Archive-name: investment-faq/general/toc Version: $Id: faq-toc,v 1.12 1994/01/28 16:45:29 lott Exp lott $ Compiler: Christopher Lott, lott@informatik.uni-kl.de This is the table of contents for the general misc.invest FAQ. Articles in this FAQ discusses issues pertaining to money and investment instruments, specifically stocks, bonds, and things like options and life insurance. Subjects more appropriate to misc.consumers are not included here. For extensive information on mutual funds, see the mutual fund FAQ, which is maintained by marks@ssdevo.enet.dec.com. Disclaimers: Rules, regulations, laws, conditions, rates, and such information discussed in this FAQ all change quite rapidly. Information given here was current at the time of writing but is almost guaranteed to be out of date by the time you read it. Mention of a product does not constitute an endorsement. Answers to questions sometimes rely on information given in other answers. Readers outside the USA can reach US-800 telephone numbers, for a charge, using a service such as MCI's Call USA. All prices are listed in US dollars unless otherwise specified. Availability of the FAQ: via news: posted monthly to misc.invest,misc.answers,news.answers via anonymous ftp: host: rtfm.mit.edu path: /pub/usenet/news.answers/investment-faq/general/* via mail: address: mail-server@rtfm.mit.edu required msg body: send usenet/news.answers/investment-faq/general/* Please send comments and new submissions to the compiler. ----------------------------------------------------------------------------- TABLE OF CONTENTS Sources for Historical Stock Information Beginning Investor's Advice Dave Rhodes and Other Chain Letters American Depository Receipts (ADR) Bankrupt Broker Beta Bonds Book-to-Bill Ratio Books About Investing (especially stocks) Bull and Bear Lore Buying and Selling Stock Without a Broker Computing the Rate of Return on Monthly Investments Computing Compound Return Discount Brokers Dividends on Stock and Mutual Funds Dollar Cost and Value Averaging Dollar Bill Presidents Dramatic Stock Price Increases and Decreases Direct Investing and DRIPS Future and Present Value of Money Getting Rich Quickly Charles Givens Goodwill Hedging Investment Associations (AAII and NAIC) Initial Public Offering (IPO) Investment Jargon Life Insurance Money-Supply Measures M1, M2, and M3 Market Makers and Specialists NASD Public Disclosure Hotline One-Letter Ticker Symbols One-Line Wisdom Option Symbols Options on Stocks P/E Ratio Pink Sheet Stocks Renting vs. Buying a Home Retirement Plan - 401(k) Round Lots of Shares Savings Bonds (from US Treasury) SEC Filings available on Internet Shorting Stocks Stock Basics Stock Exchange Phone Numbers Stock Index Types Stock Index - The Dow Stock Indexes - Others Stock Splits Technical Analysis Ticker Tape Terminology Treasury Debt Instruments Treasury Direct Uniform Gifts to Minors Act (UGMA) Warrants Wash Sale Rule (from U.S. IRS) Zero-Coupon Bonds ----------------------------------------------------------------------------- Compiler's Acknowledgements: My sincere thanks to the many submitters for their efforts. Also thanks to Jonathan I. Kamens for his guidance on FAQs and his post_faq perl script. Compilation Copyright (c) 1994 by Christopher Lott, lott@informatik.uni-kl.de -- "Christopher Lott / Email: lott@informatik.uni-kl.de / Tel: +49 (631) 205-3334" "Adresse: FB Informatik - Bau 57 / Universitaet KL / D--67653 Kaiserslautern" ------------------------------------------------------------------------------- Area # 2120 news.answers 02-01-94 20:05 Message # 5245 From : LOTT@INFORMATIK.UNI-KL.D To : ALL Subj : misc.invest FAQ on gener ÿ@SUBJECT:misc.invest FAQ on general investment topics (part 1 of 3) ÿ@PACKOUT:02-03-94…Fr Message-ID: Newsgroup: misc.invest,misc.answers,news.answers Organization: University of Kaiserslautern, Germany Archive-name: investment-faq/general/part1 Version: $Id: faq-p1,v 1.12 1994/01/28 16:45:29 lott Exp lott $ Compiler: Christopher Lott, lott@informatik.uni-kl.de This is the general FAQ for misc.invest, part 1 of 3. ----------------------------------------------------------------------------- Subject: Sources for Historical Stock Information Last-Revised: 13 Jan 94 From: bakken@cs.arizona.edu, nfs@princeton.edu, gary@intrepid.com, discar@nosc.mil, irving@Happy-Man.com, ddavis@gain.com, krshah@us.oracle.com, cr@farpoint.tucson.az.us, skrenta@usl.com, clark@soldev.tti.com, savage@dg-rtp.dg.com, zheng@emei.cs.umt.edu, peize@rpi.edu There is now a free source for historical stock information on the Internet: + Ed Savage (savage@dg-rtp.dg.com) has started collecting data. Stated purpose: "To collect publicly available market data in one place so people can FTP it easily." Donate *freely redistributable* data or access same via anonymous ftp to host name dg-rtp.dg.com. Fetch the file pub/misc.invest/README for more information on formats, content, etc. This is NOT a real-time or 15-min delay quote server. It does have close-of-day quotes for a limited number of stocks. Paid services include: + Prodigy. US$15/month for basic service includes 15 minute delayed quotes on stocks at NO additional charge. Additional US$15/month for historical data download service (flat fee). Available via local dial-up all over the US. Contact them at 800-PRO-DIGY. + Compuserve. US$8.95/month for basic service includes 15-min delayed quotes on stocks and options and access to (mutual) Fund Watch Online. Historical quotes are available for about US$.05 each. Available via local dial-up all over the US. Contact them at 800-848-8990 or +1 (614) 457-8650. + GEnie. US$8.95/month includes 4 free hours; subsequent hours are $3. Has daily closing quotes. Genie Professional service (price not given) gives historical quotes, stock reports, different investment s/w, access to Charles Schwab and online trading. Contact them at 800-638-9636. + Farpoint. ($4 or $8/week for an IBM-compatible diskette) provides daily high, low, close, and volume for for approximately 6000 stocks. They offer historical data from 1 July 89 to present. Write to Farpoint, 3412 Milwaukee Avenue, Suite 477, Northbrook, Illinois 60062. Also see the listing for the Farpoint BBS below. + Xpress. Broadcasts stock quotes and news via cable TV in the US. Decoder costs $125 and provides 9600-baud serial-line output. Tier 1 service is free and includes quotes 3x/day and news stories. Tier 2 service costs $22/month and adds 15-min delayed quotes and investment blurbs. Ftp a UNIX Xpress-reader from ftp.acns.nwu.edu in directory pub/xpress. Beware that your local cable rep. may not know that the cable co. offers it! Contact Xpress at 800-7PC-NEWS. + Worden Brothers TeleChart 2000. PC software costs $29. Historical data costs 1/2-cent/day for minimum 300 days, 1/4-cent thereafter, and includes high, low, close, and volume. Offers data from about 1988 for every listed and OTC issue and many indexes. Toll-free number for downloading data at 14.4K baud. Contact them at 800-776-4940. + Dow Jones News Retrieval. Stock, bond, mutual, index quotes as well as news articles on companies, and misc. analysis packages. US $30 per month flat rate for the after hours service (8pm-5am local time). Available via dialup over Tymnet and SprintNet; available via Internet. Contact them at 800-522-3567 or +1 (609) 452-1511. + InterTrade provides historical quotes for stocks, funds, and indices on all three major US markets on floppy disks. One year of data for a block of 500 stocks/funds/indices costs $20. Subscriptions available. Contact them at +1 (518) 371-4154 or 72066,3043@compuserve.com. + Standard & Poor's Compustat (most complete and most expensive). Contact them at ............ + Disclosure's "Compact Disclosure" on CD (only $6,000 a year). Contact them at ............ + Value Line's Database Contact them at ............ Bulletin Boards for historical stock information include: + The Farpoint BBS offers a free source of historical stock data (about 3 years worth). They give you 120 minutes of free time daily and have historical data files on hundreds of stocks. Phone number is +1 (312) 274-6128. + The Business Center BBS in San Diego carries historical data on most issues on the NYSE, NASDAQ, and AMEX. TBC also provides free 15-minute delayed quotes on over 12,000 symbols, mutual funds, and indexes. It is free but limits on-line time to 20 minutes. Phone number is +1 (619) 482-8675. + FinComm BBS. "The Online Magazine Of Wall Street Computing." Individual daily quotes available for free. US$50/year buys a premium account that offers unlimited access to historical stock data. Phone number is +1 (212) 752-8660. + Stock Data. $10/month for daily market data via modem, $30-$45 per month for weekly update via diskette. Historical data back to 1987 at $1/day. Phone number is +1 (410) 280-5533. ----------------------------------------------------------------------------- Subject: Beginning Investor's Advice Last-Revised: 16 Nov 1993 From: pearson_steven@tandem.com, egreen@east.sun.com Investing is just one aspect of personal finance. People often seem to have the itch to try their hand at investing before they get the rest of their act together. This is a big mistake. For this reason, it's a good idea for "new investors" to hit the library and read maybe read three different overall guides to personal finance - three for different perspectives, and because common themes will emerge (repetition implies authority?). Anyway, what I'm talking about are books like: Madigan and Kasoff, The First-Time Investor, ISBN 0-13-942376-1 Andrew Tobias, [Still] the Only [Other] Investment Guide You Will Ever Need. (3 versions with slightly different titles, all very similar.) Sylvia Porter, New Money Book for the 80s Money Magazine, Money Guide Another good source is the Mutual Fund Education Alliance (MFEA); write them at MFEA, 1900 Erie Street, Suite 120, Kansas City, MO 64116. What I am specifically NOT talking about is most anything that appears on a list of investing/stock market books that are posted in misc.invest from time to time. You know, Market Logic, One Up on Wall Street, Beating the Dow, Winning on Wall Street, The Intelligent Investor, etc. These are not general enough. They are investment books, not personal finance books. Many "beginning investors" have no business investing in stocks. The books recommended above give good overall money management, budgeting, purchasing, insurance, taxes, estate issues, and investing backgrounds from which to build a personal framework. Only after that should one explore particular investments. If someone needs to unload some cash in the meantime, they should put it in a money market fund, or yes, even a bank account, until they complete their basic training. While I sympathize with those who view this education as a daunting task, I don't see any better answer. People who know next to nothing and always depend on "professional advisors" to hand-hold them through all transactions are simply sheep asking to be fleeced (they may not actually be fleeced, but most of them will at least get their tails bobbed). In the long run, you are the only person ultimately responsible for your own financial situation. All beginners should read the article about Charles Givens in this FAQ. Advanced beginners should also check the recommended list of books about stocks and other investments that also appears in this FAQ. ----------------------------------------------------------------------------- Subject: Dave Rhodes and Other Chain Letters Last-Revised: 30 Sep 1993 From: pearson_steven@tandem.com, foo@netcom.com Please do NOT post the "Dave Rhodes" or any other chain letter, pyramid scheme, or other scam to misc.invest. Pyramid schemes are fraud. It's simple mathematics. You can't realistically base a business on an exponentially-growing cast of new "employees." Sending money through the mails as part of a fraudulent scheme is against US Postal regulations. Notice that it's not the *asking* that is illegal, but rather the delivery of money through the US mail that the USPS cares about. But fraud is illegal, no matter how the money is delivered, and asking that delivery use the US Mail just makes for a double whammy. Note that when someone posts this nonsense with their name and home address attached, it's fairly simple for a postal inspector to trace the offender down. Although the "Dave Rhodes" letter has been appearing almost weekly in misc.invest, and it's getting pretty old, it's mildly interesting to see how this scam mutates as it passes through various bulletin boards and newsgroups. Sometimes our friend Dave went broke in 1985, sometimes as recently as 1988. Sometimes he's now driving a mercedes, sometimes a cadillac, etc., etc. The scam just keeps getting updated to keep up with the times. ----------------------------------------------------------------------------- Subject: American Depository Receipts (ADR) Last-Revised: 11 Dec 1992 From: ask@cbnews.cb.att.com An American Depository Receipt is a share of stock of an investment in shares of a non-US corporation. For example, BigCitibank might purchase 25 million shares of a non-US stock. Call it EuroGlom Corporation (EGC). Perhaps EGC trades on the Paris exchange, where BigCitibank bought them. BigCitibank would then register with the SEC and offer for sale shares of EGC ADRs. EGC ADRs are valued in dollars, and BigCitibank could apply to the NYSE to list them. In effect, they are repackaged EGC shares, backed by EGC shares owned by BigCitibank, and they would then trade like any other stock on the NYSE. BigCitibank would take a management fee for their efforts, and the number of EGC shares represented by EGC ADRs would effectively decrease, so the price would go down a slight amount; or EGC itself might pay BigCitibank their fee in return for helping to establish a US market for EGC. Naturally, currency fluctuations will affect the US Dollar price of the ADR. Dividends paid by EGC are received by BigCitibank and distributed proportionally to EGC ADR holders. If EGC withholds (foreign) tax on the dividends before this distribution, then BigCitibank will withhold a proportional amount before distributing the dividend to ADR holders, and will report on a Form 1099-Div both the gross dividend and the amount of foreign tax withheld. Most of the time the foreign nation permits US holders (BigCitibank in this case) to vote their shares on all or most issues, and ADR holders will receive ballots which will be received by BigCitibank and voted in proportion to ADR Shareholder's vote. I don't know if BigCitibank has the option of voting shares which ADR holders failed to vote. Having said this, however, for the most part ADRs look and feel pretty much like any other stock. ----------------------------------------------------------------------------- Subject: Bankrupt Broker Last-Revised: 23 Jun 1993 From: Arthur.S.Kamlet@att.com The U.S. Securities Investor Protection Corporation (SIPC) is a federally chartered private corporation whose job is to insure shareholders against the situation of a U.S. stock-broker going bankrupt. The National Association of Security Dealers requires all of their member brokers to have SIPC insurance. Many brokers supplement the limits that SIPC insures ($100,000 cash and $500,000 total, I think-- I could be wrong here) with additional policies so you are covered up to $1 million or more. Having said that, be aware there are still quite a few brokers who do not insure with SIPC - and so are not members of the NASD. My advice is that you should not do business with a broker who is not insured by the SIPC. ----------------------------------------------------------------------------- Subject: Beta Last-Revised: 11 Dec 1992 From: RKSHUKLA@SUVM.SYR.EDU,ajayshah@almaak.usc.edu,rbp@investor.pgh.pa.us Beta is the sensitivity of a stock's returns to the returns on some market index (e.g., S&P 500). Beta values can be roughly characterized as follows: b < 0 Negative beta is possible but not likely. People thought gold stocks should have negative betas but that hasn't been true b = 0 Cash under your mattress, assuming no inflation 0 < b < 1 Dull investments (e.g., utility stocks) b = 1 Matching the index (e.g., for the S&P 500, an index fund) b > 1 Anything more volatile than the index (e.g., small cap. funds) b -> infinity Impossible, because the stock would be expected to go to zero on any market decline. 2-3 is probably as high as you will get More interesting is the idea that securities MAY have different betas in up and down markets. Forbes used to (and may still) rate mutual funds for bull and bear market performance. Here is an example showing the inner details of the beta calculation process: Suppose we collected end-of-the-month prices and any dividends for a stock and the S&P 500 index for 61 months (0..60). We need n + 1 price observations to calculate n holding period returns, so since we would like to index the returns as 1..60, the prices are indexed 0..60. Also, professional beta services use monthly data over a five year period. Now, calculate monthly holding period returns using the prices and dividends. For example, the return for month 2 will be calculated as: r_2 = ( p_2 - p_1 + d_2 ) / p_1 Here r denotes return, p denotes price, and d denotes dividend. The following table of monthly data may help in visualizing the process. Monthly data is preferred in the profession because investors' horizons are said to be monthly. =========================================== # Date Price Dividend(*) Return =========================================== 0 12/31/86 45.20 0.00 -- 1 01/31/87 47.00 0.00 0.0398 2 02/28/87 46.75 0.30 0.0011 . ... ... ... ... 59 11/30/91 46.75 0.30 0.0011 60 12/31/91 48.00 0.00 0.0267 =========================================== (*) Dividend refers to the dividend paid during the period. They are assumed to be paid on the date. For example, the dividend of 0.30 could have been paid between 02/01/87 and 02/28/87, but is assumed to be paid on 02/28/87. So now we'll have a series of 60 returns on the stock and the index (1...61). Plot the returns on a graph and fit the best-fit line (visually or using some least squares process): | * / stock | * * */ * returns| * * / * | * / * | * /* * * | / * * | / * | | +------------------------- index returns The slope of the line is Beta. Merrill Lynch, Wells Fargo, and others use a very similar process (they differ in which index they use and in some econometric nuances). Now what does Beta mean? A lot of disservice has been done to Beta in the popular press because of trying to simplify the concept. A beta of 1.5 does *not* mean that is the market goes up by 10 points, the stock will go up by 15 points. It even *doesn't* mean that if the market has a return (over some period, say a month) of 2%, the stock will have a return of 3%. To understand Beta, look at the equation of the line we just fitted: stock return = alpha + beta * index return Technically speaking, alpha is the intercept in the estimation model. It is expected to be equal to risk-free rate times (1 - beta). But it is best ignored by most people. In another (very similar equation) the intercept, which is also called alpha, is a measure of superior performance. Therefore, by computing the derivative, we can write: Change in stock return = beta * change in index return So, truly and technically speaking, if the market return is 2% above its mean, the stock return would be 3% above its mean, if the stock beta is 1.5. One shot at interpreting beta is the following. On a day the (S&P-type) market index goes up by 1%, a stock with beta of 1.5 will go up by 1.5% + epsilon. Thus it won't go up by exactly 1.5%, but by something different. The good thing is that the epsilon values for different stocks are guaranteed to be uncorrelated with each other. Hence in a diversified portfolio, you can expect all the epsilons (of different stocks) to cancel out. Thus if you hold a diversified portfolio, the beta of a stock characterizes that stock's response to fluctuations in the market portfolio. So in a diversified portfolio, the beta of stock X is a good summary of its risk properties with respect to the "systematic risk", which is fluctuations in the market index. A stock with high beta responds strongly to variations in the market, and a stock with low beta is relatively insensitive to variations in the market. E.g. if you had a portfolio of beta 1.2, and decided to add a stock with beta 1.5, then you know that you are slightly increasing the riskiness (and average return) of your portfolio. This conclusion is reached by merely comparing two numbers (1.2 and 1.5). That parsimony of computation is the major contribution of the notion of "beta". Conversely if you got cold feet about the variability of your beta = 1.2 portfolio, you could augment it with a few companies with beta less than 1. If you had wished to figure such conclusions without the notion of beta, you would have had to deal with large covariance matrices and nontrivial computations. Finally, a reference. See Malkiel, _A Random Walk Down Wall Street_, for more information on beta as an estimate of risk. ----------------------------------------------------------------------------- Subject: Bonds Last-Revised: 7 Jan 1993 From: ask@cbnews.cb.att.com Bonds are debt instruments. Let's say a corporation needs to build a new office building, or needs to purchase manufacturing equipment, or needs to purchase aircraft, they will have to raise money. One way is to arrange for banks or others to lend them money. But a generally less expensive way is to issue (sell) bonds. The corporation will agree to pay dividends on these bonds and at some time in the future to redeem these bonds. In the U.S., corporate bonds are often issued in units of $1,000. When