Stock As Investment

4.
2 Stocks and securities
4.3 Factors affecting stock prices
4.4 Stock trading platforms
4.5 Hang Seng Index
Basic of Personal Financial Management
Chapter 4 Stock Trading as an Investment

Let’s Start
Four university students majoring in finance bought some stocks
last month to earn a return. They are now discussing their
investment results.
The economy is performingYes! The bank I invested in

I bought some US stocks, but
well and the prices of mostalso announced a huge US stock prices dropped due
dividend, so its stock price
stocks are rising. You should to political issues.I bought
Luckily, the stock of a
have all earned a good increased sharply. I didn’t suffer a huge smartphone
loss. company and
return, right? its stock price increased
greatly after it announced
a new smartphone model.
Elise
Alice Jack Peter
Chapter 4 Stock Trading as an Investment 2

Let’s Start
Which of the following factors would cause the stock price of a
company to rise or drop? Based on the above case and your own
knowledge, put a ‘✓’ in the appropriate boxes.
(a) Economic conditions  (e) Size of a stock market

(b) Political situations  (f) Company’s profitability 
(c) Government policies (g) Company’s dividend
 payouts 
(d) News about the 

company

4.2 Stocks and securities
4.2 Stocks and securities
• Stocks are only one type of securities.

• Securities refer to legal documents that show either:
‒ A holder’s ownership in a company (e.g., stocks)
‒ The right to buy stock at specified prices (e.g., warrants)
‒ A loan to a company or a government (e.g., bonds)
• In Hong Kong, stocks are probably the most commonly traded

securities.

• The sources of return from stocks include dividends and capital

gains.
• Capital gains on stocks are directly influenced by stock prices.

• Factors affecting stock prices can be classified using a three-tier

approach: i This approach is based on the
three-step stock valuation process
proposed by Frank K. Reilly and
Keith C. Brown.
Tier 1
Affect prices of most
Macro-economic factors
stocks in an economy
Tier 2 Affect prices of most

Industrial factors stocks in an industry
Tier 3 Affect the stock price

Firm-specific of a particular firm
factors

• In general, if a factor improves a firm’s profitability or prospects

 Demand for the firm’s stock 
 Stock price 
• The opposite happens if a factor results in lower profitability or
poor prospects.
• We will only discuss several major factors that affect stock i
prices. As the prices of preferred

stocks are relatively stable,
this section will mainly focus
on common stocks.

A. Macro-economic factors
• Macro-economic factors are factors that affect an economy as a
whole.
• Influence the prices of most stocks in an economy
• Include economic conditions, interest rates and political
situations

Watch Out
1. Economic conditions !
In exams, when explaining how a factor
affects a company’s stock price, you
• Stock prices are positively related to should
economic conditions.
also mention:
• How it affects the company’s
• When the economy performs well profitability or prospects, or
• How it affects the demand for the
 People’s income increases. company’s stocks.
 Investment and consumption tend to increase.
 Higher profits and higher stock prices for companies
Good People’s Investment and Stock

Profits 
economy income  consumption  prices 

1. Economic conditions
• An economic downturn
 Investment decreases.
 Demand for goods and services drops.
 Lower companies’ profits and stock prices

I just received a huge
bonus. I can buy more I will pass. My salary
to reward myself. It’s on sale now! was reduced. I have
Let’s have a look! to cut my spending.
Good economy Poor economy

• Globalisation
 Economies around the world are closely connected.
 Stock markets around the world often rise and fall together.

2. Interest rates
• Borrowing involves interest costs.
• An increase in interest rates
 Firms need to pay more interest when they borrow money to
finance their activities.
 Increase operating costs and reduce their profits
 Lower stock prices
• The opposite happens when interest rates go down.
Interest Borrowing Operating Stock

Profits 
rates  costs  costs  prices 

3. Political situations
• Stock markets can be very sensitive to political uncertainty.
• A region becomes politically unstable
 Investors lose confidence in the companies in that region. i
Because of globalisation, the

 The stock prices of companies falls. possibility of war between two
countries may also hit stock
• Similarly, if a region has a stable political environment,
markets worldwide.stock
prices tend to increase.
Politically Investors have confidence

Stock prices 
stable in the region’s companies

3. Political situations
North Korea accused the US of

Britain voted to leave the EU
declaring war  The stock
 Global stock markets fell sharply
market in the US fell sharply

B. Industrial factors
• Industrial factors affect the stock prices of most firms in a
particular industry.
• Not all firms in the same industry will be affected equally by an
industrial factor
• Their stock prices tend to move up and down together.
• Government policies regarding an industry are a common
industrial factor which affects industrial prospects.

