Stocks 101 - Terms and General Information

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I don’t know much about stocks. I collected some information and found it very useful. So I decided to share with others who are in the same boat as I am. Hope that helps.

Stock exchange is a marketplace where member brokers act as agents for the public in buying and selling shares of stock. A stock exchange provides a marketplace for stocks and bonds in much the same way a commodity exchange does for such commodities as cotton, pork, and wheat. This article chiefly discusses stock exchanges in the United States.

**How a stock exchange operates **
Federal and state laws regulate the issuance, listing, and trading of securities. The Securities and Exchange Commission (SEC) administers the federal laws.

**Listing stocks. **Stocks traded on exchanges are known as listed stocks. A company that wants its shares listed on an exchange must first satisfy the exchange that it possesses enough capital, is a lawful enterprise, and is in good financial condition. Specific listing requirements vary among exchanges. The largest stock exchange in the United States, the New York Stock Exchange (NYSE), requires a corporation to have at least 2,000 shareholders, with each shareholder owning 100 or more shares. The corporation also must be able to issue at least 1 million shares and show a record of earnings that covers the last three years. However, the NYSE has been flexible in applying these rules.

Unlisted stocks–and most bonds–are bought and sold in over-the-counter trading. One important part of the over-the-counter market is an electronic service known as the National Association of Securities Dealers Automated Quotations system (NASDAQ). Many companies that qualify for NYSE or other stock-exchange listings choose to sell their stock on the NASDAQ instead.

All stocks fluctuate (change) in value. Unforeseen circumstances may diminish the earning power of a company and thus lower the price investors are willing to pay for its stock. Prosperous times or improved management may increase the value of a stock.

Trading. A person who wishes to buy shares of stock places the order with a brokerage house. The broker obtains the price from a computer display terminal and relays the order to the stock exchange. Small orders are executed electronically in seconds. A record of the transaction is sent immediately to stock tickers and electronic ticker display devices at brokerage firms throughout the country.

Stock is often traded under a contract called an option. An option allows the holder (owner) to buy or sell a certain amount of stock at a specific price within a designated time period. For example, an investor may believe that a stock will increase in value. The investor can buy an option that will allow the purchase of shares of that stock at a specific price before a certain date. If the value of the stock rises above the price set by the option, the holder will profit by buying the stock and immediately reselling it.

Each year, investors trade billions of shares worth hundreds of billions of dollars. There are approximately 2,250 stocks listed on the New York Stock Exchange. Stock prices often reflect the state of the country’s economy. If business conditions are good, stock prices have a tendency to rise, creating a bull market. If business conditions are poor, stock prices drop, causing a bear market.

Memberships on exchanges cost large sums of money because only a limited number of them exist. Before buying a seat (membership) on a stock exchange, a prospective member must satisfy the exchange of his or her financial responsibility and character.

Members known as specialists concentrate on buying and selling only one type of security or a small group of securities. Specialists are expected to maintain an orderly market, in which the prices of securities rise or fall gradually. They maintain order by buying and selling, at key times, certain amounts of the stocks for which they are responsible. The value of stock exchange memberships depends largely on general business conditions and on the relative power of other markets, such as NASDAQ.

History: The first European stock exchange was established in Antwerp, Belgium, in 1531. The first stock exchange in England was formed in 1773 by the brokers of London. Until that time, people who wished to buy or sell shares of stock had to find a broker to transact their business. In London, these people usually went to a coffee house because brokers often gathered there.

In New York City, brokers met under an old buttonwood tree on Wall Street. They organized the New York Stock Exchange in 1792. The American Stock Exchange, one of the largest in the United States, was formerly called the Curb Exchange because of its origin on the streets of New York City. Other major stock exchanges operate in Chicago, Los Angeles, and San Francisco. Abroad, major exchanges are located in Amsterdam, the Netherlands; Frankfurt, Germany; Hong Kong; Johannesburg, South Africa; London; Paris; Sydney, Australia; Tokyo; Toronto, Canada; and Zurich, Switzerland.

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**Dow Jones averages **are statistics that show the price trends of stocks traded in the United States. Dow Jones & Company, a financial news publishing firm, computes the averages every few seconds of every business day.