municipalities issue bonds, they are usually in units of $5,000. Dividends are usually paid every 6 months. Bondholders are not owners of the corporation. But if the corporation gets in financial trouble and needs to dissolve, bondholders must be paid off in full before stockholders get anything. If the corporation defaults on any bond payment, any bondholder can go into bankruptcy court and request the corporation be placed in bankruptcy. The price of a bond is a function of prevailing interest rates (as rates go up, the price of the bond goes down, and vice versa) as well as the risk perceived for the debt of the particular corporation. For example, if the company is in bankruptcy, the price of the bond will be low. ----------------------------------------------------------------------------- Subject: Book-to-Bill Ratio Last-Revised: 19 Aug 1993 From: tcmay@netcom.com The book-to-bill ration is the ratio of business "booked" (orders taken) to business "billed" (products shipped and bills sent). A book-to-bill of 1.0 implies incoming business = ougoing product. Often in downturns, the b-t-b drops to 0.9, sometimes even lower. A b-t-b of 1.1 or higher is very encouraging. ----------------------------------------------------------------------------- Subject: Books About Investing (especially stocks) Last-Revised: 19 Jan 1994 From: jhc@iris.uucp, nfs@princeton.edu, ajayshah@rcf.usc.edu, rbeville@tekig5.pen.tek.com, Chris.Hynes@launchpad.unc.edu, orwant@home.media.mit.edu Books are organized alphabetically by author's last name. Author Title(s) ----- -------- Peter Bernstein Capital Ideas Frank Cappielo New Guide to Finding the Next Superstock George S. Clason The Richest Man in Babylon Consumer's Union Consumer Reports Money Book Burton Crane The Sophicated Investor William Donoghue No-Load Mutual Fund Guide Dun & Bradstreet Guide to Your Investments 1993 Louis Engel How to Buy Stocks Norman G. Fosback Stock Market Logic Gary Gastineau The Stock Options Manual Benjamin Graham The Intelligent Investor, Security Analysis C. Colburn Hardy The Fact$ of Life Jiler How Charts Can Help You Gerald M. Loeb The Battle for Investment Survival Peter Lynch One Up on Wall Street Burton Malkiel A Random Walk Down Wall Street Lawrence McMillan Options as a Strategic Investment Sylvia Porter New Money Book for the 80s Pring Technical Analysis Explained Claude Rosenberg Stock Market Primer L. Louis Rukeyser How to Make Money in the Stock Market Terry Savage New Money Strategies for the 1990's Charles Schwab How to be Your Own Stockbroker John A. Straley What About Mutual Funds Andrew Tobias [Still] Only [other] Investment Guide You'll Ever Need (3 books, very similar titles) Train Money Masters, New Money Masters Venita Van Caspel Money Dynamics for the 1990s Richard Wurman et al. Wall Strt Jrnl Guide to Understanding Money & Markets Martin Zweig Winning on Wall Street ----------------------------------------------------------------------------- Subject: Bull and Bear Lore Last-Revised: 19 Jan 1994 From: orwant@home.media.mit.edu This information is paraphrased from _The Wall Street Journal Guide to Understanding Money & Markets_ by Wurman, Siegel, and Morris, 1990. One common myth is that the terms "bull market" and "bear market" are derived from the way those animals attack a foe, because bears attack by swiping their paws downward and bulls toss their horns upward. This is a useful mnemonic, but is not the true origin of the terms. Long ago, "bear skin jobbers" were known for selling bear skins that they did not own; i.e., the bears had not yet been caught. This was the original source of the term "bear." This term eventually was used to describe short sellers, speculators who sold shares that they did not own, bought after a price drop, and then delivered the shares. Because bull and bear baiting were once popular sports, "bulls" was understood as the opposite of "bears." I.e., the bulls were those people who bought in the expectation that a stock price would rise, not fall. ----------------------------------------------------------------------------- Subject: Buying and Selling Stock Without a Broker Last-Revised: 27 Sep 1993 From: antonio@qualcomm.com, henryc@panix.com Yes, you can buy/sell stock from/to a friend, relative or acquaintance without going through a broker. Call the company, talk to their investor relations person, and ask who the Transfer Agent for the stock is. The Transfer Agent is the person who accomplishes the transfer, i.e., by issuing new certificates with the buyer's name on them. The transfer agent is paid by the company to issue new certificates, and to keep track of who owns the company's stock. The name of the Transfer Agent is probably printed on your stock certificates, but it might have changed, so it is best to call and check. The back of the certificate contains a stock power, i.e., those words that say you want the shares to be transferred. Fill out the transferee portion with the desired name, address, and tax id number to be registered. Sign the stock power exactly as the certificate is registered: joint tenancy will require signatures from all the people listed, stock that was issued in maiden name must be signed as such, etc. In addition to signing, you must get your signature(s) guaranteed. The signature guarantee is an obscure ritual. It is similar to a notary public, but different. The people who can provide a signature guarantee are banks and stock brokers who are members of an exchange. Now, your stock broker might not be too happy to see you and help you when you are trying to avoid paying a commission, so I suggest you get the guarantee from your bank. It's very easy. Someone at the bank checks your signature card to see if your signature looks right and then applies a little rubber stamp. Also, if you have the time, have the transferee fill out a W-9 form to avoid any TEFRA withholding. W-9 forms are available from any bank or broker. Then send it all to the transfer agent. The agent will usually recommend sending securities registered mail and insuring for 2% of the total value. For safety, many people send the endorsement in a separate envelope from the stock certificate, rather than using the back of the stock certificate (if you do this, include a note that says so.) SEC regulations require transfer agents to comply with a 3 business day turn-around time for 90% of the stock transfers received in good standing. In a few days, the buyer gets a stock certificate in the mail. Poof! There is no law requiring you to use a broker to buy or sell stock, except in certain very special circumstances, such as restricted stock, or unregistered stock. As long as the stock being sold has been registered with the SEC (and all stock sold on the exchanges, NASDAQ, etc. has been registered by the company), then the public can buy and sell it at will. If you go out and create yourself a corporation (Brooklyn Bridge Inc), do not register your stock with the SEC, and then start selling stock in your company to a bunch of individuals, advertising it, etc, then you can easily violate many SEC regulations designed to protect the unsuspecting public. But this is very different than selling the ordinary registered stuff. If you own stock in a company that was issued prior to the time the company went public, depending on a variety of conditions in the SEC regulations, that stock may be restricted, and restricted stock requires some special procedures when it is sold. In brief: I do not believe that the guy who offers to sell people 1 share of Disney stock is violating any rules. Just for full disclosure: I'm not a lawyer. ----------------------------------------------------------------------------- Subject: Computing the Rate of Return on Monthly Investments Last-Revised: 4 Apr 1993 From: jedwards@ms.uky.edu Q: Assume $X is invested at the beginning of the year into some mutual fund or like account, with $Y added to the account every month. Now, down the road, if the value at any given month "i" is Vi, what conclusions can be drawn from it ? The relevant formula is F = P(1+i)**n - p((1+i)**n - 1)/i where F is the future value of your investment (i.e., the value after n periods), P is the present value of your investment (i.e., the amount of money you invest initially), p is the payment each period (p is negative if you are adding money to your account and positive if you are taking money out of your account), n is the number of periods you are interested in, and i is the interest rate per period. You cannot manipulate this formula to get a formula for i; you have to use some sort of iterative method or buy a financial calculator. One thing to keep in mind is that i is the interest rate *per period*. You may need to compound the rate to obtain a number you can compare apples-to-apples with other rates. For instance, a 1 year CD paying 12% interest is not as good an investment as an investment paying 1% per month for a year. If you put $1000 into each, you'll have $1120 in the CD at the end of the year but $1000*(1.01)**12 = $1126.82 in the other investment due to compounding. I always convert interest rates of any kind into a "simple 1-year CD equivalent" for the purposes of comparison. See also the 'irr' program, which has been posted to misc.invest, and which is now available on request from the compiler of this FAQ. ----------------------------------------------------------------------------- Subject: Computing Compound Return Last-Revised: 22 Jan 1993 From: bakken@cs.arizona.edu, chen@digital.sps.mot.com To calculate the compounded return, just figure out the factor by which the investment multiplied. Say $1000 went to $3200 in 10 years. Take the 10th root of 3.2 (the multiplying factor) and you get a compounded return of 1.1233498 (12.3% per year). To see that this works, note that 1.1233498**10 = 3.2. Another way of saying the same thing: In my calculation, I assume all the gains are reinvested so following formula applies: TR = (1 + AR) ** YR where TR is total return, AR is annualized return, and YR is year. To calculate annualized return otherwise, following formula applies: AR = (10 ** (Log TR/ YR)) - 1 Thus a total return of 950% in 20 years would be equivalent of 11.914454% annualized return. ----------------------------------------------------------------------------- Subject: Discount Brokers Last-Revised: 14 Jul 1993 From: davida@bonnie.ics.uci.edu, edwardz@ecs.comm.mot.com, gary@intrepid.com, tima@cfsmo.honeywell.com A discount broker is merely a way to save money for people who are looking out for themselves. According to Charles Schwab, the big difference between them and "the other guys" is that there is no analyst sitting in the back that will call you up and encourage you to purchase a stock. They have people there that can provide good financial advice--but only if you ask. If you walk in the door and say "I want to buy XXX", that's what they'll do. All transactions with E-Trade are apparently initiated through either touch- tone phone or computer. They are particularly cheap ($0.015/share, min $35). List of US discount brokers and phone numbers: Accutrade First National 800 762 5555 K. Aufhauser & Co. 800 368 3668 Brown & Co. 800 343 4300 Fidelity Brokerage 800 544 7272 Kennedy, Cabot, & Co. 800 252 0090 213 550 0711 Lombard 800 688 3462 Barry Murphy & Co. 800 221 2111 Norstar Brokerage 800 221 8210 Olde Discount 800 USA OLDE Pacific Brokerage Service 800 421 8395 213 939 1100 Andrew Peck Associates 800 221 5873 212 363 3770 Quick & Reilly 800 456 4049 Charles Schwab & Co. 800 442 5111 Scottsdale Securities 800 727 1995 818 440 9957 Stock Cross 800 225 6196 617 367 5700 Vanguard Discount 800 662 SHIP Waterhouse Securities 800 765 5185 Jack White & Co. 800 233 3411 E-Trade 800 786 2573 415 326 2700 Here is a table to compare commissions at various discount brokers. This is based on commission schedules gotten at various times in 1991 and 1992. These tables are for stocks only, not bonds or other investments. $2000 trades Firm 400@ 5 200@ 10 100@ 20 50@ 40 25@ 80 K. Aufhauser $ 43.49 $ 27.49 $ 25.49 $ 25.49 $ 25.49 Pacific Brokerage $ 29.00 $ 29.00 $ 29.00 $ 29.00 $ 29.00 Jack White & Co. $ 45.00 $ 39.00 $ 36.00 $ 34.50 $ 33.75 Kennedy, Cabot, & Co. $ 33.00 $ 33.00 $ 33.00 $ 23.00 $ 23.00 Bidwell & Co. $ 41.25 $ 31.25 $ 27.25 $ 25.75 $ 23.50 Quick & Reilly $ 50.00 $ 50.00 $ 49.00 $ 49.00 $ 49.00 Olde Discount $ 35.00 $ 50.00 $ 40.00 $ 40.00 $ 40.00 Vanguard Discount $ 57.00 $ 57.00 $ 48.00 $ 40.00 $ 40.00 Fidelity Brokerage $ 63.50 $ 63.50 $ 54.00 $ 54.00 $ 54.00 Charles Schwab $ 64.00 $ 64.00 $ 55.00 $ 55.00 $ 55.00 E-Trade $ 35.00 $ 35.00 $ 35.00 $ 35.00 $ 35.00 $8000 trades Firm 1600@ 5 800@ 10 400@ 20 200@ 40 100@ 80 K. Aufhauser $ 90.50 $ 61.50 $ 43.49 $ 27.49 $ 25.49 Pacific Brokerage $ 36.00 $ 44.00 $ 29.00 $ 29.00 $ 29.00 Jack White & Co. $ 81.00 $ 57.00 $ 45.00 $ 39.00 $ 36.00 Kennedy, Cabot, & Co. $ 83.00 $ 43.00 $ 33.00 $ 33.00 $ 33.00 Bidwell & Co. $ 84.75 $ 56.75 $ 45.25 $ 39.25 $ 30.25 Quick & Reilly $ 79.00 $ 79.00 $ 79.00 $ 79.00 $ 49.00 Olde Discount $ 67.50 $ 95.00 $ 70.00 $ 60.00 $ 40.00 Vanguard Discount $ 82.00 $ 82.00 $ 82.00 $ 82.00 $ 48.00 Fidelity Brokerage $ 109.00 $ 102.70 $ 102.70 $ 102.70 $ 54.00 Charles Schwab $ 120.00 $ 103.20 $ 103.20 $ 103.20 $ 55.00 E-Trade $ 35.00 $ 35.00 $ 35.00 $ 35.00 $ 35.00 $32000 trades Firm 6400@ 5 3200@ 10 1600@ 20 800@ 40 400@ 80 K. Aufhauser $ 194.50 $ 138.50 $ 90.50 $ 72.50 $ 67.50 Pacific Brokerage $ 132.00 $ 68.00 $ 36.00 $ 44.00 $ 29.00 Jack White & Co. $ 161.00 $ 97.00 $ 81.00 $ 57.00 $ 45.00 Kennedy, Cabot, & Co. $ 131.00 $ 99.00 $ 83.00 $ 43.00 $ 33.00 Bidwell & Co. $ 252.75 $ 140.75 $ 100.75 $ 88.75 $ 57.25 Quick & Reilly $ 222.00 $ 131.40 $ 131.40 $ 131.40 $ 131.40 Olde Discount $ 187.50 $ 215.00 $ 135.00 $ 115.00 $ 90.00 Vanguard Discount $ 156.00 $ 156.00 $ 156.00 $ 156.00 $ 156.00 Fidelity Brokerage $ 301.00 $ 173.00 $ 169.90 $ 169.90 $ 169.90 Charles Schwab $ 360.00 $ 200.00 $ 170.40 $ 170.40 $ 170.40 E-Trade $ 96.00 $ 48.00 $ 35.00 $ 35.00 $ 35.00 ----------------------------------------------------------------------------- Subject: Dividends on Stock and Mutual Funds Last-Revised: 22 Mar 1993 From: ask@cblph.att.com A company may periodically declare cash and/or stock dividends. This article deals with cash dividends on common stock. Two paragraphs also discuss dividends on Mutual Fund shares. A separate article elsewhere in this FAQ discusses stock splits and stock dividends. The Board of Directors of a company decides if it will declare a dividend, how often it will declare it, and the dates associated with the dividend. Quarterly payment of dividends is very common, annually or semiannually is less common, and many companies don't pay dividends at all. Other companies from time to time will declare an extra or special dividend. Mutual funds sometimes declare a year-end dividend and maybe one or more other dividends. If the Board declares a dividend, it will announce that the dividend (of a set amount) will be paid to shareholders of record as of the RECORD DATE and will be paid or distributed on the DISTRIBUTION DATE (sometimes called the Payable Date). In order to be a shareholder of record on the RECORD DATE you must own the shares on that date (when the books close for that day). Since virtually all stock trades by brokers on exchanges are settled in 5 (business) days, you must buy the shares at least 5 days before the RECORD DATE in order to be the shareholder of record on the RECORD DATE. So the (RECORD DATE - 5 days) is the day that the shareholder of record needs to own the stock to collect the dividend. He can sell it the very next day and still get the dividend. If you bought it at least 5 business days before the RECORD date and still owned it at the end of the RECORD DATE, you get the dividend. (Even if you ask your broker to sell it the day after the (RECORD DATE - 5 days), it will not have settled until after the RECORD DATE so you will own it on the RECORD DATE.) So someone who buys the stock on the (RECORD DATE - 4 days) does not get the dividend. A stock paying a 50c quarterly dividend might well be expected to trade for 50c less on that date, all things being equal. In other words, it trades for its previous price, EXcept for the DIVidend. So the (RECORD DATE - 4 days) is often called the EX-DIV date. In the financial listings, that is indicated by an x. How can you try to predict what the dividend will be before it is declared? Many companies declare regular dividends every quarter, so if you look at the last dividend paid, you can guess the next dividend will be the same. Exception: when the Board of IBM, for example, announces it can no longer guarantee to maintain the dividend, you might well expect the dividend to drop, drastically, next quarter. The financial listings in the newspapers show the expected annual dividend, and other listings show the dividends declared by Boards of directors the previous day, along with their dates. Other companies declare less regular dividends, so try to look at how well the company seems to be doing. Companies whose shares trade as ADRs (American Depository Receipts -- see article elsewhere in this FAQ) are very dependent on currency market fluctuations, so will pay differing amounts from time to time. Some companies may be temporarily prohibited from paying dividends on their common stock, usually because they have missed payments on their bonds and/or preferred stock. On the DISTRIBUTION DATE shareholders of record on the RECORD date will get the dividend. If you own the shares yourself, the company will mail you a check. If you participate in a DRIP (Dividend ReInvestment Plan, see article on DRIPs elsewhere in this FAQ) and elect to reinvest the dividend, you will have the dividend credited to your DRIP account and purchase shares, and if your stock is held by your broker for you, the broker will receive the dividend from the company and credit it to your account. Dividends on preferred stock work very much like common stock, except they are much more predictable. Tax implications: Some Mutual Funds may delay paying their year-end dividend until early January. However, the IRS requires that those dividends be constructively paid at the end of the previous year. So in these cases, you might find that a dividend paid in January was included in the previous year's 1099-DIV. Sometime before January 31 of the next year, whoever paid the dividend will send you and the IRS a Form 1099-DIV to help you report this dividend income to the IRS. Sometimes -- often with Mutual Funds -- a portion of the dividend might be treated as a non-taxable distribution or as a capital gains distribution. The 1099-DIV will list the Gross Dividends (in line 1a) and will also list any non-taxable and capital gains distributions. Enter the Gross Dividends (line 1a) on Schedule B. Subtract the non-taxable distributions as shown on Schedule B and decrease your cost basis in that stock by the amount of non-taxable distributions (but not below a cost basis of zero -- you can deduct non-taxable distributions only while the running cost basis is positive.) Deduct the capital gains distributions as shown on Schedule B, and then add them back in on Schedule D if you file Schedule D, else on the front of Form 1040. ----------------------------------------------------------------------------- Subject: Dollar Cost and Value Averaging Last-Revised: 11 Dec 1992 From: suhre@trwrb.dsd.trw.com Dollar Cost Averaging purchases a fixed dollar amount each transaction (usually monthly via a mutual fund). When the fund declines, you purchase slightly more shares, and slightly less on increases. It turns out that you lower your average cost slightly, assuming the fund fluctuates up and down. Value Averaging adjusts the amount invested, up or down, to meet a prescribed target. An example should clarify: Suppose you are going to invest $200 per month and at the end of the first month, your $200 has shrunk to $190. Then you add in $210 the next month, bringing the value to $400 (2*$200). Similarly, if the fund is worth $430 at the end of the second month, you only put in $170 to bring it up to the $600 target. What happens is that compared to dollar cost averaging, you put in more when prices are down, and less when prices are up. Dollar Cost Averaging takes advantage of the non-linearity of the 1/x curve (for those of you who are more mathematically inclined). Value Averaging just goes in a little deeper when the value is down (which implies that prices are down) and in a little less when value is up. An article in the American Association of Individual Investors showed via computer simulation that value averaging would outperform dollar- cost averaging about 95% of the time. "Outperform" is a rather vague term. As best as I remember, whatever the percentage gain of dollar- cost averaging versus buying 100% initially, value averaging would produce another 2 percent or so. Warning: Neither approach will bail you out of a declining market nor get you in on a bull market. ----------------------------------------------------------------------------- Subject: Dollar Bill Presidents Last-Revised: 19 Aug 1993 From: par@ceri.memst.edu, pmd@cbnews.cb.att.com $1 - George Washington $2 - Thomas Jefferson $5 - Abraham Lincoln $10 - Alexander Hamilton $20 - Andrew Jackson $50 - Ulysses S. Grant $100 - Benjamin Franklin $500 - William McKinley $1,000 - Grover Cleveland $5,000 - James Madison $10,000 - Salmon P. Chase $100,000 - Woodrow Wilson [ Ok, so it's trivia. - Ed. ] ----------------------------------------------------------------------------- Subject: Dramatic Stock Price Increases and Decreases Last-Revised: 12 Jan 1994 From: lwest@futserv.austin.ibm.com, suhre@trwrb.dsd.trw.com One frequently asked question is "Why