• Industrial factors indicate good industrial prospects.
 The stock prices of most firms in that industry rise.
• The opposite happens when industrial factors result in poor
industrial prospects.
Good industrial Stock prices of most firms

prospects in the industry 

• For example:
‒ An oil pipeline network is damaged by an earthquake.
Profits of Stock prices in the

Oil supply  Oil prices 
airlines  airline industry 

C. Firm-specific factors
• Firm-specific factors are factors that affect the stock price of a
particular firm.
• The key drivers of stock prices
• Can usually be controlled by the firms themselves

• Firm-specific factors are usually related to the following areas:
Current and
Dividends
future earnings
Stock price
of a firm
Company news Business risk

i
Examples of company news

are technology breakthroughs
and layoffs.

• Company performance and dividend policy are two major
firm-specific factors affecting stock prices.

1. Company performance
• A company’s performance can directly influence its stock price.
• A company performs well
 Profits increase and it would have good prospects.
 Its stock price will increase.
• If a company performs poorly, its stock price will decrease.
Good Good Stock price of

Profits 
performance prospects the company 

1. Company performance
• For example,
‒ Apple cut the production target for its iPhone X by 50% due to
disappointing sales  Its stock price dropped by 2.1%.
‒ Prada’s stock price rose by more than 14% after its sales
finally turned positive after four years.

2. Dividend policy
• Dividends and capital gains are two major sources of return from
stocks.
• The dividend policy of a company can have a significant impact
on the company’s stock price.

2. Dividend policy
• When a company pays more dividends, its stockholders earn
more money.
 The stock become a more attractive investment.
 More investors will want to buy it. If a stock becomes a less
attractive investment,
 The company’s stock price tends to increase.
investors may sell the stock.
• The opposite happens when dividend payouts decrease. i
Dividend Returns for Attractiveness Stock price of

payouts  stockholders  of the stock  the company 

D. Other factors: Speculation

• Stock prices can also be affected by speculation.
• People who engage in speculation aim to make a profit by
short-term trading. i These people are
called speculators.
• They buy stocks when they predict stock prices will rise, and sell
stocks when they predict stock prices will fall.
• Normal speculative activities should not create any unusual
stock price movement.
• Excessive speculative activities may affect stock prices greatly.


• When there is unexpected negative news or rumours about a
company or stock market, investors predict that the stock
price(s) will fall.
 



 
Lion Tech Ltd may


lay off 300 workers
next year.


• Fearful of suffering a huge loss, small investors may become
irrational and rush to sell their stocks.
 Excessive speculative activities which can push the stock
price down sharply


• If there is unexpected positive news or rumours about a company
or stock market
 Excessive speculative activities may push stock price(s)
higher.


• The table below summarises the factors affecting stock prices:
Factors Conditions Changes in stock price(s)
Good Increase 
Economic
conditions
Poor Decrease 
Macro- Increase Decrease 

Interest
economic
rates
factors Decrease Increase 
Politically stable Increase 

Political
situations
Politically unstable Decrease 


• The table below summarises the factors affecting stock prices:
Factors Conditions Changes in stock price(s)
Good industrial prospects Increase 

Industrial factors
Poor industrial prospects Decrease 
Good Increase 
Company
performance
Poor Decrease
Firm-specific
factors
Higher dividend payouts Increase 
Dividend
policy
Lower dividend payouts Decrease 

Check Your Progress (P4-1)

Will the stock price of a listed bus company tend to increase or
decrease in the following situations?
(a) One of the company’s buses crashes and kills two people.
Decrease
(b) Oil prices decrease.
Increase
(c) A riot breaks out in the city where the company operates and
the government prohibits people from going out at night.
Decrease


