Professional Documents
Culture Documents
Table of Content
INTRODUCTION.........................................................................................................................6
Dematerialization...............................................................................................................29
Depository Trust Company (DTC) .....................................................................................29
Participant Trust Company (PTC)......................................................................................30
Federal Reserve Bank (+ see Regulators).........................................................................30
EUROCLEAR....................................................................................................................30
Cedel ................................................................................................................................31
PRIMARY MARKET....................................................................................................................31
SECONDARY MARKET...............................................................................................................31
THE OVER-THE- COUNTER MARKET ..........................................................................................31
THE REGULATORS ...................................................................................................................32
THE CENTRAL BANK OF THE U.S.A. : THE FEDERAL RESERVE SYSTEM .........................................32
How the Fed works ...........................................................................................................33
Member Banks..................................................................................................................33
The Federal Reserve’s many Roles...................................................................................33
THE G30 , THE GROUP OF THIRTY ............................................................................................34
S.W.I.F.T. SOCIETY FOR W ORLDWIDE INTERBANK FINANCIAL TELECOMMUNICATIONS ...................35
TYPES OF INVESTMENT ........................................................................................................37
Introduction
This guide aims at two public targets, the beginners and the professionals
who need some memory refreshment.
Frederic Goblet
What is an Investment?
The investment process can be split in three steps: THE PRE-TRADE, THE
TRADE AND THE POST-TRADE.
The trade process is the actual agreement between the seller and the
buyer regarding the price and the quantity. At this moment, the asset
changes ownership.
The post-trade concerns everything after the trade itself: the management
of the trade.
2. He or she provides for the distribution of the securities to the investing public.
3. He or she advises firms our governments on different matters like merge and
acquisitions, economic health, …
THE CUSTODIAN
What is Custody ?
First, you need a vault in order to immobilize the assets if physical, and
secondly because it implies the exchange between cash and securities.
The Custodian
Receipts and deliveries of securities and cash are done only upon
instruction or authorization of the client or the client's authorized
investment manager. These transactions usually involve a trade, that is, a
purchase or sale of securities or cash. When a security is purchased, the
security is received in and cash is delivered out. When the security is sold,
the security is delivered out and cash is received in. Cash itself can be
purchased and sold as an investment in the context of foreign exchange.
SAFEKEEPING
INCOME
CORPORATE ACTIONS
ACCOUNTING SERVICES
The custodian may also provide accounting services to the client, although
this service is not necessarily part of every custodial contract. This
accounting can include pricing of securities in the portfolio on a daily,
weekly, or monthly basis, keeping track of expense accruals and payments,
capital purchases or contributions and disbursements, and calculating the
NET ASSET VALUE of the portfolio (also known as fund pricing.)
THE SUBCUSTODIAN
Rule: The securities stay in the local market. They remain in the country
where they are issued.
2. Collecting income,
TRUSTEE
In most cases, the trustee is liable for a loss which occurs as a result of its
actions, unless the mistake was created by a third party or unless the
contract includes a provision to indemnify the trustee from any loss or
expense.
Because agreements between the client and the trustee may vary, the
responsibilities of the trustee can be different from one client to another.
Some of the basic responsibilities of a trustee are recordkeeping, income
collection, corporate action processing, and pricing, although there can be
additional responsibilities according to the terms of the agreement.
CORPORATE TRUSTEE
THE BROKER
All brokerage firms and all brokers acting as individuals must be a member
of the exchange through which they trade, and must pay an annual
membership fee to the exchange. Exchanges have strict codes of conduct,
and can bar individuals or firms from membership due to fraudulent or
unethical activity. Brokers can hold MEMBERSHIP in more than one
exchange. Some brokers specialize in a particular security type or
commodity, and would therefore be a member of that specialized
exchange.
Exchanges do not buy or sell securities, nor do they set prices. TRADING is
conducted on the exchange “FLOOR” where each SPECIALIST presides over
the auctioning of shares for one or more of the listed companies. Sellers
willing to take the lowest prices and buyers willing to pay the highest prices
are given priority trade instructions.
Three of the most well known United States exchanges are the NEW YORK
STOCK EXCHANGE (NYSE), THE AMERICAN STOCK EXCHANGE (AMEX), AND
THE NATIONAL ASSOCIATION OF SECURITIES DEALERS AUTOMATED QUOTATION
SYSTEM (NASDAQ). Other national exchanges specialize in commodity
and security options and futures trading. These include the CHICAGO
BOARD OF TRADE, CHICAGO BOARD OF OPTIONS EXCHANGE, MID-AMERICA
COMMODITY EXCHANGE, NEW YORK COFFEE, SUGAR AND COCOA EXCHANGE,
NEW YORK COTTON EXCHANGE, NEW YORK FUTURES EXCHANGE, PACIFIC
STOCK EXCHANGE AND THE PHILADELPHIA EXCHANGE.
market value of publicly held shares of at least $10 million, total market
value of $16 million, annual net income of over $2.5 million before federal
income taxes, and 2,000 holders of 100 shares or more.
NASDAQ
Today, options are traded on five U.S. exchanges: the Chicago Board
Options Exchange, the American Stock Exchange, the New York Stock
Exchange, the Pacific Stock Exchange and the Philadelphia Stock
Exchange. Although there are five U.S. exchanges that trade standardized
options, options have become a global contagion trading on over 50
exchanges worldwide.
The NYSE COMPOSITE INDEX includes all stocks traded on the New York
Stock Exchange . The NYSE also reports the activity in four sectors -
industrial, utility, transportation and financial - in separate indexes.
The STANDARD & POOR’S 500 INDEX incorporates a broad base of 500 of
some of the largest U.S. public corporations: 400 industrial, 40 utility, 40
financial and 20 transportation companies.
The NASDAQ COMPOSITE INDEX was created to track the progress of more
than 4000 stocks listed on the National Association of Securities Dealers
Quotation System.
The AMEX MARKET VALUE INDEX monitors the performance of over 800
companies listed on the American Stock Exchange.
The RUSSELL 2000 represents the smallest two-thirds of the 3,000 largest
U.S. companies, including a great many of the initial public offerings of the
last few years.