There are three Dow Jones averages: (1) the Industrial Average, which tracks stock prices of 30 major firms; (2) the Transportation Average, which follows the stocks of 20 transportation companies; and (3) the Utility Average, which represents 15 utility companies. The Wall Street Journal, a newspaper owned by Dow Jones & Company, reports the figures. Public investment strategy is often centered on these averages.

The Industrial Average is the one most often used by investors. It tracks blue chip stocks, which are stocks issued by well-established corporations. American financial journalist Charles H. Dow introduced the Industrial Average in 1896 as an average of the stock prices of 12 companies. The Transportation Average, formerly called the Railroad Average, began in 1884. The Utility Average began in 1929.

In the beginning, the Dow Jones averages were computed by simply adding the prices of the stocks and dividing by the number of stocks. The averages soon became vulnerable to distortion, however, when some companies began splitting their stocks-that is, issuing two or more shares of stock for each existing share. Suppose, for example, that a stock was selling for $18. If the company split it two for one (issued two shares for each existing share), the price would drop to $9. The investor would lose nothing, because two shares of stock would still be worth $18. But the Dow Jones average, based on the price of a single share, would report an artificial decline in value.

To correct distortions due to stock splits and other events, Dow Jones & Company changed its way of computing the averages. Beginning in 1928, they started using a flexible divisor. Under this method, which continues today, the total of the stock prices is not simply divided by the number of stocks. Instead, it is divided by a number that can be changed to take into account stock splits and other changes.

New York Stock Exchange is the oldest and largest stock exchange in the United States. Brokers on the exchange buy and sell shares of stock in most of the largest U.S. corporations and many firms headquartered outside the United States. Prices are set largely by supply and demand on a central trading floor.

The New York Stock Exchange, often called the NYSE, sets standards for those who want to trade there. Brokers must pass a written examination. They also must register with the Securities and Exchange Commission, a U.S. government agency that administers and enforces federal laws governing the purchase and sale of stocks and bonds.

The New York Stock Exchange traces its beginnings to 1792, when a group of New York City stock dealers and traders agreed to funnel business to each other. They called their agreement the Buttonwood Agreement after the buttonwood tree under which they met to trade. New York City brokers established a formal organization, the New York Stock and Exchange Board, in 1817. This group changed its name to the New York Stock Exchange in 1863. The NYSE stands at the corner of Broad and Wall streets in New York City.

Nasdaq, pronounced NAZ dak, is the oldest electronic stock market in the world. The market's official name is The Nasdaq Stock Market(R). Originally, its name was an acronym for the National Association of Securities Dealers Automated Quotations System (Nasdaq(R)). On the Nasdaq market, brokers called market makers buy and sell stocks through a vast computer network instead of on a trading floor. Participants around the world receive trading information over this computer network. Nasdaq lists nearly 5,000 stocks, including those of many high-technology companies, such as computer manufacturers and software developers.

The National Association of Securities Dealers created the Nasdaq network in 1971. This network automated the selling of over-the-counter (OTC) stocks, which are stocks not listed on any stock market or exchange. Nasdaq became a stock market in 1975 when it began listing stocks. In 1990, Nasdaq stopped dealing in OTC stocks and changed its name to The Nasdaq Stock Market.

**Standard & Poor's indexes **are statistics that are used to measure the level of American stock market prices. These indexes are compiled and published by Standard & Poor's Corporation, an investment research and advisory firm.

The best-known of the measures is the Standard & Poor's 500 Index. It reflects stock prices for 500 companies whose shares are traded on the New York Stock Exchange. These companies consist of 400 industrial firms, 40 public utilities, 40 financial institutions, and 20 transportation companies. Altogether, the stocks of these companies make up about 80 percent of the market value of all stocks listed on the exchange.

Standard & Poor's computers calculate the 500 Index every five minutes of each business day. The index compares current stock prices with average prices during the period 1941-1943, which is called the base period. The average prices during 1941-1943, called base prices, are assigned a value of 10. Current index figures indicate how many times greater than the base prices current average prices are. For example, an index level of 250 means that average share prices are 25 times higher than the base prices. The 500 Index weights each price according to the total market value of the corporation's publicly owned shares, so that larger companies affect the index more than smaller ones do. Many investors consider the 500 Index more valuable than the Dow Jones Industrial Averages, which are based on the sum of stock prices of just 30 companies.