Are the following statements true or false? Explain.
(a) An unfavourable industrial factor will push down the stock
prices of all the companies in an industry.
False
An unfavourable industrial factor will push down the stock
prices of most but not all companies in an industry.
(b) A company’s stock price will tend to increase if the company
distributes more of its profits as dividends.
True


(c) Interest rates are positively related to stock prices in general.
False
An increase in interest rates would cause stock prices to
decrease, and vice versa.
(d) When people’s income decreases during an economic
downturn, stock prices tend to decrease as well.
True

Answering Tips Tackling MCQs about factors

affecting stock prices
In the exam, you may encounter MCQs asking you to determine
which factor(s) would affect the stock price of a certain company.
We will use the following example to show how to handle these
questions.


Example
Which of the following will affect the stock price of a listed car
manufacturer?
(1) The company announces a global recall of a certain car model
(2) The company’s dividend policy
(3) Fuel price
A. (1) and (2) only
B. (1) and (3) only
C. (2) and (3) only
D. (1), (2) and (3)

Tactics
1 First, select the factor(s) that you have learnt in this chapter.
(2) The company’s dividend policy 


Tactics
2 For each of the remaining factors, if it would affect the
company’s profits or prospects, it shall affect the company’s
stock price.
(1) The company announces a global recall of a certain car model

(3) Fuel price The recall will reduce consumers’
confidence in the car
A decrease in fuel price reduces the cost manufacturer.
of owning a car.  Reduce its sales and profits.
 Attract more people to buy cars
 Increase the car manufacturer’s profits.


Therefore, all three factors will affect the stock price of the listed
car manufacturer.


What if
If the question asks which factor(s) would cause a company’s stock
price to increase or decrease, we have to also analyse the effect of
each factor on the company’s profitability and prospects.
• If it improves a company’s profitability or prospects, it will push
up the company’s stock price.
• If it leads to lower profitability or poor prospects, it will cause the
company’s stock price to fall.

• Stocks are listed and traded on stock exchanges.

• Firms can raise capital on stock exchanges.
• A firm must meet the listing requirements set by the exchange.
• Traditionally, Trading at a stock exchange involves a physical
place.
• Technological innovation  Many stock exchanges have
switched to electronic modes.
• The trading floors of many exchanges today carry more of a
symbolic meaning than a practical use.

A. Stock exchange in Hong Kong

• Hong Kong has only one stock exchange: the Stock Exchange of
Hong Kong Ltd (SEHK)
• It is responsible for operating and maintaining the stock market
in Hong Kong.
• As SEHK is wholly owned by Hong Kong Exchanges and
Clearing Ltd (HKEX), this chapter will use HKEX when referring
to the stock exchange in Hong Kong. !
• Bonds and futures are also listed and traded on HKEX.
Watch Out
Both SEHK and HKEX refer to the
only stock exchange in Hong Kong.

B. Market capitalisation
• Before learning more about stock exchanges, you should first
know what market capitalisation is. i Market capitalisation is often
simply called ‘market cap’.
The market value of all the shares issued by a listed
company
Market capitalisation
of a company Market price of a share Number of shares issued
×
of a listed company by the company
• The total value of all the stocks listed on a stock exchange

Market capitalisation • As this shows the value of a stock exchange, it is often
of a stock exchange used as an indicator to determine a stock market’s stage
of development.

C. Main Board and GEM

• HKEX has two platforms or markets for companies to list their
stocks:
• GEM was called the Growth
‒ The Main Board Enterprise Market.
• It was renamed as GEM in
‒ GEM i February 2018.
• There are many more companies listed on the Main Board than
on GEM.
• The two platforms can be compared in terms of their listing
requirements, target companies and investment risk.


1. Listing requirements
• The main difference between the two platforms is their listing
requirements.
• The listing requirements of the Main Board are stricter than
GEM’s.
• To list on the Main Board, a company needs to
‒ pass a profit or revenue test.
‒ have a larger market capitalisation.