did &my_stock go [down][up] by &large_amount in the past &short_time?" The purpose of this answer is not to discourage you from asking this question in misc.invest, although if you ask without having done any homework, you may receive a gentle barb or two. Rather, one purpose is to inform you that you may not get an answer because in many cases no one knows. Stocks often lurch upward and downward by sizable amounts with no apparent reason, sometimes with no fundamental change in the underlying company. If this happens to your stock and you can find no reason, you should merely use this event to alert you to watch the stock more closely for a month or two. The zig (or zag) may have meaning, or it may have merely been a burp. A related question is whether stock XYZ, which used to trade at 40 and just dropped to 25, is good buy. The answer is, possibly. Buying stocks just because they look "cheap" isn't generally a good idea. All too often they look cheaper later on. (IBM looked "cheap" at 80 in 1991 after it declined from 140 or so. The stock finally bottomed in the 40's. Amgen slid from 78 to the low 30's in about 6 months, looking "cheap" along the way.) Technical analysis principles suggest to wait for XYZ to demonstrate that it has quit going down and is showing some sign of strength, perhaps purchasing in the 28 range. If you are expecting a return to 40, you can give up a few points initially. If your fundamental analysis shows 25 to be an undervalued price, you might enter in. Rarely do stocks have a big decline and a big move back up in the space of a few days. You will almost surely have time to wait and see if the market agrees with your valuation before you purchase. ----------------------------------------------------------------------------- Subject: Direct Investing and DRIPS Last-Revised: 9 Nov 1993 From: BKOTTMANN@falcon.aamrl.wpafb.af.mil, das@impulse.ece.ucsb.edu, jsb@meaddata.com, murphy@rock.enet.dec.com, johnl@iecc.com DRIPS offer an easy, low-cost way for buying stocks. Various companies (lists are available through NAIC and some brokerages) allow you to purchase shares directly from the company and thereby avoid brokerage commissions. However, you must purchase the first share through a broker, NAIC, or other conventional means. In all cases, that first share must be registered in your name, not in street name. (A practical restriction here is that for some common kinds of accounts like IRAs and Keoghs, you can't participate in a DRIP since the stock has to be held by the custodian.) Once you have that first share, additional shares can be purchased through the DRIP either through dividend reinvestments or directly by sending in a check. Thus the two names for DRIP: Dividend/Direct Re-Investment Plan. The periodic purchase also allows you to automatically dollar-cost-average the purchase of the stock. A handful of companies sell their stock directly to the public without going through an exchange or broker even for the first share. These companies are all exchange listed as well, and tend to be utilities. Money Magazine from Nov (or Dec) 92 reports that the brokerage house A.G. Edwards has a special commission rate for purchases of single shares. They charge a flat 16% of the share price. However, contributors to this FAQ report that some (all?) of the AGE offices provide this service only for current account holders. Published material on DRIPS: + _Guide to Dividend Reinvestment Plans_ Lists over a one hundred companies that offer DRIP's. The number given for the company is 800-443-6900; the cost is $9.00 (charge to CC) and they will send you the DRIPs booklet and a copy of a newsletter called the Money Paper. + _Low cost/No cost investing_ (author forgotten) Lists about 300-400 companies that offer DRIPs. + _Buying Stocks Without a Broker_ by Charles B. Carlson. Lists 900 companies/closed end funds that offer DRIPS. Included is a profile of the company and some plan specifics. These are: if partial reinvestment of dividends are allowed, discounts on stock purchased with dividends, optional cash payment amount and frequency, fees, approximate number of shareholders in the plan. [ Compiler's note: It seems to me that a listing of the hundreds or more companies that offer DRIPS belongs in its own FAQ, and I will not reprint other people's copyrighted lists. Please don't send me lists of companies that offer DRIPS. ] ----------------------------------------------------------------------------- Subject: Future and Present Value of Money Last-Revised: 28 Jan 94 From: lott@informatik.uni-kl.de This note explains briefly two concepts concerning the time-value-of-money, namely future and present value. * Future value is simply the sum to which a dollar amount invested today will grow given some appreciation rate. The formula for future value is the formula from Case 1 of present value (below), but solved for the future-sum rather than the present value. To compute the future value of a sum invested today, the formula for interest that is compounded monthly is: fv = principal * (1 + rrate/12) ** (12 * termy) where principal = dollar value you have now termy = term, in years rrate = annual rate of return in decimal (i.e., use .05 for 5%) For interest that is compounded annually, use the formula: fv = principal * (1 + rrate) ** (termy) Example: I invest 1,000 today at 10% for 10 years compounded monthly. The future value of this amount is 2707.04. * Present value is the value in today's dollars assigned to an amount of money in the future, based on some estimate rate-of-return over the long-term. In this analysis, rate-of-return is calculated based on monthly compounding. Two cases of present value are discussed next. Case 1 involves a single sum that stays invested over time. Case 2 involves a cash stream that is paid regularly over time (e.g., rent payments), and requires that you also calculate the effects of inflation. Case 1a: Present value of money invested over time. This tells you what a future sum is worth today, given some rate of return over the time between now and the future. Another way to read this is that you must invest the present value today at the rate-of-return to have some future sum in some years from now (but this only considers the raw dollars, not the purchasing power). To compute the present value of an invested sum, the formula for interest that is compounded monthly is: future-sum pv = ---------------------------------- (1 + rrate/12) ** (12 * termy) where future-sum = dollar value you want in termy years termy = term, in years rrate = annual rate of return that you can expect, in decimal Example: I need to have 10,000 in 5 years. The present value of 10,000 assuming an 8% monthly compounded rate-of-return is 6712.10. I.e., 6712 will grow to 10k in 5 years at 8%. Case 1b: This formulation can also be used to estimate the effects of inflation; i.e., compute real purchasing power of present and future sums. Simply use an estimated rate of inflation instead of a rate of return for the rrate variable in the equation. Example: In 30 years I will receive 1,000,000 (a gigabuck). What is that amount of money worth today (what is the buying power), assuming a rate of inflation of 4.5%? The answer is 259,895.65 Case 2: Present value of a cash stream. This tells you the cost in today's dollars of money that you pay over time. Usually the payments that you make increase over the term. Basically, the money you pay in 10 years is worth less than that which you pay tomorrow, and this equation lets you compute just how much. In this analysis, inflation is compounded yearly. A reasonable estimate for long-term inflation is 4.5%, but inflation has historically varied tremendously by country and time period. To compute the present value of a cash stream, the formula is: month = 12*termy paymt * (1 + irate) ** int ((month - 1)/ 12) pv = SUM --------------------------------------------- month = 1 (1 + rrate/12) ** (month - 1) where month = month number termy = term, in years paymt = monthly payment, in dollars irate = rate of inflation (increase in payment/year), in decimal rrate = rate of return on money that you can expect, in decimal int() function = keep integral part; compute yr nr from mo nr Example: You pay $500/month in rent over 10 years and estimate that inflation is 4.5% over the period (your payment increases with inflation.) Present value is 49,530.57 Two small C programs for computing future and present value are available from the compiler of this FAQ. Simply mail a note with any subject and contents to the following address: lott=invest@informatik.uni-kl.de ----------------------------------------------------------------------------- Subject: Getting Rich Quickly Last-Revised: 18 Jul 1993 From: jim@doink.b23b.ingr.com Take this with a lot of :-) 's. Legal methods: 1. Marry someone who is already rich. 2. Have a rich person die and will you their money. 3. Strike oil. 4. Discover gold. 5. Win the lottery. Illegal methods: 6. Rob a bank. 7. Blackmail someone who is rich. 8. Kidnap someone who is rich and get a big ransom. 9. Become a drug dealer. For completeness sakes: 10. "If you really want to make a lot of money, start your own religion." - L. Ron Hubbard Hubbard made that statement when he was just a science fiction writer in either the '30s or '40s. He later founded the Church of Scientology. I believe he also wrote Dianetics. ----------------------------------------------------------------------------- Subject: Charles Givens Last-Revised: 18 Nov 1993 From: Chris.Hynes@launchpad.unc.edu, mincy@think.com, lott@informatik.uni-kl.de Charles J. Givens, born in 1941, is a self-styled investment guru who regularly appears in info-mercials on late-night television to tell the world about the fortunes he has made and lost, his free seminars run by his associates, and the Charles J. Givens Organization. Givens offers investment advice through his seminars and publications. He has written several best-selling books: Wealth Without Risk (1988) Financial Self-Defense (1990) More Wealth Without Risk (1991) Membership in his organization is offered for about $400 up front and subsequent dues of $80 a year. According to reference (2), a member of his organization receives printed materials, videotapes, and audio tapes which describe financial strategies. The organization publishes a monthly newsletter. Telephone advice is also offered to members. His advice is generally simplistic and sometimes contradictory. All examples are taken from Wealth Without Risk, as cited in Reference (4). Simplistic: number 210, don't buy bonds when interest rates are rising. Contradictory: number 206, do not put your money in vacant land; number 245, invest your IRA or Keogh money in vacant land. Givens offers some helpful advice but contrary to the titles of his books, his ideas can be extremely risky. For example, some of his suggestions about insurance, especially dropping uninsured motorist coverage from one's automobile insurance, may leave people underinsured and vulnerable in case of an accident unless they are very careful about reading their policies and asking hard questions. He also makes aggressive inter- pretations of tax law, interpretations which might get one in trouble with the IRS. Prospective followers of Givens must, absolutely must, read about recent successful lawsuits against Givens as well as his criminal convictions and other disclosures about him and his organization. See below for exact references. In conclusion: his advice is simply not appropriate for everyone. References: (1) _Smart Money_, August 1993. (2) The Wall Street Journal, ``Pitching Dreams,'' 08/05/91, Page A1. (3) The Wall Street Journal, ``Enterprise: Proliferating Get-Rich Shows Scrutinized,'' 04/19/90, Page B1. (4) The Wall Street Journal, ``Double or Nothing,'' 02/15/90, Page A12. (5) The Wall Street Journal, `` Tax Report: A Special Summary and Forecast Of Federal and State Tax Developments,'' 11/01/89. ----------------------------------------------------------------------------- Subject: Goodwill Last-Revised: 18 Jul 1993 From: keefej@panix.com Goodwill is an asset that is created when one company acquires another. It represents the difference between the price the acquiror pays and the "fair market value" of the acquired company's assets. For example, if JerryCo bought Ford Motor for $15 billion, and the accountants determined that Ford's assets (plant and equipment) were worth $13 billion, $2 billion of the purchase price would be allocated to goodwill on the balance sheet. In theory the goodwill is the value of the acquired company over and above the hard assets, and it is usually thought to represent the value of the acquired company's "franchise," that is, the loyalty of its customers, the expertise of its employees; namely, the intangible factors that make people do business with the company. What is the effect on book value? Well, book value usually tries to measure the liquidation value of a company -- what you could sell it for in a hurry. The accountants look only at the fair market value of the hard assets, thus goodwill is usually deducted from total assets when book value is calculated. For most companies in most industries, book value is next to meaningless, because assets like plant and equipment are on the books at their old historical costs, rather than current values. But since it's an easy number to calculate, and easy to understand, lots of investors (both professional and amateur) use it in deciding when to buy and sell stocks. ----------------------------------------------------------------------------- Subject: Hedging Last-Revised: 11 Dec 1992 From: nfs@princeton.edu Hedging is a way of reducing some of the risk involved in holding an investment. There are many different risks against which one can hedge and many different methods of hedging. When someone mentions hedging, think of insurance. A hedge is just a way of insuring an investment against risk. Consider a simple (perhaps the simplest) case. Much of the risk in holding any particular stock is market risk; i.e. if the market falls sharply, chances are that any particular stock will fall too. So if you own a stock with good prospects but you think the stock market in general is overpriced, you may be well advised to hedge your position. There are many ways of hedging against market risk. The simplest, but most expensive method, is to buy a put option for the stock you own. (It's most expensive because you're buying insurance not only against market risk but against the risk of the specific security as well.) You can buy a put option on the market (like an OEX put) which will cover general market declines. You can hedge by selling financial futures (e.g. the S&P 500 futures). In my opinion, the best (and cheapest) hedge is to sell short the stock of a competitor to the company whose stock you hold. For example, if you like Microsoft and think they will eat Borland's lunch, buy MSFT and short BORL. No matter which way the market as a whole goes, the offsetting positions hedge away the market risk. You make money as long as you're right about the relative competitive positions of the two companies, and it doesn't matter whether the market zooms or crashes. ----------------------------------------------------------------------------- Compilation Copyright (c) 1994 by Christopher Lott, lott@informatik.uni-kl.de -- "Christopher Lott / Email: lott@informatik.uni-kl.de / Tel: +49 (631) 205-3334" "Adresse: FB Informatik - Bau 57 / Universitaet KL / D--67653 Kaiserslautern" ------------------------------------------------------------------------------- Area # 2120 news.answers 02-01-94 20:06 Message # 5250 From : LOTT@INFORMATIK.UNI-KL.D To : ALL Subj : misc.invest FAQ on gener ÿ@SUBJECT:misc.invest FAQ on general investment topics (part 2 of 3) ÿ@PACKOUT:02-03-94…Fr Message-ID: Newsgroup: misc.invest,misc.answers,news.answers Organization: University of Kaiserslautern, Germany Archive-name: investment-faq/general/part2 Version: $Id: faq-p2,v 1.12 1994/01/28 16:45:29 lott Exp lott $ Compiler: Christopher Lott, lott@informatik.uni-kl.de This is the general FAQ for misc.invest, part 2 of 3. ----------------------------------------------------------------------------- Subject: Investment Associations (AAII and NAIC) Last-Revised: 12 Sep 1993 From: rajeeva@sco.com, dlaird@terapin.com, tima@cfsmo.honeywell.com a_s_kamlet@att.com AAII: American Association of Individual Investors 625 North Michigan Avenue Chicago, IL 60611-3110 +1-312-280-0170 A summary from their brochure: AAII believes that individuals would do better if they invest in "shadow" stocks which are not followed by institutional investor and avoid affects of program trading. They admit that most of their members are experienced investors with substantial amounts to invest, but they do have programs for newer investors also. Basically, they don't manage the member's money, they just provide information. Membership costs $49 per year for an individual; with Computerized Investing newsletter, $79. A lifetime membership (including Computerized Investing) costs $490. They offer the AAII Journal 10 times a year, Individual Investor's guide to No-Load Mutual Funds annually, local chapter membership (about 50 chapters), a year-end tax strategy guide, investment seminars and study programs at extra cost (reduced for members), and a computer user' newsletter for an extra $30. They also operate a free BBS. NAIC: National Association of Investors Corp. 1515 East Eleven Mile Road Royal Oak, MI 48067 +1-313-543-0612 The NAIC is a nonprofit organization operated by and for the benefit of member clubs. The Association has been in existence since the 1950's and has around 110,000 members. Membership costs $32 per year for an individual, or $30 for a club and $10.00 per each club member. The membership provides the member with a monthly newsletter, details of your membership and information on how to start a investment club, how to analyze stocks, and how to keep records. In addition to the information provided, NAIC operates "Low-Cost Investment Plan", which allows members to invest in participating companies such as AT&T, Kellogg, McDonald's, Mobil and Quaker Oats... Most don't incur a commission although some have a nominal fee ($3-$5). Of the 500 clubs surveyed in 1989, the average club had a compound annual growth rate of 10.8% compared with 10.6% for the S&P 500 stock index...It's average portfolio was worth $66,755. ----------------------------------------------------------------------------- Subject: Initial Public Offering (IPO) Last-Revised: 28 Sep 1993 From: ask@cblph.att.com When a company whose stock is not publicly traded wants to offer that stock to the general public, it usually asks an "underwriter" to help it do this work. The underwriter is almost always an investment banking company, and the underwriter may put together a syndicate of several investment banking companies and brokers. The underwriter agrees to pay the issuer a certain price for a minimum number of shares, and then must resell those shares to buyers, often clients of the underwriting firm or its commercial brokerage cousin. Each member of the syndicate will agree to resell a certain number of shares. The underwriters charge a fee for their services. For example, if BigGlom Corporation (BGC) wants to offer its privately- held stock to the public, it may contact BigBankBrokers (BBB) to handle the underwriting. BGC and BBB may agree that 1 million shares of BGC common will be offered to the public at $10 per share. BBB's fee for this service will be $0.60 per share, so that BGC receives $9,400,000. BBB may ask several other firms to join in a syndicate and to help it market these shares to the public. A tentative date will be set, and a preliminary prospectus detailing all sorts of financial and business information will be issued by the issuer, usually with the underwriter's active assistance. Usually, terms and conditions of the offer are subject to change up until the issuer and underwriter agree to the final offer. At that point, the issuer releases the stock to the underwriter and the underwriter releases the stock to the public. It is now up to the underwriter to make sure those shares get sold, or else the underwriter is stuck with stock. The issuer and the underwriting syndicate jointly determine the price of a new issue. The approximate price listed in the red herring (the preliminary prospectus - often with words in red letters which say this is preliminary and the price is not yet set) may or may not be close to the final issue price. Consider NetManage, NETM which started trading on NASDAQ on Tuesday, 21 Sep 1993. The preliminary prospectus said they expected to release the stock at $9-10 per share. It was released at $16/share and traded two days later at $26+. In this case, there could have been sufficient demand that both the issuer (who would like to set the price as high as possible) and the underwriters (who receive a commission of perhaps 6%, but who also must resell the entire issue) agreed to issue at 16. If it then jumped to 26 on or slightly after opening, both parties underestimated demand. This happens fairly often. IPO Stock at the release price is usually not available to most of the public. You could certainly have asked your broker to buy you shares of that stock at market at opening. But it's not easy to get in on the IPO. You need a good relationship with a broker who belongs to the syndicate and can actually get their hands on some of the IPO. Usually that means you need a large account and good business relationship with that brokerage, and you have a broker who has enough influence to get some of that IPO. By the way, if you get a cold call from someone who has an IPO and wants to make you