The WILSHIRE 5000, the broadest index, includes all stocks traded OTC and
on exchanges, including the S&P 500.
When you buy or sell a security, the brokerage firm enters your order into
its computer system for transmittal to its traders at the designated
exchange or the firm’ OTC trading desk. For an exchange-listed security,
the order is sent to the BROKERAGE FIRM’S FLOOR BROKER on the exchange
THE SPECIALISTS
Brokers called "SPECIALISTS" play a critical role because they serve as the
contact point between brokers with buy and sell orders in the NYSE's two-
way auction market.
One of the specialist's jobs is to execute orders for floor brokers in their
assigned stocks. A floor broker may get an order from a customer who only
wants to buy a stock at a price lower than the current market price - or sell
it at a price higher than the current market price. In such cases, the broker
may ask the specialist to hold the order and execute it if and when the price
of the stock reaches the level specified by the customer. In this role the
specialist acts as an agent for the broker.
When your trade is executed, the brokerage firm sends you a confirm, a
written confirmation that reports the trade date (date the order takes effect,
you are the legal owner), the quantity, the description, and the price.
Commissions and Markups. Transaction costs for buying and selling stock
are based on the share price and number of shares traded during a single
market session. Stock commissions are typically a fraction of 1 percent to 3
percent. The higher the stock price and the greater the number of shares
traded, the lower the commission.
The Customer
The Brokerage Firm
Places orders to buy and
sell
Initiates transaction
Pass the order to a Floor
Broker on the Stock
Exchange
The Stock
Exchange
The Floor Broker
Securities Settlement
Free Delivery
Trade Date
TRADE DATE refers to the date upon which a buyer and seller agree to the
terms of a security purchase or sale, including the price, the amount of
shares, and the date, location, and method of exchanging the cash and the
securities. By agreeing to the trade, both buyer and seller have entered
into a mutually binding contract regarding the exchange of securities and
cash.
ACTUAL SETTLEMENT DATE refers to the date upon which the trade actually
settles. Actual settlement can occur on or after contractual settlement
date. Although the contractual settlement date is agreed to on trade date,
a trade may not settle until sometime later, due to an error or problem with
delivery of the security.
Failed Trades
settlement has occurred. A failed buy can also cause problems if the
purchaser wishes to sell the security but is unable to make delivery on the
sell since the purchase has not yet settled.
DK (Don't Know)
In some cases, the receiving party does not accept an attempted delivery
of securities for settlement. This may occur when there is a mismatch in
the information connected with the delivery, such as the name of the
security, the amount of shares or par, the price, the contractual settlement
date, the broker, etc. It may also occur if the receiving party has no
instructions regarding the trade whatsoever. The receiving party refuses to
accept delivery, saying that they "DON'T KNOW" this trade as delivered.
The expression "DK" is short for "don't know", thus, the receiver is said to
"DK" the trade. Errors which could cause a mismatch in information may
have occurred in either the buyer's or seller's instructions to their
respective agents. Both parties usually reconfirm their information and
changes are made as necessary in order to effect good delivery.
Market Conventions
Depending upon the type of security traded and the market in which the
trade occurs, the period between Trade Date and Contractual Settlement
Date will vary. The scheduled contractual settlement date is usually
denoted as TRADE DATE + (number of days), or TD + (number of days),
or T + (number of days). The following describes examples of settlement
variations within different markets as of this writing.
United States
In the United States, LONG TERM DEBT and EQUITY SECURITIES are
scheduled for Trade Date + 5 settlement.
Canada
Denmark
Italy
Korea
Sri Lanka
United Kingdom
In the United Kingdom, trades are processed for settlement every fourteen
days. The fourteen day schedule is maintained unless the scheduled
settlement date falls on a holiday, then the whole cycle is moved forward to
be begun again on the next open business day. Thus, settlements may
occur on Mondays for a while, then be pushed forward to Tuesdays, etc.
An attempt is made to settle failed trades within the next few days. Trades
are always settled through physical delivery.
Today there are numerous depositories around the world and in addition to
the standard service of maintaining ownership records, each performs
services unique to their requirements and technology. Many depositories
collect income, maintain a linkage between cash and security movements,
provide recordkeeping of securities held, and provide reporting to all
participants in the depository to facilitate income and corporate action
information flow. Depositories act as TRANSFER AGENT and PAYING AGENT,
as well.
The term "clearance system" is often used interchangeably with the term
"depository", as both generally provide some form of recordkeeping service
that facilitates the accuracy of trade information.
Book Entry
Book entry systems can be used whether or not certificates physically exist
to represent the underlying securities.
Immobilization
Dematerialization
DTC, located in New York City, is a member owned depository and not a
profit driven company. With a main purpose of providing timely and
accurate securities settlements, fees are kept to a minimum and any profits
generated are distributed to participants in DTC. Established in 1968, DTC
is the largest safekeeper of corporate stocks and bonds in the U.S. Not all
securities are "DTC eligible", or can be traded using DTC as the
depository, however, most U.S. equities and corporate bonds are eligible.
A security which is DTC eligible does not have to be traded or held in DTC.
An owner has the option of withdrawing the certificates from DTC and
holding them physically.
The FEDERAL RESERVE BANK provides a book entry system for settlements
of securities issued by the United States Treasury, including Treasury Bills,
Notes and Bonds, along with the related re-purchase agreements and
certain mortgage and loan issues. Only members of the Federal Reserve
Bank, which are generally commercial banks, may be direct participants in
this depository. Since brokers, therefore, cannot be participants, a broker
must affiliate with a member bank in order to settle transactions. Cash for
delivery or receipt of settled trades is in same day funds.
EUROCLEAR
Cedel
PRIMARY MARKET
Securities are first offered for sale in a primary market. For example, the
sale of a new bond issue, preferred stock issue, or common stock issue
takes place in the PRIMARY MARKET. These transactions increase the total
stock of financial assets in existence in the economy.