The Standard & Poor's Corporation also prepares a 100-industry survey, which appears in its weekly publication The Outlook. This survey provides prices and other statistics on 100 industries, giving an overview of the strengths and weaknesses of each industry. In addition, the company publishes separate indexes daily for transportation stocks, for utility stocks, for financial stocks, and for bonds.

Stock, Capital, is a right of ownership in a corporation. The stock is divided into a certain number of shares, and the corporation issues stockholders one or more stock certificates to show how many shares they hold. The stockholders own the company and elect a board of directors to manage it for them.

Stockholders may sell their stock whenever they want to, unless the corporation has some special rule to prevent it. Prices of stock change according to general business conditions and the earnings and future prospects of the company. If the business is doing well, stockholders may be able to sell their stock for a profit. If it is not, they may have to take a loss.

Large corporations may have many thousands of stockholders. Their stock is bought and sold in marketplaces called stock exchanges. When a sale is made, the seller signs the certificate. The buyer turns this over to the corporation and gets a new certificate.

When the corporation has made a profit, the directors may divide the profit among the stockholders as dividends, or they may decide to use it to expand the business. Dividends may be paid only out of the corporation's profits. When profits are used to expand the business, the directors and stockholders may decide to issue more stock to show that there is more money invested in the business. This new stock will be divided among the stockholders as a stock dividend.

**Kinds of stock. **The Articles of Incorporation--papers signed when the corporation is formed--may specify the different kinds of stock. Par stock must be issued for not less than a set price, called the par value, for each share. If the articles provide for no-par stock, the directors determine the issuing price of the stock and may change it whenever they wish.

All shares of stock have equal dividend and voting rights unless the articles provide differently. There may be different classes of stock, such as voting and nonvoting. Many articles provide for common and preferred stock. Preferred stock is entitled to a preference on dividends. That is, the directors must pay a certain amount --usually a percentage of par value--to the holders of preferred stock before they pay anything to the holders of common stock. If preferredstock holders share with common-stock holders in dividends beyond the percentage, the stock is called participating preferred.

Preferred stock may also be cumulative. That is, if there are no dividends given in a year, the preferred-stock holders must be given double their dividend the next year. This dividend is paid before anything is paid to the common-stock holders. It will continue to multiply for as many years as dividends are not paid.

When a corporation goes out of business, it divides its property among the stockholders. This process is called liquidation. When a company liquidates, the preferred-stock holders may be given the par value of their stock before the common-stock holders are given anything. This preferred stock is said to be preferred up to par on liquidation.

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**Bears and bulls **are the popular names for two particular points of view among those who invest in stocks or commodities. The expressions are believed to come from the way the two animals attack. The bear attacks by sweeping its paws downward, and the bull attacks by tossing its horns up in the air. A bearish investor expects prices to fall and sells with the hope of being able to buy back at a cheaper price. A bear may also be an investor who has sold short, that is, sold a commodity or a security before having actual or complete possession of it. A bullish investor believes that prices are going to go up and buys in anticipation of a market advance.
When more people want to sell than buy, prices fall. This is called a bear market. When more people want to buy than sell, prices of stocks or commodities rise. This is called a bull market.

Investment terms
Dividend **is a payment made by a company to its stockholders.
**Face value **of a bond is the amount that the company or government agrees to repay at a future date.
**Income is the payment received for goods or services (see Income).
Interest is money paid by a borrower to a lender for the use of money (see Interest).
Market price of a stock is the price per share at which the stock may be purchased or sold at a particular time.
Par value is the original value of a stock or bond. This amount is printed on the security.
Premium of a bond is the difference by which the market price exceeds the face value of the bond.
Share is one of the parts into which ownership of a corporation is divided.
Stock exchange is a place where stocks and bonds are bought or sold for investors.

Bond is a certificate issued by a business company or government promising to pay back money it has borrowed. The issuer of the bond promises to return to the bondholder the principal (amount borrowed) when the bond matures (comes due) at some future date. Most bonds pay interest at regular intervals. Because the person who buys a bond is a creditor and not a stockholder, bonds enable businesses and other issuers to raise funds without enlarging the pool of owners.

How bonds are issued. Bonds are usually issued in groups. Each bond represents a fraction of the amount being borrowed. A person could buy a bond of $1,000 denomination that is part of a $100,000 issue. This type of issue enables people of moderate means to invest, and enables businesses to obtain substantial funding. Many bonds are traded on stock exchanges.