rich, my advice is to hang up. That's the sort of IPO that gives IPOs a bad name. Even if you that know a stock is to be released within a week, there is no good way to monitor the release without calling the underwriters every day. The underwriters are trying to line up a few large customers to resell the IPO to in advance of the offer, and that could go faster or slower than predicted. Once the IPO goes off, of course, it will start trading and you can get in on the open market. ----------------------------------------------------------------------------- Subject: Investment Jargon Last-Revised: 20 Sep 1993 From: jhsu@eng-nxt03.cso.uiuc.edu, e-krol@uiuc.edu Some common jargon is explained here briefly. See other articles in the faq for more detailed explanations on most of these terms. bottom fishing: purchasing of stock declining in value going long: buying and holding stock going short: selling stock short overbought: judgemental adjective describing a market or stock implying [oversold] that people have been wildly buying [selling] it and that there is very little chance of it moving upward [downward] in the near term. Usually it applies to movement momentum rather than what the security should cost. over valued, under valued, fairly valued: judgmental adjectives describing that a market or stock is over/under/fairly priced with respect to what people believe the security is really worth. (others? -Ed.) ----------------------------------------------------------------------------- Subject: Life Insurance Last-Revised: 29 Mar 1993 From: joec@fid.morgan.com This is my standard reply to life insurance queries. And, I think many insurance agents will disagree with these comments. First of all, decide WHY you want insurance. Think of insurance as income-protection, i.e. if the insured passes away, the beneficiary receives the proceeds to offset that lost income. With that comment behind us, I would never buy insurance on kids, after all, they don't have income and they don't work. An agent might say to buy it on your kids while its cheap - but run the numbers, the agent is usually wrong, remember, agents are really salesmen/women and its in their interest to sell you insurance. Also - I am strongly against insurance on kids on two counts. One, you are placing a bet that you kid will die and you are actually paying that bet in premiums. I can't bet my child will die. Two, it sounds plausible, i.e. your kid will have a nest egg when they grow up but factor inflation in - it doesn't look so good. A policy of face amount of $10,000, at 4.5% inflation and 30 years later is like having $2,670 in today's dollars - it's NOT a lot of money. So don't plan on it being worth much in the future to your child as an investment. In summary, skip insurance on your kids. I also have some doubts about insurance as investments - it might be a good idea but it certainly muddies the water. Why not just buy your insurance as one step and your investment as another step? - its a lot simpler to keep them separate. So by now you have decided you want insurance, i.e. to protect your family against your passing away prematurely, i.e. the loss of income you represent. Next decide how LONG you want insurance for. If you're around 60 years old, I doubt you want to get any at all. Your income stream is largely over and hopefully you have accumulated the assets you need anyway by now. If you are married and both work, its not clear you need insurance at all if you pass on. The spouse just keeps working UNLESS you need both incomes to support your lifestyle (more common these days). Then you should have one policy on each of you. If you are single, its not clear you need life insurance at all. You are not supporting anyone so no one cares if you pass on, at least financially :-) If you are married and the spouse is not working, then the breadwinner needs insurance UNLESS you are independently wealthy. Some might argue you should have insurance on your spouse, i.e. as homemaker, child care provider and so forth. In my opinion, I would get a SMALL policy on the spouse, sufficient to cover the costs of burying them and also sufficient to provide for child care for a few years or so. Each case is different but I would look for a small TERM policy on the order of $50,000 or less. Get the cheapest you can find, from anywhere. It should be quite cheap. Skip any fancy policies - just go for term and plan on keeping it until your child is own his/her own. Then reduce the insurance coverage on your spouse so it is sufficient to bury your spouse. If you are independently wealthy, you don't need insurance because you already have the money you need. You might want tax shelters and the like but that is a very different topic. Suppose you have a 1 year old child, the wife stays home and the husband works. In that case, you might want 2 types of insurance: Whole life for the long haul, i.e. age 65, 70, etc., and Term until your child is off on his/her own. Once the child has left the stable, your need for insurance goes down since your responsibilities have diminished, i.e. fewer dependents, education finished, wedding expenses done, etc Mortgage insurance is popular but is it worthwhile? Generally not because it is too expensive. Perhaps you want some sort of Term during the duration of the mortgage - but remember that the mortgage balance DECLINES over time. But don't buy mortgage insurance itself - much too expensive. Include it in the overall analysis of what insurance needs you might have. What about flight insurance? Ignore it. You are quite safe in airplanes and flight insurance is incredibly expensive to buy. Insurance through work? Many larger firms offer life insurance as part of an overall benefits package. They will typically provide a certain amount of insurance for free and insurance beyond that minimum amount is offered for a fee. Although priced competitively, it may not be wise to get more than the 'free' amount offered - why? Suppose you develop a nasty health condition and then lose your job (and your benefit-provided insurance)? Trying to get re-insured elsewhere (with a health condition) may be *very* expensive. It is often wiser to have your own insurance in place through your own efforts - this insurance will stay with you and not the job. Now, how much insurance? One rule of thumb is 5x your annual income. What agents will ask you is 'Will your spouse go back to work if you pass away?' Many of us will think nobly and say NO. But its actually likely that your spouse will go back to work and good thing - otherwise your insurance needs would be much larger. After all, if the spouse stays home, your insurance must be large enough to be invested wisely to throw off enough return to live on. Assume you make $50,000 and the spouse doesn't work. You pass on. The Spouse needs to replace a portion of your income (not all of it since you won't be around to feed, wear clothes, drive an insured car, etc.). Lets assume the Spouse needs $40,000 to live on. Now that is BEFORE taxes. Lets say its $30,000 net to live on. $30,000 is the annual interest generated on a $600,000 tax-free investment at 5% per year (i.e. munibonds). So this means you need $600,000 of face value insurance to protect your $50,000 current income. These numbers will vary, depending on interest rates at the time you do your analysis and how much money you spouse will need, factoring in inflation. This is only one example of how to do it and income taxes, estate taxes and inflation can complicate it. But hopefully you get the idea. Which kind of insurance IMHO is a function of how long you need it for. I once did an analysis of TERM vs WHOLE LIFE and based on the assumptions at the time, WHOLE LIFE made more sense if I held the insurance more than about 20-23 years. But TERM was cheaper if I held it for a shorter period of time. How do you do the analysis and why does the agent want to meet you? Well, he/she will bring their fancy charts, tables of numbers and effectively snow you into thinking that the biggest, most expensive policy is the best for you over the long term. Translation: mucho commissions to the agent. Whole life is what agents make their money on due to commissions. The agents typically gets 1/2 of your first year's commissions as his pay. And he typically gets 10% of the next year's commissions and likewise through year 5. Ask him how he gets paid. If he won't tell you, ask him to leave. In my opinion, its okay that the agents get commissions but just buy what you need, don't buy some huge policy. The agent may show you compelling numbers on a $1,000,000 whole life policy but do you really need that much? They will make lots of money on commissions on such a policy, but they will likely have sold you the "Mercedes Benz" type of policy when a Ford Taurus or a Saturn sedan model would also be just fine, at far less money. Buy the life insurance you need, not what they say. What I did was to take their numbers, review their assumptions (and corrected them when they were far-fetched) and did MY analysis. They hated that but they agreed my approach was correct. They will show you a 12% rate of return to predict the cash value flow. Ignore that. It makes them look too good and its not realistic. Ask him/her exactly what they plan to invest your premium money in to get 12%. How has it done in the last 5 years? 10? Use a number between 4.5% (for TBILL investments, ultra- conservative) and 10% (for growth stocks, more risky), but not definitely not 12%. I would try 8% and insist it be done that way. Ask each agent: 1)-what is the present value of the payment stream represented by the premiums, using a discount rate of 4.5% per year (That is the inflation average since 1940). This is what the policy costs you, in today's dollars. Its very much like paying that single number now instead of a series of payments over time. 2)-what is the present value of the the cash value earned (increasing at no more than 8% a year) and discounting it back to today at the same 4.5%. This is what you get for that money you just paid, in cash value, expressed in today's dollars, i.e. as if you got it today in the mail. 3)-What is the present value of the life insurance in force over that same period, discounted back to today by 4.5%, for inflation. That is the coverage in effect in today's dollars. 4)-Pick an end date for comparing these - I use age 60 and age 65. With the above in hand from various agents, you can see fairly quickly which is the better policy, i.e. which gives you the most for your money. By the way, inflation is slippery and sneaky. All too often we see $500,000 of insurance and it sounds great, but at 4.5% inflation and 30 years from now, that $500,000 then is like $133,500 now - truly! Have the agent do your analysis, BUT you give him the rates to use, don't use his. Then you pick the policy that is the best value, i.e., you get more for your money. Factor in any tax angles as well. If the agent refuses to do this analysis for you, get rid of him/her. If the agent gets annoyed but cannot fault your analysis, then you have cleared the snow away and gotten to the truth. If they smile too much, you may have missed something. And that will cost you money. Never agree to any policy unless you understand all the numbers and all the terms. Never 'upgrade' policies by cashing in a whole life for another whole life. That just depletes your cash value, real cash available to you. And the agent gets to pocket that money, literally, through new commissions. Its no different that just writing a personal check, payable to the agent. Check out the insurer by going to the reference section of a big library. Ask for the AM BEST guide on insurance. Look up where the issuer stands relative to the competition, on dividends, on cash value, on cost of insurance per premium dollar. Agents will usually not mention TERM since they work on commission and get much more money for Whole Life than they do for term. Remember, The agents gets about 1/2 of your 1st years premium payments and 10% or so for all the money you send in over the following 4 years. Ask them to tell you how they are paid- after all, its your money they are getting. Now why don't I like UNIVERSAL or VARIABLE? Mainly because with Whole Life and with TERM, you know exactly what you must pay because the issuer must manage the investments to generate the appropriate returns to provide you with the insurance (and with cash value if whole life). With UNIVERSAL and VARIABLE, it becomes YOU who must decide how and where to invest your premium income. If you guess badly, you will have to pay a higher premium to cover those bad decisions. The insurance companies invented UNIVERSAL and VARIABLE because interest rates went crazy in the early 80's and they lost money. Rather than taking that risk again, they offered these new policies to transfer that risk to you. Of course, UNIVERSAL and VARIABLE will be cheaper in the short term but BE CAREFUL - they can and often will increase later on. Okay, so what did I do? I bought both term and whole life. I plan to keep the term until my son graduates from college and he is on his own. That is about 9 years from now. I also bought whole life (NorthWest Mutual) which I plan to keep forever, so to speak. NWM is apparently the cheapest and best around according to A.M.BEST. At this point, after 3 years with NWM, I make more in cash value each year than I pay into the policy in premiums. Thus, they are paying me to stay with them. Where do you buy term? Just buy the cheapest policy since you will tend to renew the policy once a year and you can change insurers each time. Also: A hard thing to factor in is that one day you may become uninsurable just when you need it, i.e. heart attack, cancer and the like. I would look at getting cheap term insurance but add in the options of 'guaranteed convertible' (to whole life) and 'guaranteed renewable' (they must provide the insurance). It will add somewhat to the cost of the insurance. Last thought. I'll bet you didn't you know that you are 3x more likely to become disabled during your working career than you to die during your working career. How is your short term disability insurance looking? Get a policy that has a waiting period before it kicks in. This will keep it cheaper. Look at the exclusions, if any. ----------------------------------------------------------------------------- Subject: Money-Supply Measures M1, M2, and M3 Last-Revised: 11 Dec 1992 From: merritt@macro.bu.edu M1: Money that can be spent immediately. Includes cash, checking accounts, and NOW accounts. M2: M1 + assets invested for the short term. These assets include money- market accounts and money-market mutual funds. M3: M2 + big deposits. Big deposits include institutional money-market funds and agreements among banks. "Modern Money Mechanics," which explains M1, M2, and M3 in gory detail, is available free from: Public Information Center Federal Reserve Bank of Chicago P.O. Box 834 Chicago, Illinois 60690 ----------------------------------------------------------------------------- Subject: Market Makers and Specialists Last-Revised: 18 Nov 93 From: jeffwben@aol.com Both Market Makers (MMs) and Specialists (specs) make market in stocks. MMs are part of the National Association of Securities Dealers market (NASDAQ), sometimes called Over The Counter (OTC), and specs work on the New York Stock Exchange (NYSE). These people serve a similar function but MMs and specs have a number of differences. NASDAQ is a dealer system. A firm can become a market maker (MM) on NASDAQ by applying. The requirements are relatively small, including certain capital requirements, electronic interfaces, and a willingness to make a two-sided market. You must be there every day. If you don't post continuous bids and offers every day you can be penalized and not allowed to make a market for a month. The best way to become a MM is to go to work for a firm that is a MM. MMs are regulated by the NASD who is overseen by the SEC. The NYSE uses an agency auction market system which is designed to allow the public to meet the public as much as possible. The majority of volume (approx 88%) occurs with no intervention from the dealer. The responsibility of a spec is to make a fair and orderly market in the issues assigned to them. They must yield to public orders which means they may not trade for their own account when there are public bids and offers. The spec has an affirmative obligation to eliminate imbalances of supply and demand when they occur. The exchange has strict guidelines for trading depth and continuity that must be observed. Specs are subject to fines and censures if they fail to perform this function. There are 1366 NYSE members. Approximately 450 are specialists working for 38 specialists firms. As of 11/93 there are 2283 common and 597 preferred stocks listed on the NYSE. Each individual spec handles approximately 6 issues. The very big stocks will have a spec devoted solely to them. NYSE specs have large capital requirements and are overseen by Market Surveillance at the NYSE. Every listed stock has one firm assigned to it on the floor. Most stocks are also listed on regional exchanges in LA, SF, Chi., Phil., and Bos. All NYSE trading (approx 80% of total volume) will occur at that post on the floor of the specialist assigned to it. To become a NYSE spec the normal route is to go to work for a specialist firm as a clerk and eventually to become a broker. In the OTC public almost always meets dealer which means it is nearly impossible to buy on the bid or sell on the ask. The dealers can buy on the bid even though the public is bidding. Both spec and MM are required to make a continuous market but in the case of MM's their is no one firm who has to take the responsibility if trading is not fair or orderly. During the crash the NYSE performed much better than NASDAQ. This was in spite of the fact that some stocks have 30+ MMs. Many OTC firms simply stopped making markets or answering phones until the dust settled. As you can see there are a similarities and differences. Most academic literature shows NYSE stocks trade better (in tighter ranges, less volatility, less difference in price between trades). On the NYSE 93% of trades occur at no change or 1/8 of a point difference. It is counterintuitive that one spec could make a better market than 20 MMs. The spec operates under an entirely different system. This system requires exposure of public orders to the auction and the opportunity for price improvement and to trade ahead of the dealer. The system on the NYSE is very different than NASDAQ and has been shown to create a better market for the stocks listed there. This is why 90% of US stocks that are eligible for NYSE listing have listed. ----------------------------------------------------------------------------- Subject: NASD Public Disclosure Hotline Last-Revised: 15 Aug 1993 From: yozzo@watson.ibm.com, vkochend@nyx.cs.du.edu The number for the NASD Public Disclosure Hotline is (800) 289-9999. They will send you information about cases in which a broker was found guilty of violating the law. I believe that the information that the NASD provides has been enhanced to include pending cases. In the past, they could only mention cases in which the security dealer was found guilty. (Of course, "enhanced" is in the eye of the beholder.) ----------------------------------------------------------------------------- Subject: One-Letter Ticker Symbols Last-Revised: 11 Jun 1993 From: a_s_kamlet@att.com Not all of the one-letter symbols are obvious, nor does a one-letter symbol mean the stock is a blue chip or even well known. Most, but not all, trade on the NYSE. The current list of one-letter symbols follows. I'm not sure about "H" - has that been reassigned recently? Also "M" might have been reassigned. A Attwoods plc B Barnes Group C Chrysler Corporation D Dominion Resources E Transco Energy F Ford Motor Company G Gillette H Harcourt General (formerly General Cinema; H used to be Helm Resources) I First Interstate Bancorp J Jackpot Enterprises K Kellogg L Loblaw Companies M M-Corp ( defunct - absorbed by BancOne ) N Inco, Ltd. O Odetics (O.A & O.B - no "O") P Phillips Petroleum R Ryder Systems S Sears, Roebuck & Company T AT&T U US Air V Vivra Inc W Westvaco X US Steel Y Alleghany Corp. Z Woolworth ----------------------------------------------------------------------------- Subject: One-Line Wisdom Last-Revised: 22 Aug 1993 From: suhre@trwrb.dsd.trw.com This is a collection of one-line pieces of investment wisdom, with brief explanations. Use and apply at your own risk or discretion. They are not in any particular order. 1. Hang up on cold calls. While it is theoretically possible that someone is going to offer you the opportunity of a lifetime, it is more likely that it is some sort of scam. Even if it is legitimate, the caller cannot know your financial position, goals, risk tolerance, or any other parameters which should be considered when selecting investments. If you can't bear the thought of hanging up, ask for material to be sent by mail. 2. Don't invest in anything you don't understand. There were horror stories of people who had lost fortunes by being short puts during the 87 crash. I imagine that they had no idea of the risks they were taking. Also, all the complaints about penny stocks, whether fraudulent or not, are partially a result of not understanding the risks and mechanisms. 3. If it sounds too good to be true, it probably is [too good to be true]. 3a. There's no such thing as a free lunch (TNSTAAFL). Remember, every investment opportunity competes with every other investment opportunity. If one seems wildly better than the others, there are probably hidden risks or you don't understand something. 