SECONDARY MARKET
Most Stocks and Bonds are not traded on exchanges but in the over-the-
counter market. The OTC market is not a place but rather a method of
negotiated trading which, unlike exchanges, has no central location. It is
composed of numerous dealers called market makers. Acting as
THE REGULATORS
In the U.S., the main regulatory agencies include the Securities and
Exchange Commission (SEC), and the Federal Reserve Board (Fed).
There are also specific regulators for specific markets, such as the
COMMODITIES FUTURES TRADING COMMISSION which regulates activities in
commodities futures markets.
Like other countries, the U.S. has a national bank. However, the Federal
Reserve (the Fed) is not one bank; it’s twelve separate ones governed by a
The Fed has several tools by which it influences, indirectly and to a greater
or lesser extent, the amount of money in the economy and the general level
of interest rates. These tools are reserve requirements, open market
operations, open market repurchase agreements and the discount rate.
These instruments represent the key ways that the Fed interacts with
commercials banks in the process of creating money.
Member Banks
About half of all the banks in the country are members of the Federal
Reserve System. All national Banks must belong, and state-chartered
banks are eligible if they meet the financial standards the Fed has
established.
The Fed plays many roles as part of its responsibility to keep the economy
healthy. The Fed handles the day-to-day banking business of the U.S.
government. It gets deposits of corporate taxes for unemployment,
withholding and income, and also of federal excise taxes on liquor,
tobacco, gasoline and regulated services like phone systems. It also
authorizes payment of government bills like Social Security and Medicare
as well as interest payments on Treasury bills, notes and bonds.
Moreover, the Fed manages the currencies replacement, the gold matters
and is also a clearing house for checks.
By buying and selling government securities, the Fed tries to balance the
money in circulation. When the economy is stable, the demand for goods
and services is constant, and so are prices. Achieving that stability
supports the Fed’s goals of keeping the economy healthy and maintaining
the value of the dollar.
The Fed monitors the business affairs and audits the records of all the
banks in its system. Its particular concerns are compliance with banking
rules and the quality of loans.
4) Each country should determine whether a trade netting system would help
reduce risk and improve efficiency. If a netting system is appropriate, it
should be in place by 1992.
5) Delivery vs. Payment (DVP) should be used for settling all securities
transactions. A DVP system should be in place by 1992.
9) Each country should adopt the ISO standard for securities messages and the
ISIN numbering system by 1992.
Types of Investment
2. COMMODITIES
3. SECURITIES (debt/equity)
Investment Strategies
RISK-RETURN TRADE-OFF
Generally, the highest risk investments will offer the highest potential
returns, as well as the highest potential for losses.
DIVERSIFICATION
mixing equity and debt, the investor is protected from a negative impact in
one category. For diversification to be effective, the chosen investments
should not fluctuate in a similar fashion, such that external market
conditions would cause the investments to rise or fall in value at the same
time. Diversification implies that if one asset or investment category
performs poorly, the entire portfolio will not be affected.
ASSET ALLOCATION
Everyone invests for the same basic reason: to make their assets work as
hard as they can to meet a set of financial objectives. But those objectives
are different for each of us, and they define how we invest.
The relationship between your needs, resources, goals and tolerance for
risk will pinpoint the asset allocation strategy--the method by which you
divide your assets among stocks, bonds and cash--that's best for you. The
different strategies are based on several factors, and differ in how they
balance risk and reward. In general, higher growth means a greater
emphasis on stocks--and a higher level of risk.
Stocks: 10%
Bonds: 55%
Cash: 35%
Stocks: 30%
Bonds: 60%
Cash: 10%
While moderate risk is assumed from fluctuating interest rates, this strategy
provides the greatest level of income.
Stocks: 40%
Bonds: 50%
Cash: 10%
This strategy seeks a balance between bonds for income and stocks for
growth of principal and dividends. Dividends and interest income comprise
a large part of the invested assets' total return. Some risk is assumed in
order to achieve growth.
Stocks: 70%
Bonds: 25%
Cash: 5%
In order to accumulate wealth over a 3-5 year period, this strategy places
greater emphasis on stocks. An investor would need to be willing to accept
some price volatility to achieve growth. Equities are dominant, particularly
leading companies in strategically favored industries. There is limited
turnover, and dividend reinvestment and dollar cost averaging are stressed
to achieve the growth objective.
Stocks: 80%
Bonds: 10%
Cash: 10%
What is Risk ?
EX = X1 P1 + X2 P2 + . . . + X n Pn
where Xi is the cash flow in the ith state of the economy and Pi is the
probability of the ith state of the economy.
Σ R i Pi
n
ER =
i=1
where Ri is the rate of return in the ith state of the economy and pi is the
probability of ith state of the economy.
ALPHA. With this measure, you can gauge how much better an investment
or portfolio performs, given its risk. Alpha is the return over and above the
market average, as measured by the S&P 500 Index. An Alpha of ‘0’ means
you are being adequately compensated for risk taken; a higher number
reflects better than expected performance.
BETA. With this measure, you can gauge a security’s price volatility
relative to the overall market. Theoretically, a portfolio or security with a
beta of 1.00 moves in line with S&P 500 index. A Beta higher than 1.00
denotes greater price volatility than the overall market.
n
σ= Σ
i =1
R i – ER 2 Pi
where n is the number of states of the economy, Ri is the return in the ith
state and Pi is the probability of the ith state of the economy.
By diversifying, the investor can eliminate the “unique” security risk. The
systematic risk, however, cannot be diversified.
The plot of firm excess returns versus market excess returns is called the
CHARACTERISTIC LINE, i.e.,
ER - Rf = β (ERm - Rf)
Cov (Ra , Rm )
βa =
Var R m
n
Var Rm = Σ Rmi – ERm 2 p i
i= 1
n
Cov R a, Rm = Σ Rai – ERa Rmi – ERm pi
i =1
The required rate of return equals the risk free rate plus a return to
compensate for the additional risk.
R = Rf + RP,
Assets
On the ASSET side of the balance sheet, we usually find two categories.
b) FIXED OR NONCURRENT ASSETS contain all those resources that are not
expected to be converted into cash within the operating cycle of the
firm. Security investments, plant, equipment, and land are the most
common fixed assets.
