Georgetown Collegiate Investors

Risk Committee Educational Program. By Carlos Roa (CRO)

Education Session 1: Introduction to
the Stock Market
Covering the essential basics
The Rise of the Financial Markets
Functions:
Price discovery
(determined by buyers and sellers)
Provide liquidity
Stock Exchanges
- Provides a ready means to trade stocks
- Exchange of ownership (shares), not bonds
- Companies raise money through selling ownership stakes
- Examples of Stock Exchanges: NYSE, LSE, Euronext, etc.
Bond Markets
- Market for corporate and government debt
- Allows companies to raise money via debt
Futures/Commodity Markets
- Provides stability in prices
- Allows for hedging and mitigation of risk

Equity vs. Debt
There are two ways in which a companies raise money (capital) in order to
function. These are known as the capital markets.
Equity (Stock) Debt (Bonds, Loans, etc)
Confers an ownership stake within a
company
Legal obligation to repay as a
creditor
Volatile (changes in value frequently) Stable yield (Is a form of fixed
income, constantly paying out)
Liquid (is easily traded from one
owner to another)
Illiquid (Not as easily traded relative
to other financial instruments)
Right to dividends (Profits that the
company can choose to give back to
shareholders)
No right to dividends.
Equity holders have the last right of
repayment in case of bankruptcy.
Bondholders have the first right of
repayment in case of bankruptcy.
Capital Markets Pyramid
Stocks
Preferred Stocks
Bonds (Debt)
Liquidity
Risk (Volatility)
&
Returns (Expected)
How does Financing Work?
Company X wishes to raise capital
Use Debt (Bonds, Loans) Sell Equity (Stock)
Initial Public Offering (IPO)
Secondary/Follow-on
Offering
Company already has a stock trading
publicly.
Utilizes an investment bank to sell more
shares to the public.

Company sells stock for the first time to
the public via a stock exchange.
Utilizes an investment bank to sell shares
and price the offering.

Indices of the Market
Index: Method of measuring the performance of the stock market via representative grouping of various
companies. Some examples:
Dow Jones Industrial Average (DJIA)
Standard & Poors 500 (S&P)
NASDAQ 100 (NASD)
FTSE 100
GCC Composite 200
Generally utilizes a representative subset of the largest and most stable companies across all sectors
Indices are measured in points based on percentages, not dollars
Remember, percent (%) change, not points value, is the important statistic
Indices allow investors to chart their performance as well as the status of the market
Indices are NOT TRADEABLE
Managers are rated (and often paid) based upon their performance relative to the market indices
Market (index) is used as a default riskiness (volatility) level upon which securities are judged
Elements of Return
Capital Appreciation
The rise (or fall) of the price of an equity
As the price rises (falls), the investor gets a capital gain
Dividend Yield
Cash profits returned to shareholders by the company over a
periodic basis
The old fashioned ideal of stocks (plantation style)
Diversification
As the number of stocks in a portfolio increases, business risk is
diversified away
Does not eliminate underlying market risk
Assumes a portfolio diversification across industries
Size Matters: the Market Cap
Market Cap = Price per Share * Number of Shares Outstanding
Measurement of the size of a company
Large-Cap:
Larger companies are generally older, experienced, and have a greater staying power
Larger companies experience less volatility in stock price
Large-caps arent expected to yield large percentage returns
Large-caps are usually worth over $10 billion
Mid-Cap:
Fills the range between Large-cap and Small-cap
Medium amount of risk, volatility, possible returns, etc
Usually worth between $1 billion and $10 billion
Low-Cap:
Smaller companies are newer to the market, have less of a track record
Greater volatility in stock price from greater risk and variability
Potential for higher investor profit, but also loss
Usually worth less than $1 billion
Risk vs. Return
Investors will demand a higher return from stocks with greater risk
(volatility)
Theoretically, investing in more risky companies should yield higher
results
Historically proven to be true
Is it possible to beat the market consistently?
No: Most professional money managers cant
Chimpanzee dart board experiment
Cats are better than the pros
Yes: Notable disciplined investors (e.g. Warren Buffet) have consistently
done this
Investment Strategies
Growth Investing
A strategy whereby an investor seeks out companies with good
future growth potential
Biotech companies, technology startups, etc
Value Investing
The strategy of selecting stocks that trade for less than their
intrinsic values
Notable masters: Benjamin Graham, Warren Buffet, etc.
Equity Vehicles
Stocks Preferred Stock
Exchange Traded
Funds (ETFs)
Mutual Funds
Description Shares in one
company
Shares with specific
dividends, usually
reserved for
management
Small (usually
<30) portfolio of
targeted stocks
Managed portfolio
of stocks in aboard
category (large cap,
US, growth)
Volatility High Low Depends Lower than stock
Diversification None None
Yes, but can be
targeted in
exposure
Yes
Liquidity/Reporti
ng
Highest Medium High Lowest (report at
end of day)
Turnover/Churn None None Little/None Medium-High
Fees None None Low (<1%) High (1-3%)
Leverage None None Depends on fund None
Trading Basics
Long Plays
Buying a stock and selling it after recouping the dividends and/or capital
appreciation
Buy low, sell high
Traditional investing; unlimited potential return but limited loss
Short Plays
Selling a stock selling short, and agreeing to buy back the shares later
Requires a set amount of collateral and a willing broker to take the other
side (long side) of the trade
Theoretically riskier due to potentially unlimited loss
Fulfills a natural function in the market; not unethical
Trading Basics (Cont.)
Stocks are bought at the bid price
Sold at the ask price
The difference between the bid/ask is called the bid/ask spread
Market makers (banks) receive this as a fee for taking the other side of
trades
Almost all stocks on main exchanges have bid/ask spreads of <0.25%
Illiquid stocks (penny stocks) trading on over-the-counter (OTC
exchanges may have massive spreads
Pricing Fallacy: price is not an indicator of value
It is just as good to own 10 shares of $10 stock vs. one share of $100
stock. Price is irrelevant.
Brokers charge commissions per trade, not per share

Basic Trading Information
Close: The closing price of the shares
Open: The daily beginning price of the shares
After-hours: trading occurring off the exchange
Min/Max: daily range of stock price (low/high)
52wk high/low: yearly highest and lowest price for the equity
Volume: The number of shares traded (usually an average)
Yield: The dividend yield, in % per year
Order Types
Market Order: Executed at current price
Limit Order: Computer trades after hitting a certain price in
trading
Stop Order: Computer sells after hitting price floors
Day Order: Order is cancelled if not fulfilled within the day
Good-Till-Cancelled: Order stands until executed or cancelled
Brokerages
Full Service Brokerages
Charges a high price per trade
Broker assistance in filling big orders
Broker can suggest stocks or sale
Discount Brokerages
Charges lower price per trade (less than $10)
Minimal assistance
Usually gives a basic research package
Some Common Errors
Price does not equal value
Charts and statistics need peers to compare
Always look at statistics and charts over 1 year
Dont let brokers eat up your earnings
Useful Codes:
TTM = Trailing 12 Months
YTD = Year to Date
YoY = Year over Year