4. If your only tool is a hammer, every problem looks like a nail. Someone (possibly a financial planner) with a very limited selection of products will naturally try to jam you into those which s/he sells. These may be less suitable than other products not carried. 5. Don't rush into an investment. If someone tells you that the opportunity is closing, filling up fast, or in any other way suggests a time pressure, be *very* leery. 6. Very low priced stocks require special treatment. Risks are substantial, bid/asked spreads are large, prices are volatile, and commissions are relatively high. You need a broker who knows how to purchase these stocks and dicker for a good price. ----------------------------------------------------------------------------- Subject: Option Symbols Last-Revised: 12 Sep 1993 From: di236@cleveland.Freenet.Edu Month Call Put ----- ---- --- Jan A M Feb B N Mar C O Apr D P May E Q Jun F R Jul G S Aug H T Sep I U Oct J V Nov K W Dec L X Price Code Price ---------- ----- A x05 U 7.5 B x10 V 12.5 C x15 W 17.5 D x20 X 22.5 E x25 F x30 G x35 H x40 I x45 J x50 K x55 L x60 M x65 N x70 O x75 P x80 Q x85 R x90 S x95 T x00 ----------------------------------------------------------------------------- Subject: Options on Stocks Last-Revised: 24 Feb 1993 From: ask@cbnews.cb.att.com An option is a contract between a buyer and a seller. The option is connected to something, such as a listed stock, an exchange index, futures contracts, or real estate. For simplicity, I will discuss only options connected to listed stocks. The option is designated by: - Name of the associated stock - Strike price - Expiration date - The premium paid for the option, plus brokers commission. The two most popular types of options are Calls and Puts. Example: The Wall Street Journal might list an IBM Oct 90 Call @ $2.00 Translation: This is a Call Option The company associated with it is IBM. (See also the price of IBM stock on the NYSE.) The strike price is $90.00 If you own this option, you can buy IBM @ $90.00, even if it is then trading on the NYSE @ $100.00 (I should be so lucky!) The option expires on the third Saturday following the third Friday of October, 1992. (an option is worthless and useless once it expires) If you want to buy the option, it will cost you $2.00 plus brokers commissions. If you want to sell the option, you will get $2.00 less commissions. In general, options are written on blocks of 100s of shares. So when you buy "1" IBM Oct 90 Call @ $2.00 you actually are buying a contract to buy 100 shares of IBM @ $90 per share ($9,000) on or before the expiration date in October. You will pay $200 plus commission to buy the call. If you wish to exercise your option you call your broker and say you want to exercise your option. Your broker will arrange for the person who sold you your option (a financial fiction: A computer matches up buyers with sellers in a magical way) to sell you 100 shares of IBM for $9,000 plus commission. If you instead wish to sell (sell=write) that option you instruct your broker that you wish to write 1 Call IBM Oct 90s, and the very next day your account will be credited with $200 less commission. If IBM does not reach $90 before the call expires, the option writer gets to keep that $200 (less commission) If the stock does reach above $90, you will probably be "called." If you are called you must deliver the stock. Your broker will sell your IBM stock for $9000 (and charge commission). If you owned the stock, that's OK. If you did not own the stock your broker will buy the stock at market price and immediately sell it at $9000. You pay commissions each way. If you write a Call option and own the stock that's called "Covered Call Writing." If you don't own the stock it's called "Naked Call Writing." It is quite risky to write naked calls, since the price of the stock could zoom up and you would have to buy it at the market price. My personal advice for new options people if to begin by writing covered call options for stocks currently trading below the strike price of the option (write out-of-the-money covered calls). When the strike price of a call is above the current market price of the associated stock, the call is "out of the money," and when the strike price of a call is below the current market price of the associated stock, the call is "in the money." Most regular folks like you and me do not exercise our options; we trade them back, covering our original trade. Saves commissions and all that. The other common option is the PUT. If you buy a put from me, you gain the right to sell me your stock at the strike price on or before the expiration date. Puts are almost the mirror-image of calls. ----------------------------------------------------------------------------- Subject: P/E Ratio Last-Revised: 22 Jan 1993 From: egreen@east.sun.com, schindler@csa2.lbl.gov P/E is shorthand for Price/Earnings Ratio. The price/earnings ratio is a tool for determining the value the market has placed on a common stock. A lot can be said about this little number, but in short, companies expected to grow and have higher earnings in the future should have a higher P/E than companies in decline. For example, if Amgen has a lot of products in the pipeline, I wouldn't mind paying a large multiple of its current earnings to buy the stock. It will have a large P/E. I am expecting it to grow quickly. P/E is determined by dividing the current market price of one share of a company's stock by that company's per-share earnings (after-tax profit divided by number of outstanding shares). For example, a company that earned $5M last year, with a million shares outstanding, had earnings per share of $5. If that company's stock currently sells for $50/share, it has a P/E of 10. Investors are willing to pay $10 for every $1 of last year's earnings. P/Es are traditionally computed with trailing earnings (earnings from the year past, called a trailing P/E) but are sometimes computed with leading earnings (earnings projected for the year to come, called a leading P/E). Like other indicators, it is best viewed over time, looking for a trend. A company with a steadily increasing P/E is being viewed by the investment community as becoming more and more speculative. PE is a much better comparison of the value of a stock than the price. A $10 stock with a PE of 40 is much more "expensive" than a $100 stock with a PE of 6. You are paying more for the $10 stock's future earnings stream. The $10 stock is probably a small company with an exciting product with few competitors. The $100 stock is probably pretty staid - maybe a buggy whip manufacturer. ----------------------------------------------------------------------------- Subject: Pink Sheet Stocks Last-Revised: 27 Oct 1993 From: a_s_kamlet@att.com, rsl@aplpy.jhuapl.edu A company whose shares are traded on the so-called "pink sheets" is commonly one that does not meet the minimal criteria for capitalization and number of shareholders that are required by the NASDAQ and OTC and most exchanges to be listed there. The "pink sheet" designation is a holdover from the days when the quotes for these stocks were printed on pink paper. "Pink Sheet" stocks have both advantages and disadvantages. Disadvantages: 1) Thinly traded. Can make it tough (and expensive) to buy or sell shares. 2) Bid/Ask spreads tend to be pretty steep. So if you bought today the stock might have to go up 40-80% before you'd make money. 3) Market makers may be limited. Much discussion has taken place in this group about the effect of a limited number of market makers on thinly traded stocks. (They are the ones who are really going to profit). 4) Can be tough to follow. Very little coverage by analysts and papers. Advantages: 1) Normally low priced. Buying a few hundred share shouldn't cost a lot. 2) Many companies list in the "Pink Sheets" as a first step to getting listed on the National Market. This alone can result in some price appreciation, as it may attract buyers that were previously wary. In other words, there are plenty of risks for the possible reward, but aren't there always? ----------------------------------------------------------------------------- Subject: Renting vs. Buying a Home Last-Revised: 28 Jan 94 From: mincy@think.com, lott@informatik.uni-kl.de This note will explain one way to compare the monetary costs of renting vs. buying a home. It is extremely predjudiced towards the US system. Small C programs for computing future value, present value, and loan amortization schedules (used to write this article) are available from the compiler of this FAQ. Simply mail a note with any subject and contents to the following address: lott=invest@informatik.uni-kl.de SUMMARY: - If you are guaranteed an appreciation rate that is a few points above inflation, buy. - If the monthly costs of buying are basically the same as renting, buy. - The shorter the term, the more advantageous it is to rent. - Tax consequences in the US are fairly minor in the long term. The three important factors that affect the analysis the most: 1) Relative cash flows; e.g., rent compared to monthly ownership expenses 2) Length of term 3) Rate of appreciation The approach used here is to determine the present value of the money you will pay over the term for the home. In the case of buying, the appreciation rate and thereby the future value of the home is estimated. This analysis neglects utility costs because they can easily be the same whether you rent or buy. However, adding them to the analysis is simple; treat them the same as the costs for insurance in both cases. Opportunity costs of buying are effectively captured by the present value. For example, pretend that you are able to buy a house without having to have a mortgage. Now the question is, is it better to buy the house with your hoard of cash or is it better to invest the cash and continue to rent? To answer this question you have to have estimates for rental costs and house costs (see below), and you have a projected growth rate for the cash investment and projected growth rate for the house. If you project a 4% growth rate for the house and a 15% growth rate for the cash then holding the cash would be a much better investment. Renting a Home. * Step 1: Gather data. You will need: - monthly rent - renter's insurance (usually inexpensive) - term (period of time over which you will rent) - estimated inflation rate to compute present value (historically 4.5%) - estimated annual rate of increase in the rent (can use inflation rate) * Step 2: Compute the present value of the cash stream that you will pay over the term, which is the cost of renting over that term. This analysis assumes that there are no tax consequences (benefits) associated with paying rent. Long-term example: Rent = 990 / month Insurance = 10 / month Term = 30 years Rent increases = 4.5% annually Inflation = 4.5% annually For this cash stream, present value = 348,137.17. Short-term example: Same numbers, but just 2 years. Present value = 23,502.38 Buying a Home. * Step 1: Gather data. You need a lot to do a fairly thorough analysis: - purchase price - down payment & closing costs - other regular expenses, such as condo fees - amount of mortgage - mortgage rate - mortgage term - mortgage payments (this is tricky for a variable-rate mortgage) - property taxes - homeowner's insurance - your tax bracket - the current standard deduction you get Other values have to be estimated, and they affect the analysis critically: - continuing maintenance costs (I estimate 1/2 of PP over 30 years.) - estimated inflation rate to compute present value (historically 4.5%) - rate of increase of property taxes, maintenance costs, etc. (infl. rate) - appreciation rate of the home (THE most important number of all) * Step 2: compute the monthly expense. This includes the mortgage payment, fees, property tax, insurance, and maintenance. The mortgage payment is fixed, but you have to figure inflation into the rest. Then compute the present value of the cash stream. * Step 3: compute your tax savings. This is different in every case, but roughly you multiply your tax bracket times the amount by which your interest plus other deductible expenses (e.g., property tax, state income tax) exceeds your standard deduction. No fair using the whole amount because everyone gets the standard deduction for free. Must be summed over the term because the standard deduction will increase annually, as will your expenses. Note that late in the mortgage your interest payments will be be well below the standard deduction. I compute savings of about 5% for 33% tax bracket. * Step 4: compute the future value of the home based on the purchase price, estimated appreciation rate, and the term. Once you have the future value, compute the present value of that sum based on the inflation rate you estimated earlier and the term you used to compute future value. If appreciation > inflation, you win. Else you lose. * Step 5: Compute final cost. All numbers must be in present value. Final-cost = Down-payment + S2 (expenses) - S3 (tax sav) - S4 (prop value) Long-term example #1: * Step 1 - the data: Purchase price = 145,000 Down payment etc = 10,000 Mortgage amount = 140,000 Mortgage rate = 8.00% Mortgage term = 30 years Mortgage payment = 1027.27 / mo Property taxes = about 1% of valuation; I'll use 1200/yr = 100/mo (which increases same as inflation, we'll say) Homeowner's ins = 50 / mo Condo fees etc = 0 Tax bracket = 33% Standard ded = 5600 Estimates: Maintenance = 1/2 PP is 72,500, or 201/mo; I'll use 200/mo Inflation rate = 4.5% annually Prop taxes incr = 4.5% annually Home appreciates = 6% annually (the NUMBER ONE critical factor) * Step 2 - the monthly expense, both fixed and changing components: Fixed component is the mortgage at 1027.27 monthly. Present value = 203,503.48 Changing component is the rest at 350.00 monthly. Present value = 121,848.01 Total from Step 2: 325,351.49 * Step 3 - the tax savings. I use my loan program to compute this. Based on the data given above, I compute the savings: Present value = 14,686.22. Not much at all. * Step 4 - the future and present value of the home. See data above. Future value = 873,273.41 and present value = 226,959.96 (which is larger than 145k since appreciation > inflation) Before you compute present value, you should subtract reasonable closing costs for the sale; for example, a real estate brokerage fee. * Step 5 - the final analysis for 6% appreciation. Final = 10,000 + 325,351.49 - 14,686.22 - 226,959.96 = 93,705.31 So over the 30 years, assuming that you sell the house in the 30th year for the estimated future value, the present value of your total cost is 93k. (You're 93k in the hole after 30 years ~~ you only paid 260.23/month.) Long-term example #2: all numbers the same BUT the home appreciates 7%/year. Step 4 now comes out FV=1,176,892.13 and PV=305,869.15 Final = 10,000 + 325,351.49 - 14,686.22 - 305,869.15 = 14796.12 So in this example, 7% was an approximate break-even point in the absolute sense; i.e., you lived for 30 years at near zero cost in today's dollars. Long-term example #3: all numbers the same BUT the home appreciates 8%/year. Step 4 now comes out FV=1,585,680.80 and PV=412,111.55 Final = 10,000 + 325,351.49 - 14,686.22 - 412,111.55 = -91,446.28 The negative number means you lived in the home for 30 years and left it in the 30th year with a profit; i.e., you were paid to live there. Long-term example #4: all numbers the same BUT the home appreciates 2%/year. Step 4 now comes out FV=264,075.30 and PV=68,632.02 Final = 10,000 + 325,351.49 - 14,686.22 - 68,632.02 = 252,033.25 In this case of poor appreciation, home ownership cost 252k in today's money, or about 700/month. If you could have rented for that, you'd be even. Short-term example #1: all numbers the same as Long-term example #1, but you sell the home after 2 years. Future home value in 2 years is 163,438.17 Cost = down&cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt) = 10,000 + 31,849.52 - 4,156.81 - pv(163,438.17 - 137,563.91) = 10,000 + 31,849.52 - 4,156.81 - 23,651.27 = 14,041.44 Short-term example #2: all numbers the same as Long-term example #4, but you sell the home after 2 years. Future home value in 2 years is 150,912.54 Cost = down&cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt) = 10,000 + 31,849.52 - 4,156.81 - pv(150912.54 - 137,563.91) = 10,000 + 31,849.52 - 4,156.81 - 12,201.78 = 25,490.93 Some closing comments: Once again, the three important factors that affect the analysis the most are cash flows, term, and appreciation. If the relative cash flows are basically the same, then the other two factors affect the analysis the most. The longer you hold the house, the less appreciation you need to beat renting. This relationship always holds, however, the scale changes. For shorter holding periods you also face a risk of market downturn. If there is a substantial risk of a market downturn you shouldn't buy a house unless you are willing to hold the house for a long period. If you have a nice cheap rent controlled appartment, then you should probably not buy. There are other variables that affect the analysis, for example, the inflation rate. If the inflation rate increases, the rental scenario tends to get much worse, while the ownership scenario tends to look better. Question: Is it true that you can usually rent for less than buying? Answer 1: It depends. It isn't a binary state. It is a fairly complex set of relationships. In large metropolitan areas, where real estate is generally much more expensive then it is usually better to rent, unless you get a good appreciation rate or if you are going to own for a long period of time. It depends on what you can rent and what you can buy. In other areas, where real estate is relatively cheap, I would say it is probably better to own. On the other hand, if you are currently at a market peak and the country is about to go into a recession it is better to rent and let property values and rent fall. If you are currently at the bottom of the market and the economy is getting better then it is better to own. Answer 2: When you rent from somebody, you are paying that person to assume the risk of homeownership. Landlords are renting out property with the long term goal of making money. They aren't renting out property because they want to do their renters any special favors. This suggests to me that it is generally better to own. ----------------------------------------------------------------------------- Subject: Retirement Plan - 401(k) Last-Revised: 1 Apr 1993 From: nieters@crd.ge.com A 401(k) plan is an employee-funded, retirement savings plan. It takes its name from the section of the Internal Revenue Code of 1986 which created these plans. An employer will typically match a certain percent of the amount contributed to the plan by the employee, up to some maximum. Note: I have been looking at my 401(k) in pretty good detail lately, but this article is subject to my standard disclaimer that I'm not responsible for errors or poor advice. Example: the employee can contribute up to 7% of gross pay to the fund, and the company matches this money at 50%. Total contribution to the plan is 10.5% of the employee's salary. Pre-tax contributions: Employees have the option of making all or part of their contributions from pre-tax (gross) income. This has the added benefit of reducing the amount of tax paid by the employee from each check now and deferring it until you take this pre-tax money out of the plan. Both the employer contribution (if any) and any growth of the fund compound tax-free until age 59-1/2, when the employee is eligible to receive distributions from the plan. Pre-tax note: Current law allows up to a maximum of 15% to be deducted from your pay before federal income and (in most places) state or local income taxes are calculated. There are IRS rules which regulate withdrawals of pre-tax contributions and which place limits on pre-tax contributions; these affect how much you can save. After-tax contributions: If you elect to save any of your contributions on an after-tax basis, the contribution comes out of your pay after taxes are deducted. While it doesn't help your current tax situation, these funds may be easier to withdraw since they are not subject to the strict IRS rules which apply to pre-tax contributions. Later, when you receive a distribution from the 401(k), you pay no tax on the portion of your distribution attributed to after-tax contributions. Contribution limits: IRS rules won't allow contributions on pay over a certain amount (limit was $228,860 in 1992, and is subject to change). The IRS also limits how much total pre-tax pay you can contribute (limit was $8,728 in pre-tax money in 1992, and is subject to change). Employees who are defined as "highly compensated" by the IRS (salary over $60,535 in 1992 - again, subject to change) may not be allowed to save at the maximum rates. Your benefits department should notify you if you are affected. Finally, the IRS limits the total amount contributed to your 401(k) and pension plans each year to the lesser of some amount ($30,000 in 1992, and subject to change of course) or 25% of your annual compensation. This is generally taken to mean the amount of taxable income reported on your W-2 form(s). Advantages: Since the employee is allowed to contribute to his/her 401(k) with pre-tax money, it reduces the amount of tax paid out of each pay check. All employer contributions and fund gains (or losses) grow tax-free until age 59-1/2. The employee can decide where to direct future contributions and/or current savings. If your company matches your contributions, it's like getting extra money on top of your salary. The compounding effect of consistent periodic contributions over the period of 20 or 30 years is quite dramatic. Because the program is a personal investment program for you, the benefits may not be used as security for loans outside the program. This includes the additional protection of the funds from garnishment or attachment by creditors or assigned to anyone else except in the case of domestic relations court cases dealing with divorce decree or child support orders. While the 401(k) is similar in nature to an IRA, an IRA won't enjoy any matching company contributions and personal IRA contributions are only tax deductible if your gross income is under some limit (limit phases in at $40,000 in 1992). Disadvantages: It is "difficult" (or at least expensive) to access your 401(k) savings before age 59-1/2 (see next section). 