Liabilities
normal operating cycle of the firms but are payable at some later date.
Noncurrent liabilities are often referred to as long-term liabilities.
Owner's equity
OWNER'S EQUITY represents the book value of the owner's interest in the
assets of the firm. Owner's equity is comprised of capital stock (par value
of common stock plus paid in capital) and retained earnings (undistributed
earnings).
2. COST OF GOODS SOLD is simply the cost of the product sold or service
provided. There are two widely used methods for computing cost of
goods sold. The First In First Out (FIFO) method assigns to cost of
goods sold the prices the firms paid on the oldest item in inventory.
The Last In First Out (LIFO) method assigns cost to items sold based
on the cost of the most recently purchased inventory item. The method
selected can have an important effect on net earnings for a period in
which prices have risen or fallen significantly.
7. NET INCOME AFTER TAXES represents net earning for the period after
income taxes.
8. RETAINED EARNINGS for the period represent any earnings that remain
after all dividends have been paid to stockholders. This amount is often
added to the existing retained earnings figure on the balance sheet.
A positive NPV decision earns more than the fair rate of return.
The REQUIRED RATE OF RETURN is the return that exactly reflects the risk of
the expected future cash flows.
If it is equal to the required rate of return, the investment has a zero NPV.
If it is greater than the required rate of return, the investment has a positive
NPV.
If it is less than the required rate of return, the investment has a negative
NPV.
1
PV = FVn
(1 + r )
n
FVn = PV (1 + r )
n
Over the years, studies have shown that successful stock investing is a
matter of time rather than a matter of timing. That's because stock prices
can move up and down dramatically on a day-to-day basis but, over the
long-term, build wealth better than any other investment vehicle.
From the investment point of view, there are two main reasons why
investors are interested in investing in equity securities: dividend payments
and the growth of the stock's market value.
GOING PUBLIC
The first time companies issue stock, is called GOING PUBLIC. After that,
they can raise additional money, or capital, by selling additional stock.
THE PRICE
The Price
If selling shares, you are interested in the bid, the highest price offered by
a buyer. If buying shares, you want to know the offer, the lowest price at
which one or more shareholders have agreed to sell.
Prices are still quoted in points and fractional points (1/8, ¼, 3/8, ½, 5/8,…)
The Spread
The difference between the bid price and the offer is the SPREAD. The
spread varies usually between 1/8 and $1. A larger spread may indicate
greater risk to market makers or low trading activity.
The Ticker
52-weeks
52 Weeks Hi/Lo The highest and lowest prices paid for Disney's stock
during the past year. The numbers are expressed in
points, but represent dollar amounts. In this case, 677/8
is the same as $67.875. Knowing the highs and lows for
the past 52 weeks can help an investor evaluate a
stock's current price.
Vol 100s The total amount of stock traded during the previous
day. On that day, 3,200,100 shares of Disney stock
changed hands. The number does not include odd lots
or sales of less than 100 shares.
Hi and Lo The highest price paid for Disney stock during the
previous day was $69.125 (or 691/8). The lowest was
$67.75 (or 673/4).
Close The last price paid for Disney at the end of the previous
day was $68.625 (or 685/8).
Net Chg The last price on the previous day, $68.625 (or 685/8),
was 87.5 cents (or 7/8 of a dollar) more than the last
price on the preceding day. Brokers call this "closing up
7/8
."
There is an old saying on Wall Street that a stock is worth what somebody
is willing to pay for it. Moreover, that is true - the price of a stock is
determined by buyers. As they gain new information, investors decide
whether they are willing to pay more for a stock or less. Their changing
perceptions continually push stock prices up or down.
Simply put, the price of a stock - or for any product or service, for that
matter - is determined by supply and demand. The supply of stocks is
based on the number of shares a company has issued, or sold to the
public. People wanting to buy those shares from the people who already
own them create the demand for stocks. If people think they will make
money on a stock, they will want to buy it.
But here's the catch: supply is limited, and not everyone who wants to own
a company's stock can. The more people desire to own a stock, the more
they will be willing to pay for it. High demand for a stock pushes up its
price. Similarly, as the value of a stock increases, owners are more
reluctant to sell it.
The rise continues until prospective buyers decide the price has gone too
high. Then, fewer people are willing to buy the stock at the high price.
Stockowners who are anxious to sell must lower the price at which they are
willing to sell. The stock's price falls until investors believe the stock is
again worth the price at which owners are willing to sell.
The laws of supply and demand explain why stock prices fluctuate. How do
investors and analysts arrive at their decisions as to whether a stock is
worth buying or selling at a given price? Above all, they examine the
financial health of the company offering the stock. Investors are not likely to
put a high value on stock in a company that is going to lose money. They
look for a business with a history of making strong profits and consistently
paying healthy dividends.
Sentiment may also count. For example, when the owners of the Boston
Celtics basketball team offered shares of stock in 1986, analysts suggested
that the stock was overvalued. But investors - most of them Celtic fans -
had a high regard for the team and were willing to pay the price to be
associated with it.
Many industries expand and contract in cycles. For example, home building
declines when interest rates rise.
ECONOMIC TREND
Analysts also monitor the U.S. budget deficit - the gap between the money
the Federal Government takes in and the money it spends. When the
deficit grows, the Government has to increase its borrowing of money that
would otherwise be available to businesses to expand and consumers to
spend.
Many other indicators signal changes in the economy. Among them are
stock prices, unemployment rates (the percentage of U.S. workers who
cannot find jobs), and changes in the value of the dollar (the amount of
foreign currencies that can be purchased for each U.S. dollar).
These indicators are more than just numbers. They point to changes in the
way ordinary people spend their money - and, in turn, how the economy is
likely to perform. If unemployment rates are falling, or if people are getting
good values for their money, they are probably going to feel optimistic
about the economy. They are more likely to spend money, benefiting
companies and stock prices.
Nothing alters people's attitudes toward saving and investing more than
their perceptions of a major news event. For example, when a nation has
declared war, stock prices may go up. That's because a country at war
needs armaments, supplies for troops, spare parts, and huge amounts of
fuel. Therefore, companies gear up to produce and sell more goods.