2. Target companies
• The Main Board and GEM are designed for different kinds of
companies:
‒ The Main Board mainly targets larger and more established
companies.
‒ GEM is positioned as a capital-raising platform for small and
medium-sized companies.


3. Investment risk
• The Main Board and GEM target different types of companies
 The risk of investing in the two markets is different.


3. Investment risk
a. Main board
• Companies listed on the Main Board have passed a profit or
revenue test.
 They have a certain level of profitability in general.
 Stock prices tend to be more stable and are less likely to
drop sharply.


3. Investment risk
b. GEM
• There are no profit or revenue requirements for companies listing
on GEM
 No guarantee of their profitability
• While they may experience rapid growth, they are also more
likely to suffer a huge loss and go bankrupt.
 Stock prices may fluctuate greatly.
• Investing in GEM companies is riskier than investing in those on
the Main Board.


3. Investment risk
b. GEM
• The differences between the Main Board and GEM:
Main Board GEM
Listing
Stricter Less strict
requirements
Target Larger and more Small and medium-sized
companies established companies companies
Investment
Lower Higher
risk


Do the following statements describe the Main Board, GEM or both
platforms?
(a) It is operated by Hong Kong Exchanges and Clearing Ltd
(HKEX).
Main Board and GEM
(b) Stock prices on the platform are more likely to drop sharply.
GEM
(c) It mainly targets small and medium-sized companies.
GEM


Do the following statements describe the Main Board, GEM or both
platforms?
(d) To list on the platform, a company needs to meet stricter listing
requirements.
Main Board
(e) It provides a channel for companies to list their stocks in Hong
Kong.
Main Board and GEM
(f) More companies are listed on this platform.
Main Board

4.5 Hang Seng Index
4.5 Hang Seng Index
1. What is a stock market index?

• It is useful for investors to understand the trend in stock prices
on a stock market.
• A stock market index is an indicator of the overall performance
of a stock market. i The selected stocks are the
constituent stocks of the
• It is computed by selecting a smaller group of listed
stock marketstocks
index. which
can accurately reflect the general price movements on the stock
market.

4.5 Hang Seng Index
2. The most commonly used stock market index in

Hong Kong
• There are a number of stock market indexes that reflect stock
market performance in Hong Kong.
• The Hang Seng Index (HSI) is the most commonly used.
• Some general facts about the HSI:
Facts about the Hang Seng Index (HSI)

• Launch date: 24 November 1969
• Number of constituent stocks: 58 (as of July 2021)
• Comprises the largest and most liquid stocks listed on the
Main Board of HKEX i
The transaction frequency of
a liquid stock is relatively high.

4.5 Hang Seng Index
3. Features of the HSI

a. How is the HSI calculated?
• The HSI is computed from the market capitalisation of all its
constituents, with a different weighting assigned to each
constituent stock.
• When the prices of most constituent stocks increase
 The HSI will increase as well.

4.5 Hang Seng Index

b. How can a company be eligible as an HSI constituent?
• To be eligible as an HSI constituent, a company
‒ must be a non-foreign company which is financially sound. i
This means the company is

‒ must be listed on the Main Board of HKEX and have a large
not from places outside China.
market capitalisation. !
‒ should have been listed for at least two years in general.
Watch Out
Companies listed on GEM cannot
become HSI constituents.

4.5 Hang Seng Index

b. How can a company be eligible as an HSI constituent?
• As the market capitalisation of stocks changes, HSI constituents
are changed from time to time.
• Cathay Pacific, which had been a constituent for 31 years, was
removed from the index in December 2017.

4.5 Hang Seng Index

c. The four sector sub-indexes
• To better reflect the price movements of the major sectors of the
Hong Kong stock market, four sector sub-indexes were created.
• They include finance, utilities, properties, and commerce and
industry.
• All of the HSI constituents are classified into these four business
sectors.