401(k) plans don't have the luxury of being insured by the Pension Benefit Guaranty Corporation (PBGC). (But then again, some pensions don't enjoy this luxury either.) Investments: A 401(k) should have available different investment options. These funds usually include a money market, bond funds of varying maturities (short, intermediate, long term), company stock, mutual fund, US Series EE Savings Bonds, and others. The employee chooses how to invest the savings and is typically allowed to change where current savings are invested and/or where future contributions will go a specific number of times a year. This may be quarterly, bi-monthly, or some similar time period. The employee is also typically allowed to stop contributions at any time. Accessing savings before age 59-1/2: It is legal to take a loan from your 401(k) before age 59-1/2 for certain reasons including hardship loans, buying a house, or paying for education. When a loan is obtained, you must pay the loan back with regular payments (these can be set up as payroll deductions) but you are, in effect, paying yourself back both the principal and the interest, not a bank. If you take a withdrawal from your 401(k) as money other than a loan, not only must you pay tax on any pre-tax contributions and on the growth, you must also pay an additional 10% penalty to the government. In short, you can get the money out of your 401(k) before age 59-1/2 for something other than a loan, but it is expensive to do so. Accessing savings after age 59-1/2: At age 59-1/2 you are allowed to access your 401(k) savings. This can be done as a lump sum distribution or as annual installments. If you choose the latter, money not withdrawn from the 401(k) can continue to grow in the fund. 401(k) distributions are separate from pension funds. Changing jobs: Since a 401(k) is a company administered plan, if you change or lose jobs, this can affect your savings. Different companies handle this situation in different ways. Some will allow you to keep your savings in the program until age 59-1/2. This is the simplest idea. Others will require you to take the money out. Things get more complicated here. Your new company may allow you to make a "rollover" contribution to its 401(k) which would let you take all the 401(k) savings from your old job and put them into your new company's plan. If this is not a possibility, you may have to look into an IRA or other retirement account to put the funds. Whatever you do regarding rollovers, BE EXTREMELY CAREFUL!! This can not be emphasized enough. Recent legislation by Congress has added a twist to the rollover procedures. It used to be that you could receive the rollover money in the form of a check made out to you and you had a period of time (60 days) to roll this cash into a new retirement account (either 401(k) or IRA). Now, however, employees taking a withdrawal have the opportunity to make a "direct rollover" of the taxable amount of a 401(k) to a new plan. This means the check goes directly from your old company to your new company (or new plan). If this is done (ie. you never "touch" the money), no tax is withheld or owed on the direct rollover amount. If the direct rollover option is not chosen, the withdrawal is immediately subject to a mandatory tax withholding of 20% of the taxable portion which the old company is required to take. The remaining 80% must still be rolled over within 60 days to a new retirement account or else is is subject to the 10% tax mentioned above. The 20% withholding can be recovered using a special form filed with your next tax return to the IRS. If you forget to file that form, however, the 20% is lost. Check with your benefits department if you choose to do any type of rollover of your 401(k) funds. Epilogue: If you have been in an employee contributed retirement plan since before 1986, some of the rules may be different on those funds invested pre-1986. Consult your benefits department for more details, Expert (sic) opinions from financial advisors typically say that the average 401(k) participant is not aggressive enough with their investment options. Historically, stocks have outperformed all other forms of investment and will probably continue to do so. Since the investment period of 401(k) savings is relatively long - 20 to 40 years - this will minimize the daily fluctuations of the market and allow a "buy and hold" strategy to pay off. As you near retirement, you might want to switch your investments to more conservative funds to preserve their value. ----------------------------------------------------------------------------- Subject: Round Lots of Shares Last-Revised: 23 Apr 1993 From: ask@cbnews.cb.att.com There are some advantages to buying round lots (usually 100 shares) but if they don't apply to you, then don't worry about it. Possible limitations on non-round-lots are: - The broker might add 1/8 of a point to the price -- but usually the broker will either not do this, or will not do it when you place your order before the market opens or after it closes. - Some limit orders might not be accepted for odd lots. - If these shares cover short calls, you usually need a round lot. ----------------------------------------------------------------------------- Compilation Copyright (c) 1994 by Christopher Lott, lott@informatik.uni-kl.de -- "Christopher Lott / Email: lott@informatik.uni-kl.de / Tel: +49 (631) 205-3334" "Adresse: FB Informatik - Bau 57 / Universitaet KL / D--67653 Kaiserslautern" ------------------------------------------------------------------------------- Area # 2120 news.answers 02-01-94 20:06 Message # 5255 From : LOTT@INFORMATIK.UNI-KL.D To : ALL Subj : misc.invest FAQ on gener ÿ@SUBJECT:misc.invest FAQ on general investment topics (part 3 of 3) ÿ@PACKOUT:02-03-94…Fr Message-ID: Newsgroup: misc.invest,misc.answers,news.answers Organization: University of Kaiserslautern, Germany Archive-name: investment-faq/general/part3 Version: $Id: faq-p3,v 1.12 1994/01/28 16:45:29 lott Exp lott $ Compiler: Christopher Lott, lott@informatik.uni-kl.de This is the general FAQ for misc.invest, part 3 of 3. ----------------------------------------------------------------------------- Subject: Savings Bonds (from US Treasury) Last-Revised: 13 Jan 1994 From: ask@cblph.att.com, hamachi@adobe.com, rlcarr@animato.network23.com Series EE Savings bonds currently pay better than bank C/D rates, and are exempt from State and local income taxes. You can buy up to $15,000 per year in US Savings Bonds. Many employers have an employee bond purchase/payroll deduction plan, and most commercial banks act as agents for the Treasury and will let you fill out the purchase forms and forward them to the Treasury. You will receive the bonds in the mail a few weeks later. Series EE bonds cost half their face value. So you would purchase a $100 bond for $50. The interest rate is set by the Treasury. Currently the interest rate is set every November and May for a period of 6 months, and is credited each month until the 30th month, and credited every 6 months thereafter. The periodic rates are set at 85% of 5-year US Treasuries. However, the Treasury Dept currently guarantees that the minimum interest rate for bonds held at least 5 years is 6% [ but see below for updated information ]. Bonds can be cashed anytime after 6 months, and must be cashed before they expire, which for current bonds is 30 years after issue date. Since rates change every 6 months, it is not too meaningful to ask when a bond will be worth its face value. A bond's issue date is the first day of the month of purchase, and when you cash it in the interest is calculated to the first day of the month you cash it in (up to 30 months, and to the previous 6 month interval after). So it is advantageous to purchase bonds near the end of a month, and to cash it near the beginning of a month that it credits interest (each month between month 6 through 30, and every 6 months thereafter.) Series E bonds were issued before 1980, and are very similar to EE bonds except they were purchased at 75% of face value. Everything else stated here about EE bonds applies also to E bonds. Interest on an EE/E bond can be deferred until the bond is cashed in, or if you prefer, can be declared on your federal tax return as earned each year. When you cash the bond you will be issued a Form 1099-INT and would normally declare as interest all funds received over what you paid for the bond (and have not yet declared). However, you can choose to defer declaring the interest on the EE bonds and instead use the proceeds from cashing in an EE bond to purchase an HH Savings bond (prior to 1980, H Bonds). You can purchase HH Bonds in multiples of $500 from the proceeds of EE bonds. HH Bonds pay interest every 6 months and you will receive a check from the Treasury. When the HH bond matures, you will receive the principal, and a 1099-INT for that deferred EE interest. Savings Bonds are not negotiable instruments, and cannot be transferred to anyone at will. They can be transferred in limited circumstances, and there could be tax consequences at the time of transfer. Using Savings Bonds for College Tuition: EE bonds purchased in your name after December 31, 1989 can be used to pay for college tuition for your children or for you, and the interest may not be taxable. They have to have been issued while you were at least 24 years old. There are income limits: To use the full interest benefit your adjusted gross income must be less than (for 1992 income) $44,150 single, and 66,200 married, and phases out entirely at $59,150 single and $96,200 married. Use Form 8815 to exclude interest for college tuition. (This exclusion is not available for taxpayers who file as Married Filing Separately.) Effective March 1, 1993, the guaranteed interest rates were lowered to 4% for EE bonds bought on March 1, 1993 or later and held at least 5 years. The 4% rate is currently guaranteed as the minimum rate for 18 years. EE bonds will earn a flat 4% through the first 5 years rather than a graduated rate, and the interest will accrue monthly through the life of the bond after the initial six months, rather than semiannually after 30 months. So, all EE bonds issued since 3/93 will yield 4%, even if cashed in before 5 years have passed. The former rate -- 6% -- had been guaranteed for 12 years -- and continues for bonds bought when the 6% guarantee was in effect. Prior to the 6% rate, the guaranteed rate had been 7.5%. You can call the Federal Reserve Bank of Kansas City to request redemp- tion tables for US Savings Bonds. The number is (800) 333-2919, but is unfortunately not reachable from the entire US (direct dial not given). Hours are 6AM to 3PM PST Monday through Friday. ----------------------------------------------------------------------------- Subject: SEC Filings available on Internet Last-Revised: 19 Jan 1994 From: lott@informatik.uni-kl.de A limited number of 10-K and 10-Q filings sent by companies to the Securities and Exchange Commission (SEC) are now available for anonymous ftp on the Internet. The project, named Edgar, began in January 1994 and will almost certainly grow rapidly in terms of the amount of information available as well as number of access methods. To get started, send mail to edgar-interest-request@town.hall.org or use anonymous ftp to host town.hall.org. ----------------------------------------------------------------------------- Subject: Shorting Stocks Last-Revised: 11 Dec 1992 From: ask@cblph.att.com Shorting means to sell something you don't own. If I do not own shares of IBM stock but I ask my broker to sell short 100 shares of IBM I have committed shorting. In broker's lingo, I have established a short position in IBM of 100 shares. Or, to really confuse the language, I hold 100 shares of IBM short. Why would you want to short? Because you believe the price of that stock will go down, and you can soon buy it back at a lower price than you sold it at. When you buy back your short position, you "close your short position." The broker will effectively borrow those shares from another client's account or from the broker's own account, and effectively lend you the shares to sell short. This is all done with mirrors; no stock certificates are issued, no paper changes hands, no lender is identified by name. My account will be credited with the sales price of 100 shares of IBM less broker's commission. But the broker has actually lent me the stock to sell; no way is he going to pay interest on the funds from the short sale. (Exception: Really big spenders sometimes negotiate a full or partial payment of interest on short sales funds provided sufficient collateral exists in the account and the broker doesn't want to lose the client. If you're not a really big spender, don't expect to receive any interest on the funds obtained from the short sale.) Also expect the broker to make you put up additional collateral. Why? Well, what happens if the stock price goes way up? You will have to assure the broker that if he needs to return the shares whence he got them (see "mirrors" above) you will be able to purchase them and "close your short position." If the price has doubled, you will have to spend twice as much as you received. So your broker will insist you have enough collateral in your account which can be sold if needed to close your short position. More lingo: Having sufficient collateral in your account that the broker can glom onto at will, means you have "cover" for your short position. As the price goes up you must provide more cover. Since you borrowed these shares, if dividends are declared, you will be responsible for paying those dividends to the fictitious person from whom you borrowed. Too bad. Even if you hold you short position for over a year, your capital gains are short term. A short squeeze can result when the price of the stock goes up. When the people who have gone short buy the stock to cover their previous short-sales, this can cause the price to rise further. It's a death spiral - as the price goes higher, more shorts feel driven to cover themselves, and so on. You can short other securities besides stock. For example, every time I write (sell) an option I don't already own long, I am establishing a short position in that option. The collateral position I must hold in my account generally tracks the price of the underlying stock and not the price of the option itself. So if I write a naked call option on IBM November 70s and receive a mere $100 after commissions, I may be asked to put up collateral in my account of $3,500 or more! And if in November IBM has regained ground and is at $90 [ I should be so lucky ], I would be forced to buy back (close my short position in the call option) at a cost of about $2000, for a big loss. Selling short is seductively simple. Brokers get commissions by showing you how easy it is to generate short term funds for your account, but you really can't do much with them. My personal advice is if you are strongly convinced a stock will be going down, buy the out-of-the-money put instead, if such a put is available. A put's value increases as the stock price falls (but decreases sort of linearly over time) and is strongly leveraged, so a small fall in price of the stock translates to a large increase in value of the put. Let's return to our IBM, market price of 66 (yuck.) Let's say I strongly believe that IBM will fall to, oh, 58 by mid-November. I could short IBM stock at 66, sell it at 58 in mid-November if I'm right, and make about net $660. If instead it goes to 70, and I have to sell then I lose net $500 or so. That's a 10% gain or an 8% loss or so. Now, I could buy the IBM November 65 put for maybe net $200. If it goes down to 58 in mid November, I sell (close my position) for about $600, for a 300% gain. If it doesn't go below 65, I lose my entire 200 investment. But if you strongly believe IBM will go way way down, you should shoot for the 300% gain with the put and not the 10% gain by shorting the stock itself. Depends on how convinced you are. Having said this, I add a strong caution: Puts are very risky, and depend very much on odd market behavior beyond your control, and you can easily lose your entire purchase price fast. If you short options, you can lose even more than your purchase price! One more word of advice. Start simply. If you never bought stock start by buying some stock. When you feel like you sort of understand what you are doing, when you have followed several stocks in the financial section of the paper and watched what happens over the course of a few months, when you have read a bit more and perhaps seriously tracked some important financials of several companies, you might -- might -- want to expand your investing choices beyond buying stock. If you want to get into options (see FAQ on options) start with writing covered calls. I would place selling stock short or writing or buying other options lower on the list -- later in time. ----------------------------------------------------------------------------- Subject: Stock Basics Last-Revised: 12 Jan 1994 From: a_s_kamlet@att.com Perhaps we should start by looking at the basics: What is stock? Why does a company issue stock? Why do investors pay good money for little pieces of paper called stock certificates? What do investors look for? What about Value Line ratings and what about dividends? To start with, if a company wants to raise capital (money) one of its options is to issue stock. It has other methods, such as issuing bonds and getting a loan from the bank. But stock raises capital without creating debt, without creating a legal obligation to repay those funds. What do they buyers of the stock -- the new owners of the company -- expect for their investment? The popular answer, the answer many people would give is: they expect to make lots of money, they expect other people to pay them more than they paid themselves. Well, that doesn't just happen randomly or by chance (well, maybe sometimes it does, who knows?) The less popular, less simple answer is: shareholders -- the company's owners -- expect their investment to earn more, for the company, than other forms of investment. If that happens, if the return on investment is high, the price tends to increase. Why? Who really knows? But it is true that within an industry the Price/Earnings ratio tends to stay within a narrow range over any reasonable period of time -- measured in months or a year or so. So if the earnings go up, the price goes up. And investors look for companies whose earnings are likely to go up. How much? There's a number -- the accountants call it Shareholder Equity -- that in some magical sense represents the amount of money the investors have invested in the company. I say magical because while it translates to (Assets - Liabilities) there is often a lot of accounting trickery that goes into determining Assets and Liabilities. But looking at Shareholder Equity, (and dividing that by the number of shares held to get the book value per share) if a company is able to earn, say, $1.50 on a stock whose book value is $10, that's a 15% return. That's actually a good return these days, much better than you can get in a bank or C/D or Treasury bond, and so people might be more encouraged to buy, while sellers are anxious to hold on. So the price might be bid up to the point where sellers might be persuaded to sell. What about dividends? Dividends are certainly more tangible income than potential earnings increases and stock price increases, so what does it mean when a dividend is non-existent or very low? A company paying no or low dividends is really saying to its investors -- its owners, "We believe we can earn more, and return more value to shareholders by retaining the earnings, by putting that money to work, than by paying it out and not having it to invest in new plant or goods or salaries." And having said that, they are expected to earn a good return on not only their previous equity, but on the increased equity represented by retained earnings. So a company whose book value last year was $10 and who retains its entire $1.50 earnings, increases its book value to 11.50 less certain expenses. That increased book value - let's say it is now $11 -- means the company must earn at least $1.65 this year just to keep up with its 15% return on equity. If the company earns $1.80, the owners have indeed made a good investment, and other investors, seeking to get in on a good thing, bid up the price. That's the theory anyway. In spite of that, many investors still buy or sell based on what some commentator says or on announcement of a new product or on the hiring (or resignation) of a key officer, or on general sexiness of the company's products. And that will always happen. What is the moral of all this: Look at a company's financials, look at the Value Line and S&P charts and recommendations, do some homework before buying. Does Value Line and S&P take the actual dividend into account when issuing its "Timeliness" and "Safety" ratings? Not exactly. They