News of other events can push stock prices down. If fighting between Iran
and Iraq, for example, flares up in the Persian Gulf, U.S. stock prices may
drop. That's because fighting may decrease the supply of oil coming from
that region. Consequently, oil may become more expensive and the cost of
all U.S. goods that rely on oil or petroleum products may increase.
People are reluctant to invest unless they feel confident about the future of
the economy. If investors are not sure how a major event will affect the
nation's economy, they are likely to hesitate about investing in securities.
For example, if investors are uncertain of a new president's attitude toward
business, stock prices may drop while investors await developments.
The price of a stock is not by itself any indication of value by itself. Stocks
are analyzed based on a multitude of criteria, including Price/Earnings ratio
and dividends.
PRICE/EARNINGS RATIO
Company earnings are anticipated and estimated, therefore you can see
how a stock’s P/E reflects investors’ feelings about the company’s future
prospects.
The higher the P/E, the more earnings growth investors are expecting.
Stocks with a higher P/E, usually over 20, are considered riskier than
stocks with lower growth.
DIVIDENDS
Dividends may also be paid in shares of stock when its Board of Directors
feel that the money can be best used to expand the business or develop
new products.
Stocks that pay dividends regularly are known as INCOME STOCK, while
those that pay little or no dividend while reinvesting their profit are known
as GROWTH STOCKS.
The Dividend Yield is the percentage of purchase price you get back
through dividends each year.
For example, if you buy a stock for $100 a share and receive $4 per share,
the stock has a dividend yield of 4%. However, if you get $4 per share on
stock you buy for $50 a share, your yield would be 8%.
STOCK SPLIT
Common Stock
Preferred stock
There are five distinct types of preferred stock. These are cumulative
preferred, participating preferred, convertible preferred, prior preferred, and
callable preferred stocks.
Owning a stock gives you the right to vote on important company issues
and policies.
Book Value
Tender Offer
Insider Trading
Warrant
Program Trading
Some of the big investors speed up the process of buying and selling
stocks by using program trading techniques that involve placing large
Such sudden buying or selling can cause abrupt price changes or even
dramatic shifts in the entire market. The stock market crash of 1987
occurred, at least in part, because of program trading triggered by falling
prices. To prevent potentially catastrophic program trades, trading now
shuts down in a major sell-off to let things cool down.
Rule of 72
Capitalization
Arbitrage
Blue Chips
Blue Chips is a term borrowed from poker, where the blue chips are the
most valuable, and refers to the stocks of the largest, most consistently
profitable corporations.
A bull market is a period during which stock prices are generally rising. A
bear market is a period which stock prices are generally falling. Each of
these is fueled by investors' perceptions of where the economy and the
market are going.
If investors believe they are in the midst of a bull market, or one seems
likely, they will feel confident that prices are going up. Their own
confidence helps to keep stock prices rising. During a bear market
investors believe stock prices will fall. They hesitate to invest in stocks, and
their own concerns help keep stock prices down. A bull or bear market can
last anywhere from several months to several years.
SHORT SELLING
The most common form of stock investing is buying long. When you are
“LONG A STOCK”(meaning you owe the stock), the most you can lose is the
amount of cash you invested. However, if an investor believes that the
price of a company’s shares will decline, he may speculate by selling the
stocks short. SELLING A STOCK SHORT involves selling borrowed shares with
the expectation that the price will fall, providing the opportunity to buy them
back cheaper - sell high, buy low - The short seller’s profit is the difference
between the buy and sell prices, less commissions.
You borrow shares from your broker, sell them and get the money. Then
you wait, expecting the price of the stock to drop. If it does, you buy the
shares at the lower price and repay the broker to settle the loan (plus some
interest and commission). Buying shares back is called COVERING THE
SHORT POSITION.
BUYING WARRANTS
For example, you might pay $1 a share for the right to buy XCo. Stock at
$10 within 5 years. If the price goes up to $14 and you EXERCISE (use) your
warrant, you save $3 every share. You can then sell the shares at a higher
price to make a profit.
Companies sell warrants if they plan to raise money by issuing new stock
or selling stocks they hold in reserve.
BUYING ON MARGIN
Investors who want to buy stock but do not want to pay the full price can
LEVERAGE their purchase by buying on margin. They set up a MARGIN
ACCOUNT with a broker, sign a margin agreement, and maintain a minimum
balance. Then they can borrow 50% of the price of the stock and use the
combined funds to make the purchase.
Investors who buy on margin pay interest on the loan portion of their
purchase but do not have to repay the loan itself until they sell the stock.
Despite its advantages, buying on margin can be very risky. For example,
the price of the stock you buy could drop so much that selling it would not
raise enough cash to repay the loan to your broker. To protect themselves
in cases like this, brokers issue a MARGIN CALL if the value of your
investment falls below 75% of its original value. That means you have to
put additional money into your margin account.
Municipal Bonds
Corporate Bonds
U.S. Treasury Bonds
States, cities, counties and towns Corporations use bonds The U.S. Treasury floats debt
issue bonds * to raise capital to pay for expansion, issues
* to pay for public projects: modernization * to pay for a wide range of
schools, highways, stadiums,... * to cover operating expenses government activities
* to supplement their operating * to financnce corporate take-overs * to pay off national debt
budgets or other changes in management
structure
Bond
Matures
Money Markets
LONG TERM DEBT refers to debt that has a maturity of one year or longer.
This type of debt is traded on what is called the CAPITAL MARKET while
SHORT TERM DEBT refers to debt that has a maturity of less than one year.
This type of debt is traded on what is called the MONEY MARKET, as the
liquidity of these instruments makes them almost as fluid as money. A
company or government would issue short term debt in order to cover
temporary shortfalls in cash flows. An investor would buy short-term debt
to earn interest on excess cash.
The major classifications are quite simple: debt is broken down into two
short- and long-term instruments. Short-term debt is traded on the money
markets while the long-term debt trades on the bond markets.
TREASURY BILLS are issued so that the central government can finance its
short-term cash needs, and are auctioned at regular intervals. They
normally come in a variety of term structures, with 3 months, 6 months and
1 year being the most common.
