling price and of the dividend payments made while the stock is held. Principle #2: Risk (page 183) Stockholders require compensation for the risk they face, and the higher the risk the higher the compensation. Principle #4: Markets (page 189) The stock market plays a crucial role in every modern capitalist economy. The prices determined in the stock market tell us the market value of companies, which determines the allocation of resources. Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets 104
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Chapter 8 Stocks, Stock Markets, and Market Efficiency Teaching Tips/Student Stumbling Blocks Pay attention to the text’s careful explanation of the difference between price- weighted and value-weight stock indices. The text provides excellent examples illustrating the concepts presented. This chapter continues the use of present value analysis to analyze how bond prices are determined. You may wish to begin with a review of the tools from Chapter 5. Spend time going carefully through the examples given in the text, paying particular attention to the assumptions made, and reinforce these concepts by assigning end-of-chapter problems. Features in this Chapter
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This note was uploaded on 02/12/2012 for the course ECON 101 taught by Professor Abrams during the Spring '11 term at Adams State University.

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CH4 - Chapter 8 Stocks, Stock Markets, and Market...

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