Kinds of bonds. There are several kinds of bonds. Mortgage bonds give the investor a claim on some or all of a company's property. Such a claim, called a lien, is given as security in case the loan is not repaid when due. Debentures are bonds that are not protected by a lien. Collateral trust bonds are secured by property called collateral (often stocks or bonds) deposited with a trustee. Income bonds promise to repay principal but to pay interest only when there are earnings. Callable bonds may be redeemed by the issuing corporation under stated conditions before maturity. Serial bonds mature in relatively small amounts at stated intervals. Municipal bonds are issued by state or local governments. Inflation-indexed bonds protect bondholders from being repaid in dollars whose value has been reduced by inflation (rising prices). The amounts investors receive are adjusted to correspond to current market prices.

**Bond ratings. **Bonds are assigned ratings by independent organizations, such as Moody's Investors Service and Standard & Poor's Corporation, based on their degree of risk. Risk is determined by how likely it seems that the issuer might default (fail to meet its obligations). The riskier a bond, the lower its rating. Because investment experts perceive large, established companies as low-risk, bonds issued by such companies usually have investment-grade ratings. These ratings mean that the companies pay lower interest rates to investors. Bonds with noninvestment grade ratings must offer a higher rate of interest to make up for their higher risk. Such bonds-also called high-yield bonds or junk bonds-have gained popularity among investors because their high interest rates often more than make up for the risk of default. Many companies issue such bonds to raise money for investing in new technologies.

Mortgage is a loan agreement that enables a person to borrow money to purchase a house or other property. The property is used as security for the loan. If the borrower does not repay the loan on time, the lender may take possession of the property. Almost all mortgages involve real estate.

A mortgage actually consists of two legal documents. One document, called a note, specifies the amount of the loan, the repayment terms, and other conditions of the agreement. The other document is the mortgage itself, which gives the lender legal claim to the property if the loan is not repaid. The term mortgage commonly refers to the entire loan agreement. The lender is called the mortgagee, and the borrower is called the mortgager.

A person can obtain a mortgage from a bank, insurance company, mortgage company, savings and loan association, or other financial institutions. The interest rate and other terms vary from lender to lender. Most mortgage agreements require the mortgager to repay the loan in monthly installments over a period of 20 years or more. Part of each payment goes toward the unpaid balance of the loan, called the principal, and part toward the interest. As the borrower pays off the loan, more of each monthly payment goes toward the principal, and less toward the interest. The mortgager gradually increases the equity, which is the value of the property beyond the amount owed on it.

If the borrower misses a number of payments or violates any other condition of the agreement, the lender may foreclose the mortgage. Foreclosure is a legal procedure by which the lender takes over the mortgaged property. The lender then may sell the property, keep the amount owed, and give the borrower the rest. More than one mortgage may be placed on a property. If foreclosure occurs, the holder of the second mortgage gets nothing until the claims of the first have been met.

Two United States government agencies, the Federal Housing Administration (FHA) and the Department of Veterans Affairs, guarantee some home mortgage loans against loss to the lender. Loans unprotected by a government agency are called conventional loans.

Mortgage loans have traditionally been a popular investment for financial institutions because of the great safety of such loans. During periods of rapidly rising prices, however, lenders may hesitate to tie up their money in mortgages. Interest rates soar during these periods of inflation, but most mortgages pay interest at a fixed rate throughout their term. Thus, a lending institution that issues a 25-year mortgage at 8 percent interest may lose an opportunity to lend the money later at 12 percent. Inflation also drives down the purchasing power of money. As a result, the dollars that lenders get back have less buying power than the dollars they lent. Therefore, in periods of inflation, many lending institutions charge an additional fee called points for granting a mortgage loan. Each point equals 1 percent of the amount of the loan. The fee is regarded as prepaid interest and must be paid when the mortgage is signed.

To counteract the effects of inflation, lending institutions have developed other types of mortgages. In a graduated-payment mortgage, the borrower makes lower monthly payments for the first few years and higher payments later. In a variable-rate or adjustable-rate mortgage, the interest rate rises and falls in relation to current interest rates. In a growing-equity mortgage, monthly payments increase between 3 and 7 percent yearly until the balance is paid. In a balloon-payment mortgage, payments are lower for the first few years and then a large single payment repays the remaining balance.