They are the lowest money market yields available because the
government is considered the highest quality credit risk in the country.
Since a large and ready secondary market exists for Treasury Bills, their
prices will vary during their outstanding lives. If interest rate conditions
change, the price of the bill will also change reflecting this.
COMMERCIAL PAPER
Large investors who have excellent credit ratings may sometimes be able
to negotiate favorable terms with issuers, such as arranging short term CP
for as little as 3 days.
BANKER’S ACCEPTANCE
and interest at the end of the term of the loan. This arrangement is known
as a BANKER'S ACCEPTANCE (BA). Businesses usually enter into this type
of arrangement in order to finance the purchase of goods from other
countries.
Before the loan is repaid, the bank can sell the BA on the secondary
market to an investor. This investor now is due to receive the repayment of
the loan from the business. The bank guarantees payment on the BA; if
the business does not pay the loan, the investor has the legal right to
collect the money from the bank that originated the BA. BAs are issued at
a discount.
CERTIFICATES OF DEPOSIT
Banks that have excellent financial standing are called "prime banks" and
the CDs that they issue are referred to as "prime CDs". This is because
the bank has a recognized ability to honor the maturity payments. Prime
CDs have a minimum denomination of $1 million.
Most CDs are denominated in the currency of the country in which they are
issued. Eurodollar CDs, however, represent U.S. dollars that are
deposited in foreign banks or foreign branches in U.S. banks. U.S. dollar
denominated CDs, issued by foreign banks through foreign branches in the
U.S. market, are called Yankee CDs.
Eurodollars have their own market rate quoted by the major banks in
London holding and trading eurodollars. The rate is quoted on a term
basis, in addition to overnight money. The usual term structures are 1, 3, 6,
9 and 12 months, and 3 and 5 years. Rates for these terms are quoted on
a spread basis, called the interbank rate. A quote of 11-11 ¼ % means that
a bank will take a deposit at 11% and loan (to a prime customer) at 11 ¼
%. It is from the offer side of this spread that the eurodollar rates derives its
name, LIBOR; the London, Inter-Bank Offered Rate.
In order to raise capital, a firm may issue DEBT SECURITIES. Issuing debt
securities is, in effect, taking out a loan, with the buyers of the security
being the lenders. The issuer of a debt security is therefore obligated to
pay the buyers of the security INTEREST according to a predetermined
schedule, and to return the investment PRINCIPAL to the investor at a
specified future date, known as MATURITY DATE.
Creditor Vs Owner
Debt has one general advantage over equity which again serves to
underscore the basic differences between these two forms of financing.
Bond holders are CREDITORS of the issuer, not OWNERS. This means that
creditors are senior to equity holders in the capital structure of a company.
In the event that bankruptcy arises, bond holders must be paid before the
equity holders are compensated. This holds true for the payment of interest
as well as the payment of principal.
For the company, on the other hand, this also means it will be able to raise
the money it requires without adding new shareholders to the rolls.
Bondholders are, for the most part, a silent majority whose interests are
more muted and less politically and organizationally significant than the
interests of actual owners of a company.
Registration
All new security issues must be registered with the Securities and
Exchange Commission (SEC). REGISTRATION involves the filing of financial
statements regarding the firm and other related information. A firm wishing
to issue debt must qualify by possessing adequate financial status within
established guidelines. Issuing debt places constraints on the firm;
because the firm has an obligation to repay creditors, it must maintain the
ability to meet these commitments.
An interest rate of a bond never changes, although other interest rates do.
If the bond is paying more interest than is available elsewhere, investors
will be willing to pay more to own it. If the bond is paying less, the reverse
is true. When interest rates drop, the value of existing bonds usually goes
up.
If the bond investors buy at par, and holds the bond to maturity, INFLATION
(or the shrinking value of the currency) is the worst enemy. Generally,
when inflation is up, interest rates go up. Conversely, when inflation is low,
so are interest rates. It’s the change in interest rates that causes bond
prices to move up or down.
VALUE
The major factors that dictate bond prices and yields are credit quality of
the issuer, market interest rates, length of the bond’s maturity, and supply
and demand.
"PAR" is the term used for the principal value, or the face value of a debt
instrument, and is the amount that will be paid to the holder at maturity.
Debt can be sold at, below, or above par value.
Securities can also sell at a discount from the current accrued value if
market interest rates have increased since the security was issued. A
security with a stated rate below market value is less attractive to investors;
a discounted price will help to equalize the value of the security in the
marketplace.
LONG TERM DEBT refers to debt that has a maturity of one year or longer.
This type of debt is traded on what is called the CAPITAL MARKET, as a
company or government would issue long term debt to raise capital to
cover expenditures, which are expected to have a long-range payback.
Many types of long term debt securities exist with different interest and
maturity terms. There are also several other ways in which security types
differ. Descriptions of some of the most commonly traded long term
security types follow.
They are three major groups of bond issuers in the United States:
corporations, the U.S. Government and municipalities (state and local
governments).
The CURRENT YIELD is the coupon rate on a bond divided by its current
market price.
$90 = 9.18%
$980
discount or premium
coupon +/- years to maturity = YTM
market price + redemption price
2
Investors can buy bonds from brokers, banks, or directly from certain
issuers.
Newly issued bonds and those trading in the secondary market are
available from stockbrokers and from some banks. Treasuries, though, are
sold at issue directly to investors without any intermediary - or any
commission.
CALL
In some instances, an issuer of long term debt may wish to repay all of the
outstanding principal on a debt security prior to the scheduled maturity
date, thereby retiring the debt. This is known as a CALL. Calls can be
made on the entire issue, or on only a portion of the issue. The right of the
issuer to do this will be clearly stated in the security's prospectus.
DEFAULT
firm's debt securities are among the first in line with a claim to any
liquidation of the assets of the company. Shareholders, as owners, are last
in line.
COLLATERAL
TREASURY SECURITIES
Treasury Bills
Treasury Notes
T-NOTES are issued in increments of $1,000 for terms longer than 1 year
but fewer than 10 years. Unlike T-bills, T-notes contain coupons and pay
interest semiannually. The minimum purchase is $5,000 on maturities of
fewer than 5 years and $1,000 on maturities of 5 years or more.
