The Economic Functions of the Stock Market

A. The stock market allows nearly anyone to participate in the risks

and opportunities of corporate America. Real returns for the past two centuries
have averaged 7 percent per year.

B. How the Stock Market Works for Savers and Investors

1. Savers invest in the stock market as a strategy to build

wealth.

2. Investors can buy a diverse portfolio of shares and hold

them over long periods of time, substantially reducing risk.

3. Small investors can purchase stock in an equity mutual fund,

a corporation that buys and holds shares of stock in many firms.

4. Equity mutual funds have reduced the risk of stock ownership

and attracted large amounts of funds into the market, helping to push stock prices
upward.

C. How the Stock Market Works for Corporations

1. To raise money, a corporation can a) use retained earnings,

b) borrow money, or c) sell stock. Buyers can, if they wish, later resell shares on
the stock market.

2. Each share of the stock is a fractional share in the firm�s

future net revenues.

3. People buy the stock of a corporation to get future

dividends paid from corporate earnings and gains derived from increases in share
prices.

4. The decisions of a firm�s executives influence the firm�s

stock price. When investors (and their advisors and fund managers) believe that the
decisions of corporate managers will increase the firm�s future income, they will
buy more of the stock, driving its price up. When investors believe that bad
decisions are being made, the reverse happens and the stock�s price falls.

5. Corporate board members are usually stockholders, and top

managers are often given stock options. The value of the stock options will rise
sharply as the firm�s stock price increases. This helps bring the interest of
corporate decision makers into harmony with other stockholders.

D. How the Stock Market Works for the Economy

1. The stock market benefits stockholders, helps discipline

corporate decision makers to be more efficient, and to undertake productive
projects.

2. The price of a corporation�s shares constantly sends signals

to the listed corporation�s board of directors and managers. Changing stock prices
reward good decisions and penalize bad ones.

3. To increase the firm's value, the firm must undertake

productive projects.

II. Stock Prices

 A. Underlying the price of a firm�s stock is the present value of the
firm�s expected future net earnings, or profit.

B. The value of a share depends on (1) the expected size of future

net earnings, (2) when these earnings will be achieved, and (3) the interest rate
by which the investor discounts the future income.

C. The PE (price/earnings) ratio of a firm is a general measure of the

price of the stock compared to the actual asset value of the company. A PE below
the sector average represents an 'undervalued' stock; a PE ration above the sector
represents an 'overvalued' stock.

D. The PEG (PE/Growth) ratio is a general measure of the price of the

stock versus it's future expected earnings. The closer to 1 the PEG ratio is, the
more the stock price represents actual predicted future value.

III. Stock Analysis

A. Stockholder who purchase stock for long term gain from dividends
and capital gains are investors; stockholder who purchase stock for short term gain
from capital gains are speculators.

B. Speculators are primarily concerned with the value and volatility

of the stock itself; investors are more concerned with the health and growth of the
company the stock represents.

C. Speculators use Technical analysis of the quantitative aspects of

the stock's price over time to go long or sell short.

D. Investors use Fundamental analysis of both the historical

quantitative and qualitative aspects of a company to buy shares in a company.

1. Quantitative analysis looks at the historical trends of

the company's stock in terms of prices and dividends

2 Qualitativ