report it, but their ratings are primarily based on earnings potential, performance in their industry, past history, and a few other factors. (I don't think anyone knows all the other factors. That's why people pay for the ratings.) Can a stock broker be relied on to provide well-analyzed, well thought out information and recommendations? Yes and no. On the one hand, a stock broker is in business to sell you stock. Would you trust a used-car dealer to carefully analyze the available cars and sell you the best car for the best price? Then why would you trust a broker to do the same? On the other hand, there are people who get paid to analyze company financial positions and make carefully thought out recommendations, sometimes to buy or to hold or to sell stock. While many of these folks work in the "research" departments of full-service brokers, some work for Value Line, S&P etc, and have less of an axe to grind. Brokers who rely on this information really do have solid grounding behind their recommendations. Probably the best people to listen to are those who make investment decisions for the largest of Mutual Funds, although the investment decisions are often after the fact, and announced 4 times a year. An even better source would be those who make investment decisions for the very large pension funds, which have more money invested than most mutual funds. Unfortunately that information is often less available. If you can catch one of these people on CNN for example, that could be interesting. ----------------------------------------------------------------------------- Subject: Stock Exchange Phone Numbers Last-Revised: 13 Aug 1993 From: asuncion@ac.dal.ca If you wish to know the telephone number for a specific company that is listed on a stock exchange, call the exchange and request to be connected with their "listings" or "research" department. AMEX +1 212 306-1000 ASE +1 403 974-7400 MSE +1 514 871-2424 NASDAQ +1 202 728-8333/8039 NYSE +1 212 656-3000 TSE +1 416 947-4700 VSE +1 604 689-3334/643-6500 ----------------------------------------------------------------------------- Subject: Stock Index Types Last-Revised: 11 Dec 1992 From: susant@usc.edu There are three major classes of indices in use today in the US. They are: A - equally weighted price index (an example is the Dow Jones Industrial Average) B - market-capitalization-weighted index (an example is the S&P Industrial Average) C - equally-weighted returns index (the only one of its kind is the Value-Line index) Of these, A and B are widely used. All my profs in the business school claim that C is very weird and don't emphasize it too much. + Type A index: As the name suggests, the index is calculated by taking the average of the prices of a set of companies: Index = Sum(Prices of N companies) / divisor In this calculation, two questions crop up: 1. What is "N"? The DJIA takes the 30 large "blue-chip" companies. Why 30? I think it's more a historical hangover than any thing else. One rationale for 30 might be that a large fraction of market capitalization is often clustered in largest 50 companies or so. Does the set of N companies change across time? If so, how often is the list updated (wrt companies)? I suspect these decisions are quite judgemental and hence not readily replicable. If the DJIA only has 30 companies, how do we select these 30? Why should they have equal weights? These are real criticisms of the DJIA type index. 2. The divisor is not always equal to N for N companies. What happens to the index when there is a stock issue by one of the companies in the set? The price drops, but the number of shares have increased to leave the market capitalization of the shares the same. Since the index does not take the latter into account, it has to compensate for the drop in price by tweaking the divisor. For examples on this, look at pg. 61 of Bodie, Kane, & Marcus, _Investments_ (henceforth, BKM). Historically, this index format was computationally convenient. It doesn't have a very sound economic basis to justify it's existence today. The DJIA is widely cited on the evening news, but not used by real finance folks. I have an intuition that the DJIA type index will actually be BAD if the number of companies is very large. If it's to make any sense at all, it should be very few "brilliantly" chosen companies. + Type B index: In this index, each of the N company's price is weighted by the market capitalization of the company. Sum (Company market capitalization * Price) over N companies Index = ------------------------------------------------------------ Market capitalisation for these N companies Here you do not take into account the dividend data, so effectively you're tracking the short-run capital gains of the market. Practical questions regarding this index: 1. What is "N"? I would use the largest N possible to get as close to the "full" market as possible. BTW in the US there are companies who make a living on only calculating extremely complete value-weighted indexes for the NYSE and foreign markets. CMIE should sell a very-complete value-weighted index to some such folks. Why does S&P use 500? Once again, I'm guessing that it's for historical reasons when computation over 20,000 companies every day was difficult and because of the concentration of market capitalization in the largest lot of companies. Today, computation over 20k companies for a Sun workstation is no problem, so the S&P idea is obsolete. 2. How to deal with companies entering and exiting the index? If we're doing an index containing "every single company possible" then the answer to this question is easy -- each time a company enters or exits we recalculate all weights. But if we're a value-weighted index like the S&P500 (where there are only 500 companies) it's a problem. Recently Wang went bankrupt and S&P decided to replace them by Sun -- how do you justify such choices? The value weighted index is superior to the DJIA type index for deep reasons. Anyone doing modern finance will not use the DJIA type index. A glimmer of the reasoning for this is as follows: If I held a portfolio with equal number of shares of each of the 30 DJIA companies then the DJIA index would accurately reflect my capital gains. BUT we know that it is possible to find a portfolio which has the same returns as the DJIA portfolio but at a smaller risk. (This is a mathematical fact). Thus, by definition, nobody is ever going to own a DJIA portfolio. In contrast, there is a extremely good interpretation for the value weighted portfolio -- it's the highest returns you can get for it's level of risk. Thus you would have good reason for owning a value-weighted market portfolio, thus justifying it's index. Yet another intuition about the value-weighted index -- a smart investor is not going to ever buy equal number of shares of a given set of companies, which is what index type a. tracks. If you take into consideration that the price movements of companies are correlated with others, you are going to hedge your returns by buying different proportions of company shares. This is in effect what the index type B does and this is why it is a smarter index to follow. One very neat property of this kind of index is that it is readily applied to industry indices. Thus you can simply apply the above formula to all machine tool companies, and you get a machine tool index. This industry-index is conceptually sound, with excellent interpretations. Thus on a day when the market index goes up 6%, if machine tools goes up 10%, you know the market found some good news on machine tools. + Type C index: Here the index is the average of the returns of a certain set of companies. Value Line publishes two versions of it: * the arithmetic index : (VLAI/N) = 1 * Sum(N returns) * the geometric index : VLGI = {Product(1 + return) over N}^{1/n}, which is just the geometric mean of the N returns. Notice that these indices imply that the dollar value on each company has to be the same. Discussed further in BKM, pg 66. ----------------------------------------------------------------------------- Subject: Stock Index - The Dow Last-Revised: 11 Dec 1992 From: vision@cup.portal.com, nfs@princeton.edu The Dow Jones Industrial Average is computed from the following stocks: Ticker Name ------ ---- AA Alcoa ALD Allied Signal AXP American Express BA Boeing BS Bethlehem Steel CAT Caterpillar CHV Chevron DD Du Pont DIS Disney EK Eastman Kodak GE General Electric GM General Motors GT Goodyear Tire IBM International Business Machines IP International Paper JPM JP Morgan Bank KO Coca Cola MCD McDonalds MMM Minnesota Mining and Manufacturing (3M) MO Philip Morris MRK Merck PG Procter and Gamble S Sears, Roebuck T AT&T TX Texaco UK Union Carbide UTX United Technologies WX Westinghouse XON Exxon Z Woolworth The Dow Jones averages are computed by summing the prices of the stocks in the average and then dividing by a constant called the "divisor". The divisor for the industrial average is adjusted periodically to reflect splits in the stocks making up the average; the divisor was originally 30 but has been reduced over the years to 0.462685 (as of 92-10-31). The current value of the divisor can be found in the Wall Street Journal and Barron's. ----------------------------------------------------------------------------- Subject: Stock Indexes - Others Last-Revised: 27 Sep 1993 From: jld1@ihlpm.att.com, pearson_steven@tandem.com, jordan@imsi.com, rajiv@bongo.cc.utexas.edu, r_ison@csn.org Standard & Poor's 500: 500 of the biggest US corporations. This is a very popular institutional index, and recently becoming more popular among individuals. Most often used measure of broad stock market results. Wilshire 5000 Includes most publicly traded shares. Considered by some a better measure of market as a whole, becuase it includes smaller companies. Wilshire 4500 These are all firms *except* the S&P 500. Value Line Composite See Martin Zweig's Winning on Wall Street for a good description. It is a price-weighted index as opposed to a capitalization index. Zweig (and others) think this gives better tracking of investment results, since it is not over-weighted in IBM, for example, and most individuals are likewise not weighted by market cap in their portfolios (unless they buy index funds). Nikkei Dow (Japan) I believe "Dow" is a misnomer. It is called the Nikkei index (or the Nikkei-xx, where xx is the number of shares in it, which I can't quote to you out of my head). "Dow" comes from Dow Jones & Company, which publishes DJIA numbers. Nikkei is considered the "Japanese Dow," in that it is the most popular and commonly quoted Japanese market index, but I don't think Dow Jones owns it. S&P 100 (and OEX) The S&P 100 is an index of 100 stocks. The "OEX" is the option on this index, one of the most heavily traded options around. S&P MidCap 400 Medium capitalization firms. CAC-40 (France) This is 40 stocks on the Paris Stock Exchange formed into an index. The futures contract on this index is probably the most heavily traded futures contract in the world. Europe, Australia, and Far-East (EAFE) Compiled by Morgan Stanley. Russell 1000 Russell 2000 Designed to be a comprehensive representation of the U.S. small-cap equities market. The index consists of the smallest 2000 companies out of the top 3000 in domestic equity capitalization. The stocks range from $40M to $456M in value of outstanding shares. This index is capitalization weighted; i.e., it gives greater weight to stocks with greater market value (i.e., shares * price). Russell 3000 NYSE Composite [options on index] Gold & Silver Index [options on index] AMEX Composite NASDAQ Composite Topix (Japan) DAX (Germany) FTSE 100 (Great Britain) Major Market Index (MMI) [ Compiler's note: a few explanations are still missing. Can anyone supply a few? ] ----------------------------------------------------------------------------- Subject: Stock Splits Last-Revised: 1 Mar 1993 From: egreen@east.sun.com, schindler@csa2.lbl.gov, ask@cblph.att.com Ordinary splits occur when the company distributes more stock to holders of existing stock. A stock split, say 2-for-1, is when a company simply issues one additional share for every one outstanding. After the split, there will be two shares for every one pre-split share. (So it is called a "2-for-1 split.") If the stock was at $50 per share, after the split, each share is worth $25, because the company's net assets didn't increase, only the number of outstanding shares. Sometimes an ordinary split is referred to as a percent. A 2:1 split is a 100% stock split (or 100% stock dividend). A 50% split would be a 3:2 split (or 50% stock dividend). You will get 1 more share of stock for every 2 shares you owned. Reverse splits occur when a company wants to raise the price of their stock, so it no longer looks like a "penny stock" but looks more like a self-respecting stock. Or they might want to conduct a massive reverse split to eliminate small holders. If a $1 stock is split 1:10 the new shares will be worth $10. Holders will have to trade in their 10 Old Shares to receive 1 New Share. Often a split is announced long before the effective date of the split, along with the "record date." Shareholders of record on the record date will receive the split shares on the effective date (distribution date). Sometimes the split stock begins trading as "when issued" on or about the record date. The newspaper listing will show both the pre- split stock as well as the when-issued split stock with the suffix "wi." (Stock dividends of 10% or less will generally not trade wi.) Theoretically a stock split is a non-event. The fraction of the company each of your shares represents is reduced, but you are given enough shares so that your total fraction of the company owned remains the same. On the day of the split, the value of the stock is also adjusted so that the total capitalization of the company remains the same. In practice, an ordinary split often drives the new price per share up, as more of the public is attracted by the lower price. A company might split when it feels its per-share price has risen beyond what an individual investor is willing to pay, particularly since they are usually bought and sold in 100's. They may wish to attract individuals to stabilize the price, as institutional investors buy and sell more often than individuals. ----------------------------------------------------------------------------- Subject: Technical Analysis Last-Revised: 12 Feb 1994 From: suhre@trwrb.dsd.trw.com The following material introduces technical analysis and is intended to be educational. If you are intrigued, do your own reading. The answers are brief and cannot possibly do justice to the topics. The references provide a substantial amount of information. The contributions of the reviewers is appreciated. First, the references: 1. Technical Analysis of the Futures Markets, by John J. Murphy. New York Institute of Finance. 2. Technical Analysis Explained, by Martin Pring. McGraw Hill. 3. Stan Weinstein's Secrets for Profiting in Bull and Bear Markets, by Stan Weinstein. Dow Jones-Irwin. Next, the discussion: 1. What is technical analysis? Technical analysis attempts to use *past* stock price and volume information to predict *future* price movements. Note the emphasis. It also attempts to time the markets. 2. Does it have any chance of working, or is it just like reading tea leaves? There are a couple of plausibility arguments. One is that the chart patterns represent the past behavior of the pool of investors. Since that pool doesn't change rapidly, one might expect to see similar chart patterns in the future. Another argument is that the chart patterns display the action inherent in an auction market. Since not everyone reacts to information instantly, the chart can provide some predictive value. A third argument is that the chart patterns appear over and over again. Even if I don't know why they happen, I shouldn't trade or invest against them. A fourth argument is that investors swing from overly optimistic to excessively pessimistic and back again. Technical analysis can provide some estimates of this situation. A contrary view is that it is just coincidence and there is little, if any, causality present. Or that even if there is some sort of causality process going on, it isn't strong enough to trade off of. A very contrary view: The past and future performance of a stock may be correlated, but that does not mean or imply causality. So, relying on technical analysis to buy/sell a stock is like relying on the position of the stars in the atmosphere or the phases of the moon to decide whether to buy or sell. 3. I am a fundamentalist. Should I know anything about technical analysis? Perhaps. You should consider delaying purchase of stocks whose chart patterns look bad, no matter how good the fundamentals. The market is telling you something is still awry. Another argument is that the technicians won't be buying and they will not be helping the stock move up. On the other hand (as the economists say), it makes it easy for you to buy in front of them. And, of course, you can ignore technical analysis viewpoints and rely solely on fundamentals. 4. What are moving averages? Observe that a period can be a day, a week, a month, or as little as 1 minute. Stock and mutual fund charts normally are daily postings or weekly postings. An N period (simple) moving average is computed by summing the last N data points and dividing by N. Moving averages are normally simple unless otherwise specified. An exponential moving average is computed slightly differently. Let X[i] be a series of data points. Then the Exponential Moving Average (EMA) is computed by EMA[i] = (1 - sm) * EMA[i-1] + sm * X[i] where sm = 2/(N+1), and EMA[1] = X[1]. "sm" is the smoothing constant for an N period EMA. Note that the EMA provides more weighting to the recent data, less weighting to the old data. 4a. What is Stage Analysis? Stan Weinstein [Ref 3] developed a theory (based on his observations) that stocks usually go through four stages in order. Stage 1 is a time period where the stock fluctuates in a relatively narrow range. Little or nothing seems to be happening and the stock price will wander back and forth across the 200 day moving average. This period is generally called "base building". Stage 2 is an advancing stage characterized by the stock rising above the 200 and 50 day moving averages. The stock may drop below the 50 day average and still be considered in Stage 2. Fundamentally, Stage 2 is triggered by a perception of improved conditions with the company. Stage 3 is a "peaking out" of the stock price action. Typically the price will begin to cross the 200 day moving average, and the average may begin to round over on the chart. This is the time to take profits. Finally, the Stage 4 decline begins. The stock price drops below the 50 and 200 day moving averages, and continues down until a new Stage 1 begins. Take the pledge right now: hold up your right hand and say "I will never purchase a stock in Stage 4". One could have avoided the late 92-93 debacle in IBM by standing aside as it worked its way through a Stage 4 decline. 5. What is a whipsaw? This is where you purchase based on a moving average crossing (or some other signal) and then the price moves in the other direction giving a sell signal shortly thereafter, frequently with a loss. Whipsaws can substantially increase your commissions for stocks and excessive mutual fund switching may be prohibited by the fund manager. 5a. Why a 200 day moving average as opposed to 190 or 210? Moving averages are chosen as a compromise between being too late to catch much move after a change in trend, and getting whipsawed. The shorter the moving average, the more fluctuations it has. There are considerations regarding cyclic stock patterns and which of those are filtered out by the moving average filter. A discussion of filters is far beyond the scope of this FAQ. See Hurst's book on stock transactions for some discussion. 6. Explain support and resistance levels, and how to use them. Suppose a stock drops to a price, say 35, and rebounds. And that this happens a few more times. Then 35 is considered a "support" level. The concept is that there are buyers waiting to buy at that price. Imagine someone who had planned to purchase and his broker talked him out of it. After seeing the price rise, he swears he's not going to let the stock get away from him again. Similarly, an advance to a price, say 45, which is repeatedly followed by a pullback to lower prices because a "resistance" level. The notion is that there are buyers who purchased at 45 and have watched a deterioration into a loss position. They are now waiting to get out even. Or there are sellers who consider 45 overvalued and want to take their profits. One strategy is to attempt to purchase near support and take profits near resistance. Another is to wait for an "upside breakout" where the stock penetrates a previous resistance level. Purchase on anticipation of a further move up. [See references for more details.] The support level (and subsequent support levels after rises) can provide information for use in setting stops. See the "About Stocks" section of the FAQ for more details. 6a. What would cause these levels to be penetrated? Abrupt changes in a company's prospects will be reacted to in the stock market almost immediately. If the news is extreme enough, the reaction will appear as a jump or gap in prices. More modest changes will result, in general, in more modest changes in price. 6b. What is an "upside breakout"? If a stock has traded in a narrow range for some time (i.e. built a base) and then advances above the resistance level, this is said to be an "upside breakout". Breakouts are suspect if they do not occur on high volume (compared to average daily volume). Some traders use a "buy stop" which calls for purchase when a stock rises above a certain price. 