Treasury Bonds
Trading
PRIMARY MARKET
SECONDARY MARKET
Most investors buy Treasury securities from brokers so they can know the
yield prior to purchase and can sell them any time.
AGENCY SECURITIES
Ginnie Maes are the most popular agency securities because they are very
liquid, formally backed by the full faith and credit of the U.S. government,
and pay higher yields than Treasury securities.
FANNIES MAE are mortgage bonds issued by the Federal National Mortgage
Association (FNMA), a federally sponsored, quasi-private corporate that
provides funds to the mortgage market by purchasing convential mortgage
loans from banks and other lenders. Like Ginnie Maes, these loans are
packaged into pools by financial institutions and sold to investors. They
lack official government backing, but they are considered a moral
obligation of the U.S. government. Interest is paid monthly.
FREDDIE MACS are securities issued by the Federal Home Loan Mortgage
Corporation (FHLMC), a federally sponsored corporation that loans money
to member institutions so they may supply conventional mortgage loans at
competitive rates. FHLMC issues both coupon bonds and monthly on the
mortgage securities.
Sallie Maes
Mutual Funds
The redemption price depends upon the value of the company's portfolio at
that time (the "net asset value"). There is no secondary trading market for
the shares of such companies.
CLOSED-END FUNDS resemble stocks in the way they are traded. While
these funds do invest in a variety of securities, they raise money only once,
offer only a fixed number of shares, and are traded on an exchange (hence
the name EXCHANGE-TRADED funds) or over-the-counter. The market price
of a closed-end fund fluctuates in response to investor demand as well as
to changes in the value of its holdings.
For instance, if you own one of the million shares issued by a certain
mutual fund, your share is worth approximately 1/1,000,000 of the total
value of the securities that the fund owns. And the price of your share will
fluctuate in a fairly direct relationship with the price of the securities owned
by the fund. This example is simplified, and does not take into account
certain costs of buying or selling shares, or annual fees of owning the fund.
There are several ways that investors are charged for buying, selling or just
owning mutual funds--the mutual fund checklist might will help you
understand some of the more common terms. But be sure to read the
prospectus that every fund must issue before making any purchase.
INCOME DISTRIBUTIONS are from the money the fund earns on its
investments. CAPITAL GAIN DISTRIBUTIONS are the profits from selling
investments. Different funds pay their distributions on different schedules -
from once a day to once a year. Many funds offer investors the option of
reinvesting all or part of their distribution in the fund.
Fund investors pay taxes on the distribution they receive from the fund,
whether the money is reinvested or paid out in cash.
These are some of the terms you may come across in reading about mutual
funds:
Objective
Every fund has its own objective: aggressive growth, income, preservation
of capital, etc. Choose carefully before investing, and make sure the fund is
appropriate for your goals. The discussion of asset allocation will help you
decide what strategy is right for you.
Performance
A fund's total return is the actual increase or decrease in the value of its
investments, including appreciation and dividends or interest paid.
Research a fund's performance over a 1, 5 and 10 year period, and
compare it with others of its kind. Moreover, remember an old maxim: past
performance is no guarantee of future results!
In a NO-LOAD fund, an investor buys shares directly from the mutual fund
company. While these funds carry no sales charges (and a maximum
0.25% 12b-1 fee--see below), they do charge the management fees and
administrative fees found in load funds.
Finally, be sure that the company through which you invest offers a wide
range of funds, and the flexibility to switch your investment from one fund
to another as your needs or overall economic conditions change.
MANAGEMENT FEES are annual charges to administer the fund. All funds
charge this fee, though the amount varies from a fraction of one percent to
over two percent.
EXCHANGE FEES can apply when money is shifted from one fund to another
within the same mutual fund company.
The fund’s NAV is the dollar value of one share of stock in the fund, the
price a fund pays per share when you sell. It is figured by totaling the
value of all the fund’s holdings and dividing by the number of shares.
Pension Funds
Collectively, pension funds are a strong force in the market due to the large
dollar amounts invested in these funds and the volume of trading.
There are two classifications of pension funds, Defined Benefit Plans and
Defined Contribution Plans.
Defined benefit plans are the largest group of pension funds and are
known simply as pension funds. They are subject to THE EMPLOYEE
RETIREMENT INCOME SECURITY ACT (ERISA) and are not taxed.
In a defined benefit plan the employer is usually the sole contributor to this
retirement fund hence the word "benefit" in the name. The employer funds
the plan based on projected benefits to be paid, and the employee receives
a predetermined amount upon retirement, typically based on a formula of
the employee's length of service and salary. The contributions are
invested according to the employer's investment strategies, and any profits
or losses resulting from the investments belong to the employer. The
employee does not assume the investment risk as in a defined contribution
plan but does not share in the gains either.
Option are the RIGHT to buy or sell a specific item for a preset price during
a specified period of time.
Unlike other investments where the risks may have no limit, options offer a
known risk to buyers. An option buyer absolutely cannot lose more than the
price of the option, the premium. Because the right to buy or sell the
underlying security at a specific price expires on a given date, the option
will expire worthless if the conditions for profitable exercise or sale of the
contract are not met by the expiration date. An uncovered option seller, on
the other hand, faces unlimited risk, because it obligates the seller to either
buy (puts) or sell (calls) the underlying security at the market price. Like
stock, options can be sold or bought after the initial transaction. If an option
buyer or seller changes his investment strategy, the investor can sell or
buy the option contract any time prior to the expiration date.
The number of shares covered, the expiration date and the strike price or
exercise price are all standardized. The price of the option or the premium
is the primary variable, and generally is dependent on the option's exercise
price relative to the price of the underlying security, the time until
expiration, stock and stock index volatility, dividends and interest rates.
There are two types of options contracts: CALLS and PUTS. Call options
contracts allow the purchaser to buy the underlying security, while the
seller of a call is obligated to sell the underlying security. Put options
contracts allow the purchaser to sell the underlying security, while the
seller of a put is obligated to buy the underlying security. The strike price or
exercise price is the price at which the holder can buy the stock (for call
options) or sell the stock (for put options). Each options contract specifies
an expiration date in addition to the strike price. The expiration date is the
last day an options contract can be exercised. Most options expire on the
Saturday after the third Friday of each expiration month.
