[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

Chapter 39
A STUDENT’S GUIDE
TO INVESTING
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The 1990s saw a tremendous rise in the value of the stock market—it seemed
as if almost every day some new company was selling shares to the public
and creating new billionaires overnight. This picture all changed abruptly
in 2000 when the stock market collapsed, causing millions to see their paper wealth
disappear. The ups and downs of the stock market are often taken as key signals of
the economy’s health, and the swings of the financial market that we have seen
during the past ten years are nothing new. When Alexander Hamilton, as the first
U.S. secretary of the treasury under President George Washington, set up the first
market for the new government’s bonds in 1791, prices skyrocketed by more than
1,000 percent in the first month of trading before collapsing in value.
But what can economics tell us about the stock market and how it behaves? And
what can economics tell us about how you should invest your money? Every decision
to save is accompanied by a decision about what to do with the savings. They might
go under the mattress, but usually savings are invested—most often in bank accounts,
the stock or bond market, or the real estate market. These financial opportunities
can be thought of as enticements to defer consumption—to save. Broadly speaking,
an investment is the purchase of an asset in the expectation of receiving a return.
For the economy as a whole, real investment must be distinguished from financial
investment. Real investment includes the purchase of new factories and
machines; it is the investment that is part of aggregate expenditures. Financial
investment is the purchase of financial assets such as stocks and bonds that are
expected to generate income or to appreciate in value.
This chapter examines financial investment. It first takes up the major alternatives
available to savers and discusses the characteristics of those that are important
to investors. From these characteristics, we can establish a simple theory to
explain how the prices of financial assets such as stocks and bonds are determined.
We can use what we learn about the characteristics of investment alternatives and
the theory of asset prices to develop some strategies for intelligent investing.
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