6c. Is there a "downside breakout"? Not by that name -- the opposite of upside breakout is called "penetration of support" or "breakdown". Corresponding to "buy stops," a trader can set a "sell stop" to exit a position on breakdown. 7. Explain breadth measurements and how to use them. A breadth measurement is something taken across a market. For example, looking at the number of advancing stocks compared to declining stocks on the NYSE is a breadth measurement. Or looking at the number of stocks above their 200 day moving average. Or looking at the percentage of stocks in Stage 1 and 2 configurations. In general, a technically healthy market should see a lot of stocks advancing, not just the Dow 30. If the breadth measurements are poor in an advancing sense and the market has been advancing for some time, then this can indicate a market turning point (assuming that the advancing breadth is declining) and you should consider taking profits, not entering new long positions, and/or tightening stops. (See the divergence discussion.) 7a. What is a divergence? What is the significance? In general, a divergence is said to occur when two readings are not moving generally together when they would be expected to. For example, if the DJIA moves up a lot but the S&P 500 moves very little or even declines, a divergence is created. Divergences can signify turning points in the market. At a major market low, the "blue chip" stocks tend to move up first as investors becoming willing to purchase quality. Hence the S&P 500 may be advancing while the NYSE composite is moving very little. Divergences, like everything else, are not 100 per cent reliable. But they do provide yellow or red alerts. And the bigger the divergence, the stronger the signal. Divergence and breadth are related concepts. (See the breadth discussion.) 8. How much are charting services and what ones are available? They aren't cheap. Daily Graphs (weekly charts with daily prices) is $465 for the NYSE edition, $432 for the AMEX/OTC edition. Somewhat cheaper for biweekly or monthly. Mansfield charts are weekly with weekly prices. Mansfield shows about 2.5 years of action, Daily Graphs shows 1 year or 6 months for the less active stocks. S&P Trendline Chart Guide is about $145 per year. It provides over 4,000 charts. These charts show one year of weekly price/volume data and do not provide nearly the detail that Daily Graphs do. You get what you pay for. There are other charting services available. These are merely representative. 9. Can I get charts with a PC program? Yes. There are many programs available for various prices. Daily quotes run about $35 or so a month from Dial Data, for example. Or you can manually enter the data from the newspaper. 10. What would a PC program do that a charting service doesn't? Programs provide a wide range of technical analysis computations in addition to moving averages. RSI, MACD, Stochastics, etc., are routinely included. See Murphy's book [Ref 1] for definitions. Frequently you can change the length of the moving averages or other parameters. As another example, AIQ StockExpert provides an "expert rating" suggesting purchase or short depending on the rating. Intermediate values of the rating are less conclusive. 11. What does a charting service do that PC doesn't? Charts generally contain a fair amount of fundamental information such as sales, dividends, prior growth rates, institutional ownership. 11a. Can I draw my own charts? Of course. For example, if you only want to follow a handful of mutual funds of stocks, charting on a weekly basis is easy enough. EMAs are also easy enough to compute, but will take a while to overcome the lack of a suitable starting value. 12. What about wedges, exhaustion gaps, breakaway gaps, coils, saucer bottoms, and all those other weird formations? The answer is beyond the scope of this FAQ article. Such patterns can be seen, particularly if you have a good imagination. Many believe they are not reliable. There is some discussion in Murphy [Ref 1]. 13. Are then any aspects of technical analysis that don't seem quite so much like hokum or tea leaf reading? RSI (Relative Strength Indicator) is based on the observation that a stock which is advancing will tend to close nearer to the high of the day than the low. The reverse is true for declining stocks. RSI is a formula which attempts to provide a number which will indicate where you are in the declining/advancing stage. 14. Can I develop my own technical indicators? Yes. The problem is validating them via some sort of backtesting procedure. This requires data and work. One suggestion is to split the data into two time periods. Develop your indicator on one half and then see if it still works on the other half. If you aren't careful, you end up "curve fitting" your system to the data. ----------------------------------------------------------------------------- Subject: Ticker Tape Terminology Last-Revised: 11 Dec 1992 From: capskb@alliant.backbone.uoknor.edu, nfs@cs.princeton.edu Ticker tape says: Translation (but see below): NIKE68 1/2 100 shares sold at 68 1/2 10sNIKE68 1/2 1000 shares sold at " 10.000sNIKE68 1/2 10000 shares sold at " The extra zeroes for the big trades are to make them stand out. All trades on CNN and CNBC are delayed by 15 minutes. CNBC once advertised a "ticker guide pamphlet, free for the asking", back when they merged with FNN. It also has explanations for the futures they show. However, the first translation is not necessarily correct. CNBC has a dynamic maximum size for transactions that are displayed this way. Depending on how busy things are at any particular time, the maximum varies from 100 to 5000 shares. You can figure out the current maximum by watching carefully for about five minutes. If the smallest number of shares you see in the second format is "10s" for any traded security, then the first form can mean anything from 100 to 900 shares. If the smallest you see is "50s" (which is pretty common), the first form means anything between 100 and 4900 shares. Note that at busy times, a broker's ticker drops the volume figure and then everything but the last dollar digit (e.g. on a busy day, a trade of 25,000 IBM at 68 3/4 shows only as "IBM 8 3/4" on a broker's ticker). That never happens on CNBC, so I don't know how they can keep up with all trades without "forgetting" a few. ----------------------------------------------------------------------------- Subject: Treasury Debt Instruments Last-Revised: 2 Dec 1993 From: ask@cblph.att.com, blaine@fnma.com The US Treasury Department periodically borrows money and issues IOUs in the form of bills, notes, or bonds ("Treasuries"). The differences are in their maturities and denominations: Bill Note Bond Maturity up to 1 year 1 - 10 years 10 - 30/40 years Denomination $5,000 $1,000 $1,000 (10,000 minimum) Treasuries are auctioned. Short term T-bills are auctioned every Monday, and longer term bills, notes, and bonds are auctioned at other intervals. T-Notes and Bonds pay a stated interest rate semi-annually, and are redeemed at face value at maturity. Exception: Some 30 year and longer bonds may be called (redeemed) at 25 years. T-bills work a bit differently. They are sold on a "discounted basis." This means you pay, say, $9,700 for a 1-year T-bill. At maturity the Treasury will pay you (via electronic transfer to your designated bank checking account) $10,000. The $300 discount is the "interest." In this example, you receive a return of $300 on a $9,700 investment, which is a simple rate of slightly more than 3%. Treasuries can be bought through a bank or broker, but you will usually have to pay a fee or commission to do this. They can also be bought with no fee using the Treasury Direct program, which is described elsewhere in the FAQ. In practice, the first T-bill purchase requires you to send a certified or cashiers check for the full face value, and within a week or so, after the auction sets the interest rate, the Treasury will return the discount ($300 in the example above) to your checking account. For some reason, you can purchase notes and bonds with a personal check. Treasuries are negotiable. If you own Treasuries you can sell them at any time and there is a ready market. The sale price depends on market interest rates. Since they are fully negotiable, you may also pledge them as collateral for loans. Treasury bills, notes, and bonds are the standard for safety. By definition, everything is relative to Treasuries; there is no safer investment in the U.S. They are backed by the "Full Faith and Credit" of the United States. Interest on Treasuries is taxable by the Federal Government in the year paid. States and local municipalities do not tax Treasury interest income. T-bill interest is recognized at maturity, so they offer a way to move income from one year to the next. The US Treasury also issues Zero Coupon Bonds. The ``Separate Trading of Registered Interest and Principal of Securities'' (a.k.a. STRIPS) program was introduced in February 1986. All new T-Bonds and T-notes with maturities greater than 10 years are eligible. As of 1987, the securities clear through the Federal Reserve's books entry system. As of December 1988, 65% of the ZERO-COUPON Treasury market consisted of those created under the STRIPS program. However, the US Treasury did not always issue Zero Coupon Bonds. Between 1982 and 1986, a number of enterprising companies and funds purchased Treasuries, stripped off the ``coupon'' (an anachronism from the days when new bonds had coupons attached to them) and sold the coupons for income and the non-coupon portion (TIGeRs or Strips) as zeroes. Merrill Lynch was the first when it introduced TIGR's and Solomon introduced the CATS. Once the US Treasury started its program, the origination of trademarks and generics ended. There are still TIGRs out there, but no new ones are being issued. Other US Debt obligations that may be worth considering are US Savings ----------------------------------------------------------------------------- Subject: Treasury Direct Last-Revised: 22 Apr 1993 From: jberlin@falcon.aamrl.wpafb.af.mil, ask@cblph.att.com You can buy Treasury Instruments directly from the US Treasury. Contact any Federal Reserve Bank (for example, New York: 33 Liberty Street, New York NY 10045) and ask for forms to participate in the Treasury Direct program. The minimum for a Treasury Note (2 years and up) is only $5K and in some instances (I believe 5 year notes) $1K. There are no fees and you may elect to have interest payments made directly to your account. You even may pay with a personal check, no need for a cashier's or certified check as Treasury Bills (1 year and under) required. In the Treasury Direct program, you can ask that you roll over the matured Treasury towards the purchase of a new one. AAII Journal had an article on this a couple of years ago. Like they said, the government service is great, they just do not advertise it well. ----------------------------------------------------------------------------- Subject: Uniform Gifts to Minors Act (UGMA) Last-Revised: 27 Sep 1993 From: ask@cbnews.cb.att.com, schindler@csa1.lbl.gov, eck@panix.com The Uniform Gifts to Minors Act allows you to give $10,000 per year to any minor, tax free. You must appoint a custodian. Some accountants advise that one person should make the gift and that a different person should be the custodian. The reason is that if the donor and custodian are the same person, that person is considered to exercise sufficient control over the assets to warrant inclusion of the UGMA in his/her estate. For more info, see Lober, Louis v. US, 346 US 335 (1953) (53-2 USTC par. 10922); Rev Ruls 57-366, 59-357, 70-348. All of these are cited in the RIA Federal Tax Coordinator 2d, volume 22A, paragraph R-2619, which says (among other things) "Giving cash, stocks, bonds, notes, etc., to children through a custodian may result in the transferred property being included in the donor's gross estate unless someone other than the donor is named as custodian." To give such a gift, go to your friendly neighborhood stockbroker, bank, mutual fund manager, or (close your eyes now: S&L), etc. and say that you wish to open a Uniform Gifts (in some states "Transfers") to Minors Act account. You register it as: [ Name of Custodian ] as custodian for [ Name of Minor ] under the Uniform Gifts/Transfers to Minors Act - [ Name of State of Minor's residence ] You use the minor's social security number as the taxpayer ID for this account. When you fill out the W-9 form for this account, it will show this form. The custodian should certify the W-9 form. The money now belongs to the minor and the custodian has a legal fiduciary responsibility to handle the money in a prudent manner for the benefit of the minor. So you can buy common stocks but cannot write naked options. You cannot "invest" the money on the horses, planning to donate the winnings to the minor. And when the minor reaches age of majority - usually 18 - the minor can claim all of the funds even if that's against your wishes. You cannot place any conditions on those funds once the minor becomes an adult. Until the minor reaches 14, the first $600 earned by the minor is tax free, the next $600 is taxed at the minor's rate, and the rest is taxed at the higher of the minor's or the parent's rate. After the minor reaches 14, all earnings over $600 are taxed at the minor's rate. Note that if you want to continue doing your childs taxes even after they turn 18, there is no reason they need to know about their UGMA account that you set up for them. They certainly can't blow their college fund on a Trans Am if they don't know about it. Even if your child does his/her own taxes, you can still give them gifts through a trust without them knowing about it until they are more mature. Call and ask Twentieth Century Investors for information about their GiftTrust fund. The fund is entirely composed of trusts like this. The trust pays its own taxes. ----------------------------------------------------------------------------- Subject: Warrants Last-Revised: 11 Dec 1992 From: ask@cblph.att.com There are many meanings to the word warrant. The marshal can show up on your doorstep with a warrant for your arrest. Many army helicopter pilots are warrant officers, who have received a warrant from the president of the US to serve in the Army of the United States. The State of California ran out of money earlier this year and issued things that looked a lot like checks, but had no promise to pay behind them. If I did that I could be arrested for writing a bad check. When the State of California did it, they called these thingies "warrants" and got away with it. And a warrant is also a financial instrument which was issued with certain conditions. The issuer of that warrant sets those conditions. Sometimes the warrant and common or preferred convertible stock are issued by a startup company bundled together as "units" and at some later date the units will split into warrants and stock. This is a common financing method for some startup companies. This is the "warrant" most readers of the misc.invest newsgroup ask about. As an example of a "condition," there may be an exchange privilege which lets you exchange 1 warrant plus $25 in cash (or even no cash at all) for 100 shares of common stock in the corporation, any time after some fixed date and before some other designated date. (And often the issuer can extend the "expiration date.") So there are some similarities between warrants and call options for common stock. Both allow holders to exercise the warrant/option before an expiration date, for a certain number of shares. But the option is issued by independent parties, such as a member of the Chicago Board Options Exchange, while the warrant is issued and guaranteed by the corporate issuer itself. The lifetime of a warrant is often measured in years, while the lifetime of a call option is months. Sometimes the issuer will try to establish a market for the warrant, and even try to register it with a listed exchange. The price can then be obtained from any broker. Other times the warrant will be privately held, or not registered with an exchange, and the price is less obvious, as is true with non-listed stocks. ----------------------------------------------------------------------------- Subject: Wash Sale Rule (from U.S. IRS) Last-Revised: 14 Dec 1992 From: acheng@ncsa.uiuc.edu From IRS publication 550, "Investment Income and Expenses" (1990). Here is the introductory paragraph from p.37: Wash Sales You cannot deduct losses from wash sales or trades of stock or securities. However, the gain from these sales is taxable. A wash sale occurs when you sell stock or securities at a loss and within 30 days before or after the sale you buy or acquire in a fully taxable trade, or acquire a contract or option to buy, substantially identical stock or securities. If you sell stock and your spouse or a corporation you control buys substantially identical stock, you also have a wash sale. You add the disallowed loss to the basis of the new stock or security. It goes on explaining all those terms (substantially identical, stock or security, ...). It runs on several pages, too much to type in. You should definitely call IRS for the most updated ones for detail. Phone number: 800-TAX-FORM (800-829-3676). ----------------------------------------------------------------------------- Subject: Zero-Coupon Bonds Last-Revised: 11 Dec 1992 From: ask@cblph.att.com Not too many years ago every bond had coupons attached to it. Every so often, usually every 6 months, bond owners would take a scissors to the bond, clip out the coupon, and present the coupon to the bond issuer or to a bank for payment. Those were "bearer bonds" meaning the bearer (the person who had physical possession of the bond) owned it. Today, many bonds are issued as "registered" which means even if you get to touch the actual bond at all, it will be registered in your name and interest will be mailed to you every 6 months. It is not too common to see such coupons. Registered bonds will not generally have coupons, but may still pay interest each year. It's sort of like the issuer is clipping the coupons for you and mailing you a check. But if they pay interest periodically, they are still called Coupon Bonds, just as if the coupons were attached. When the bond matures, the issuer redeems the bond and pays you the face amount. You may have paid $1000 for the bond 20 years ago and you have received interest every 6 months for the last 20 years, and you now redeem the matured bond for $1000. A Zero-coupon bond has no coupons and there is no interest paid. But at maturity, the issuer promises to redeem the bond at face value. Obviously, the original cost of a $1000 bond is much less than $1000. The actual price depends on: a) the holding period -- the number of years to maturity, b) the prevailing interest rates, and c) the risk involved (with the bond issuer). Taxes: Even though the bond holder does not receive any interest while holding zeroes, in the US the IRS requires that you "impute" an annual interest income and report this income each year. Usually, the issuer will send you a Form 1099-OID (Original Issue Discount) which lists the imputed interest and which should be reported like any other interest you receive. There is also an IRS publication covering imputed interest on Original Issue Discount instruments. For capital gains purposes, the imputed interest you earned between the time you acquired and the time you sold or redeemed the bond is added to your cost basis. If you held the bond continually from the time it was issued until it matured, you will generally not have any gain or loss. Zeroes tend to be more susceptible to prevailing interest rates, and some people buy zeroes hoping to get capital gains when interest rates drop. There is high leverage. If rates go up, they can always hold them. Zeroes sometimes pay a better rate than coupon bonds (whether registered or not). When a zero is bought for a tax deferred account, such as an IRA, the imputed interest does not have to be reported as income, so the paperwork is lessened. Both corporate and municipalities issue zeroes, and imputed interest on municipals is tax-free in the same way coupon interest on municipals is. (The zero could be subject to AMT). Some marketeers have created their own zeroes, starting with coupon bonds, by clipping all the coupons and selling the bond less the coupons as one product -- very much like a zero -- and the coupons as another product. Even US Treasuries can be split into two products to form a zero US Treasury. There are other products which are combinations of zeroes and regular bonds. For example, a bond may be a zero for the first five years of its life, and pay a stated interest rate thereafter. It will be treated as an OID instrument while it pays no interest. (Note: The "no interest" must be part of the original offering; if a cumulative instrument intends to pay interest but defaults, that does not make this a zero and does not cause imputed interest to be calculated.) Like other bonds, some zeroes might be callable by the issuer (they are redeemed) prior to maturity, at a stated price. ----------------------------------------------------------------------------- Compilation Copyright (c) 1994 by Christopher Lott, lott@informatik.uni-kl.de -- "Christopher Lott / Email: lott@informatik.uni-kl.de / Tel: +49 (631) 205-3334" "Adresse: FB Informatik - Bau 57 / Universitaet KL / D--67653 Kaiserslautern" -------------------------------------------------------------------------------