4.5 Hang Seng Index

c. The four sector sub-indexes
• The figure below shows an example from each sector:
Finance Utilities
Properties Commerce and industry

4.5 Hang Seng Index
4. Importance of the HSI

a. For understanding general price movements on the Hong
Kong stock market !
• The HSI includes the largest and most liquid
Watch Out stocks on the Hong
Kong stock market. The HSI only indicates general stock

price movements. The price of some
stocks or even constituent stocks may
 Reflect overall stock market performance.
move in the opposite direction.
• The movements of stock prices tend to follow that of the HSI in

general.
 The HSI can help investors better understand general price
movements on the Hong Kong stock market.
 Help make investment decisions

4.5 Hang Seng Index

b. For comparing stock market performance
• The HSI has been computed continually since its launch in 1969.
• Investors can compare
‒ the performance of the Hong Kong stock market over time.
‒ the performance of the Hong Kong stock market against that
of other stock markets.

4.5 Hang Seng Index

c. For evaluating the performance of particular stocks
• The HSI can serve as a benchmark for evaluating the
performance of particular stocks in Hong Kong.
• By comparing the price movements of particular stocks to trends
in the HSI.
 Investors can determine the relative performance of their
investment choices against the overall performance of the
stock market.

4.5 Hang Seng Index

(a) The Hang Seng Index (HSI) measures the general
performance of stocks listed in Hong Kong and other parts of
China.
False
The HSI only measures the general performance of stocks
listed in Hong Kong.

4.5 Hang Seng Index

(b) The four sub-indexes of the HSI are financial services,
tourism, trading and logistics, and professional and producer
services.
False
The four sub-indexes of the HSI are finance, utilities,
properties, and commerce and industry.

4.5 Hang Seng Index

(c) The HSI can help investors compare the performance of the
Hong Kong stock market at different points in time.
True
(d) All of the HSI constituents are listed on the Main Board of
HKEX.
True

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4.

2 Stocks and securities

4.3 Factors affecting stock prices

4.4 Stock trading platforms

4.5 Hang Seng Index

Basic of Personal Financial Management

Chapter 4 Stock Trading as an Investment

The economy is performingYes! The bank I invested in

Chapter 4 Stock Trading as an Investment 2

(a) Economic conditions  (e) Size of a stock market

(d) News about the 

Chapter 4 Stock Trading as an Investment 3

• Stocks are only one type of securities.

• In Hong Kong, stocks are probably the most commonly traded

Chapter 4 Stock Trading as an Investment 5

• The sources of return from stocks include dividends and capital

Chapter 4 Stock Trading as an Investment 7

• Factors affecting stock prices can be classified using a three-tier

Tier 2 Affect prices of most

Tier 3 Affect the stock price

Chapter 4 Stock Trading as an Investment 8

• In general, if a factor improves a firm’s profitability or prospects

prices. As the prices of preferred

Chapter 4 Stock Trading as an Investment 9

Chapter 4 Stock Trading as an Investment 10

Good People’s Investment and Stock

Chapter 4 Stock Trading as an Investment 11

Chapter 4 Stock Trading as an Investment 12

Good economy Poor economy

Chapter 4 Stock Trading as an Investment 13

Chapter 4 Stock Trading as an Investment 14

Interest Borrowing Operating Stock

Chapter 4 Stock Trading as an Investment 15

Because of globalisation, the

Politically Investors have confidence

Chapter 4 Stock Trading as an Investment 16

North Korea accused the US of

Chapter 4 Stock Trading as an Investment 17

Chapter 4 Stock Trading as an Investment 18

Good industrial Stock prices of most firms

Chapter 4 Stock Trading as an Investment 19

Profits of Stock prices in the

Chapter 4 Stock Trading as an Investment 20

Chapter 4 Stock Trading as an Investment 21

Company news Business risk

Examples of company news

Chapter 4 Stock Trading as an Investment 22

Chapter 4 Stock Trading as an Investment 23

Good Good Stock price of

Chapter 4 Stock Trading as an Investment 24

Chapter 4 Stock Trading as an Investment 25

Chapter 4 Stock Trading as an Investment 26

• The opposite happens when dividend payouts decrease. i

Dividend Returns for Attractiveness Stock price of

Chapter 4 Stock Trading as an Investment 27

D. Other factors: Speculation

Chapter 4 Stock Trading as an Investment 28