The Stock Market (part D)
by
Charles Lamson
The Stock Market and Mutual Funds
Mutual funds are companies that pool the funds of many investors and then invest in several hundred or even thousands of stocks. In addition, some mutual funds invest in bonds or some combination of both stocks and bonds. The small investor who buys into the fund can own a small piece of the large basket of stocks and/or bonds. Any individual can tap into the higher returns of the stock market while at the same time minimizing the risk of doing so by purchasing shares of a mutual fund.
For many investors, mutual funds may offer less risk and greater safety than individual stocks because of diversification. Since all securities do not perform equally well over the business cycle (returns are not perfectly correlated), diversification reduces risk. The risk of investing in a single company that fails is eliminated. If a mutual fund has invested in 1,000 companies, the risk that all of them will go under at once is much less than the risk that any of them will be forced into bankruptcy. If only one or a few of the companies perform poorly, the overall returns to the mutual fund are hardly affected. Mutual fund companies offer highly trained professional management to research the best investments. This not only saves the individual investor time and effort, but also is intended to improve the performance (yield) of the portfolio.
The Major Domestic exchanges
The New York Stock Exchange (NYSE)
The New York Stock Exchange (NYSE) located on Wall Street in New York City is the world's largest market for trading securities. For the stock of a corporation to be listed on the NYSE, the corporation must apply to the exchange and meet several criteria dealing with the size and number of shareholders. The NYSE seeks to enhance trading by ensuring that markets for any traded stock are sufficiently broad and deep.
The NYSE (known as the "Big Board") is a highly visible auction-type market where members, who act as agents for their customers, buy and sell shares of stock. Each member of the exchange has purchased a seat on the exchange.
The benefits of membership include participating directly in stock trading and charging commissions for trading stocks for customers. The customers may be financial or nonfinancial institutions or individual investors. The NYSE is self-regulating---meaning that every transaction is under constant surveillance by the exchange to ensure that trades are executed fairly.
Each company whose stock is listed on the Big Board is assigned to a single post where a specialist in that stock manages the auction process. Members of the NYSE bring all large buy and sell orders to the floor, either electronically or by a broker on the floor of the exchange. Orders for a specific stock are funneled to the appropriate post. If the post is surrounded by more brokers looking to buy the stock than to sell at the existing price, the stock's price will rise. If the reverse is true, the price will fall. In this way, the forces of supply and demand determine prices.
When a new price is reached, a clerk records the information on a device that sends it out over the ticker. The ticker provides a constant stream of stock symbols and prices, each symbol consists of three or fewer letters and represents the stock of a particular corporation. The ticker continually posts stock prices electronically on displays in brokerage houses and on computer screens around the world. For small orders of fewer than 3,000 shares, the process is a little different. The brokerage firm representing the buyer or seller of the stock routes the order to the Designated Order Turnaround (DOT) system. DOT is a computer system that sends buy or sell orders to the specialist's post where the transaction is automatically executed. The vast majority of trades are transacted through the DOT system.
To access closing prices and other information on NYSE-listed companies, search their database at www.nyse.com.
On occasion, there have been large fluctuations in stock prices. During the week of October 12 to 16, 1987, the Dow fell 250 points. On Monday, October 19, 1987, it fell 508 points, or more than 20 percent. Not only was this the largest point drop in history to that date, but it was also be far the largest percentage drop. To give you some idea of its magnitude, the next largest percentage decline occurred on October 28, 1929, when the market fell 12.8 percent near the start of the Great Depression.
In response to the October 1987 crash, certain reforms were instituted to limit such severe declines. In particular, "circuit breakers" were introduced to temporarily halt market trading if prices fall by some specified amount. During the halt, market makers have a chance to take positions and evaluate new information to provide support for the market. Bargains cannot be snatched up, stopping the free fall in prices. Originally, the new rules called for trading to be halted for half an hour if the market dropped 250 points from the previous day's close. If the market dropped 400 points, trading was to be halted for one hour.
The circuit breakers that halt all market trading were first tripped on October 24, 1997, as stocks fell in response to the Asian crisis. Shortly thereafter, the point ranges were broadened to 350 and 550 points. At the time, many analysts called for switching to a percentage change system from the point change system because trading halts based on percentage changes would be more meaningful. The Dow had increased so dramatically throughout the 1990s that a 350- 550-point change was not nearly as significant as when the Dow was at lower levels.
In response, the NYSE adopted a threshold percentage rule that took effect on April 15, 1998. The point threshold is adjusted quarterly based on a percentage of the average closing level of the Dow Jones Industrial Average during the previous month. The thresholds are as follows:
 Other Exchanges
In addition to being the home of the Big Board, New York is the home of the American Stock Exchange. The dollar value of stocks traded on the American Stock Exchange is small compared to the NYSE and the criteria for the stock of a corporation to be traded are not as stringent. Regional exchanges that primarily trade stocks listed on the NYSE are located in Boston, Cincinnati, Chicago, Los Angeles, San Francisco, Philadelphia, and Spokane. Stocks of a given company may be traded on more than one exchange, and specialists on the floor of each exchange watch prices on competing exchanges.
Many foreign countries also have stock exchanges with varying degrees of development and depth. Some European exchanges, such as the London Stock Exchange and Amsterdam Stock Exchange, predate those in the United States. The Nikkei Exchange in Tokyo, the London Stock Exchange, the DAX in Germany, and the Toronto Stock Exchange in Canada are among the busiest exchanges around the world. In September 2000, the Amsterdam, Brussels, and Paris stock exchanges merged to form the Euronext exchange. More cross-border mergers are expected, particularly in European countries that participate in the Euro. In recent years, many emerging economies have developed stock exchanges concomitant with the globalization of finance and the increase in capital flows.
The American Stock Exchange provides a listing of current stock market performance at www.amex.com.
Recap
The volume and value of stocks traded have increased dramatically. Program trading by institutional investors allows for the pre-programming of computers to buy or sell baskets or stocks. Buying stocks on the margin refers to putting up only a fraction of the stock's selling price and borrowing the rest. Stocks may be traded in organized markets, such as the NYSE, the American Stock Exchange, or other regional stock exchanges. Organized exchanges operate auction-type markets where a specialist trades large blocks of shares. The NYSE is by far the largest organized exchange. Each stock is traded at a specific post, which may trade up to several dozen stocks. Smaller trades are made on the NYSE via a computer system (the DOT system) that sends buy or orders to the specialist's post, where the transaction is automatically executed.
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