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Equity Markets and Total Wealth


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  • 1. Equity Markets and Total Wealth Chris Wise Conrad Culbertson Sam Ullrich Ryan Turner Richard Berry
  • 2. What are Equity Markets?
    • A Market for the trading of company stock, also known as the Stock Market
    • How companies gain capital?
  • 3. How markets can be affected by Interest Rates
    • Increasing the interest rates hurts the equity markets.
    • Investors have less disposable income to invest.
    • Companies would have less money to seek growth opportunities.
    • Both leading to a market slow down.
  • 4. Total Wealth
    • In general, total wealth is how much a person’s assets are worth. Houses, stocks, baseball cards, anything you own counts toward your total wealth
    • An increase in your belongings leads to an increase in your total wealth.
  • 5. Wealth Effect
    • Relationship between rising stock prices and higher consumer spending.
    • Economists’ main concern with the wealth effect is that as the value of stocks increase people will become in a sense too rich, causing higher spending, which in turn would put upward pressure on productive capacity and cause inflation.
  • 6. The Big 3
    • Dow-Jones Industrial Average (DOW)- measure the industrial output of the United States
    • NASDAQ- mostly comprised of newer tech and service companies
    • S&P 500-The Standard and Poor’s ranking of the top 500 companies with regard to net worth
  • 7. Dow Jones Industrial Average
    • Also known as the Dow, Dow Jones, and the Dow 30.
    • Charles Dow created the index in order to measure the performance of the thirty largest industrial companies in the American stock market.
  • 8. Brief History of DJIA
    • During the late 1800’s, investors on Wall Street found it difficult to determine whether stocks were generally rising, falling, or remaining the same.
    • Charles Dow developed his average to put an end to the confusion and encourage people to invest in stocks, which were not as appealing as bonds at the time.
    • Since May of 1896 when the industrial average was created, the original railroad and utilities companies have been replaced by thirty of the most well-know and established companies of our time.
    • Examples include: Boeing Co., McDonalds, Disney (Walt), Exxon Mobil, and Microsoft.
  • 9. How to Compute the DJIA
    • DJIA= (1/d) Σ P
    • Price-weighted average
    • Supporters of the market valuation or market capitalization weighting average (NASDAQ and S&P 500) believe the Dow is flawed.
    • Based on this data collection, the DJIA in recent years follows this trend….
  • 10. Dow Jones Industrial Average 1980-2006 Closing Price Year
  • 11. Federal Funds Rate 2001-2007 Year Interest Rate
  • 12. Comparing the DJIA with the Federal Funds Rate
    • DJIA has been volatile and increased exponentially for the past twenty years.
    • DJIA has recently climbed up to an all-time high on January 11th, 2007 with a closing price of 12,514.98.
    • The federal funds rate drops at about the same time as the DJIA during the September 11th attacks, however instead of recovering in between the Iraq war, the federal funds rate continues to decrease and stay near or below 1%.
    • Consider how increasingly high the DJIA has been in the past year compared to the stable federal funds rate of 5.25% the Federal Reserve has maintained since June of 2006.
    • Some positive correlation.
  • 13. NASDAQ
    • - The world’s 1 st electronic stock market
    • - NASDAQ began trading on Feb. 8, 1971
    • Comprised of more than 3,200 companies
    • Trades more shares per day than any other U.S. stock market
  • 14. NASDAQ
    •   - Played a large role in lowering the spread
    • *Spread= difference between the bid price of the stock and the total price paid for the stock
    • - Made NASDAQ unpopular with brokerages
  • 15. Business Investment
    • Goldman, Sachs & Co. looked at the correlation between B.I. and the stock market
    • Concluded that a rise in the stock market will lower the cost of equity capital for companies
    • This in turns causes the companies to increase their business investment
    • From 1995-1998 the real cost of declined 24%
    • Consequently this decrease led to a 12% increase in business investment
  • 16. NASDAQ Percentage Change (Quarterly 2004-2006)
  • 17.  
  • 18. S&P 500
    • Includes the stock indexes of the 500 major companies traded on the New York Stock Exchange(NYSE)
    • The most widely watched index of large-cap US stocks
    • The S&P 500 is used largely as an indicator of the broader market
      • includes both "growth" stocks and generally less volatile "value" stocks.
  • 19. S&P 500 History
    • Used as a “Benchmark” when comparing to all stocks
    • The Dow was used previously, but its lack of depth eliminated it as a Benchmark
    • Created in 1923 and only consisted the index’s of only 90 companies
    • On March 4, 1957, a broad, real-time stock market index, the S&P 500 was introduced
  • 20. S&P 500 History Cont.
    • Standard & Poor's introduced to the financial world a new methodology for evaluating stock performance called the "base-weighted" aggregative technique.
    • This was possible thanks to advances in computers, which could now calculate and publicize the index in real-time (one-minute intervals).
  • 21. S&P 500 History Cont.
    • Uses a market capitalization weighted average price to earnings ratio
    • Stocks are traded at a multiple of 55
    • It is hard to describe how crazy these current valuation levels in the S&P have become.
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  • 26. Historical Highs for S&P 500
  • 27. Monetary Policy
    • The FOMC implements its decisions about monetary policy by changing its target for a particular federal funds rate
    • The higher the targeted rated=> the tighter the monetary policy will be creating a higher federal funds rate
    • A lower targeted rate=>considered a looser monetary policy
  • 28. Federal Reserve and Stock Market
    • The FOMC sets monetary policy.
    • Stock portfolios respond significantly to changes in monetary policy=> an easier monetary policy raises stock prices.
    • Increase in Stocks will increase Wealth.
  • 29. Wealth and Consumer Spending
    • Easier monetary policy, for example, raises stock prices.
    • Higher stock prices increase the wealth of households, prompting consumers to spend more--a result known as the wealth effect .
    • Moreover, high stock prices effectively reduce the cost of capital for firms, stimulating increased capital investment.
    • Increases in both types of spending--consumer spending and business spending--tend to stimulate the economy
  • 30. Policy Recommendation
    • Even though interest rates do not directly affect the equity markets, there is enough indirect correlation for us to recommend to decrease the federal funds rate.
    • Why? If companies and consumers are spending less or making less profit then the future cash flows of the companies will decrease  lower stock prices.
  • 31. Multiple Choice Questions
    • The Dow Jones Industrial Average is computed using a formula based on:
    • A. Market Capitalization
    • B. Stock Prices
    • C. Both A and B
    • D. None of the above
  • 32. Multiple Choice Questions
    • The Wealth effect is the relationship between Stock Prices and what?
      • Inflation
      • Consumer Spending
      • Business Spending
      • None of the above
  • 33. Multiple Choice Questions
    • The Goldman, Sachs & Co. concluded that higher stock prices have _______ with business investments:
    • A. a Negative Relationship
    • B. a Positive Relationship
    • C. No Relationship
  • 34. Multiple Choice Questions
    • The S&P 500 is used largely as an indicator of the broader market, as it includes _____:
    • A. Bubble Stocks
    • B. "growth" stocks
    • C. less volatile "value" stocks
    • D. Both A. and C.
    • E. Both B. and C.