There are two types of exercise styles: American and European. These
terms refer to when the options are exercisable and have nothing to do with
the geographic location of the markets in which the options are traded.
American-style options may be exercised by the holder on any business
day up to the expiration date. European-style options may be exercised
only on the last business day before expiration.
Call options are referred to as "IN THE MONEY" when the strike price is below
the market price of the underlying security. Call options are "OUT OF THE
MONEY" when the strike price is above the market price. For put options, the
reverse is true. A put option is "in the money" when the market price of the
underlying security is below the strike price. On the other hand, put options
are "out of the money" when the market price of the underlying is above the
strike price of the option. Options are "AT THE MONEY" when the market
price equals the strike price, a situation which rarely occurs. Therefore,
these options are sometimes referred to as "NEAR THE MONEY".
FUTURES
Futures contracts are financial assets just like stocks and bonds, but with
some important differences. These differences are what make futures such
an appealing investment for traders. Many tend to think that futures are
complicated to understand and consequently, miss many opportunities by
not trading them. It helps to remember a simple but true formula that
applies to futures trading as surely as it does to trading in stocks, bonds,
real estate, and even old comic books and hockey cards. Money is made if
you "buy low and sell high". With futures, you can sell before you buy, so
our simple rule can also read: Money is made if you "sell high and buy
back low". Keeping this rule in mind puts you on your first step to becoming
a successful trader.commodity futures broker, futures trader, commodities
futures trading, financial and commodity futures markets, paper trading, full
service broker assisted accounts.
This sounds more complicated than it actually is. Let's take an example.
Suppose you, being hungry and health conscious, go to a grocery store to
buy bananas. You select some bananas, take them to the cashier (express
lane, of course), and pay for them. The bananas are now yours. This is a
simple transaction which you have probably done many times before. The
exchange of money in return for goods, in this case, bananas, occurs now,
in the present. A futures transaction is just like this with one difference, the
exchange of money for goods is deferred until some time in the future. This
is why futures contracts are regarded as deferred delivery contracts. To
continue with the example, buying banana futures would work something
like this: You go to the grocery store, select the bananas that you want,
and tell the cashier, "I'll buy these bananas tomorrow at the price they are
marked at now." The cashier agrees to sell you the bananas tomorrow.
When you return the following day, you pay for the bananas (at yesterday's
price) and then take them home. Of course, the futures market doesn't
quite work exactly like this, but the idea is the same.commodity futures
broker, futures trader, commodities futures trading, financial and
When you buy a futures contract, the price represents the price at which
you are committed to buying the underlying commodity when the futures
contract expires. Similarly, when you sell a futures contract, the price
represents the price at which you are committed to selling the underlying
commodity when the futures contract expires. (Not all futures contracts
require physical delivery upon expiration, some are simply settled by cash.)
For example, if you buy a COMEX December gold futures at $380 per
ounce, then you have the obligation to buy 100 ounces of gold at a price of
$380 per ounce in December when the futures expires. (COMEX, which
stands for the Commodities Exchange in New York, is the futures exchange
on which gold futures trade. COMEX has set the quantity of gold underlying
the contract at 100 ounces.) The price of gold futures constantly fluctuates
in response to several factors such as supply and demand, interest rates,
and prices of other precious metals. However, no matter what the price of
gold does after you buy the futures, you will be able to buy gold at the
price of $380 per ounce - you have locked in this purchase price.
Futures prices are often different than cash prices for the same commodity.
You may find in some cases that futures prices are consistently above cash
prices, in which case the futures are said to be trading at a forward
premium, or you may find that futures prices are consistently below cash
prices, in which case the futures are said to be trading at a forward
discount. Whether a futures price is at a forward premium or discount
depends upon cost-of-carry considerations, and these may change over
time. Consequently, a futures price can move, for example, from a forward
discount to a forward premium. This can happen for commodity futures in
which there is a shortage of immediate supply of the underlying
commodity.commodity futures broker, futures trader, commodities futures
trading, financial and commodity futures markets, paper trading, full service
broker assisted accounts.
Futures as an Investment
When you buy a futures, you lock in a purchase price for the underlying
commodity. Similarly, when you sell a futures, you lock in a selling price of
the underlying commodity. How, then, do you make money trading futures?
Well, futures prices move around all of the time, that is, they are volatile.
Prices of agricultural commodities, for example, may rise in response to
unfavorable weather conditions, increased demand by importers, or spread
of plant diseases, and fall in response to abundant supplies or a shift in
consumer preference. If prices go up after you buy a futures contract, then
you earn profit since the futures contract has increased in value. For
example, if you buy one gold futures at $340 per ounce and two weeks
later, the price of gold futures is trading at $350 per ounce, then your
futures contract is now worth $10 per ounce more than when you bought it.
One futures contract represents 100 ounces of gold, so the total profit on
your gold futures position is $1,000. That's the thrill. Be careful, though.
Gold prices could have fallen instead, in which case you would have
suffered a loss. As a trader, your challenge is to anticipate price
movements correctly and make the appropriate trade. If you expect prices
to rise, you will buy futures and if you expect prices to decline, you will sell
futures. If your expectations turn out to be correct, then you will make
money. If not, you will lose money. Realistically, it is virtually impossible to
be right all of the time. In fact, many traders are wrong more often than
right. BUT, they can still be successful traders.
Offsetting Contracts
Books
n The Super Traders, Secrets & Successes of Wall Street’s Best & Brightest,
Alan Rubenfeld
n Reuters Glossary
Internet Resources
on the web
http://www.wallstreetcity.com/ online financial services for individual
and professional investors.
http://www.dbc.com/ consumer-oriented financial
information.
http://www.pcfn.com/ news, investment databases, research,
on-line trading, and realtime market
quotes using Telesphere's Global
Ticker
http://www.brill.com/expert.html A World Wide Web guide to mutual
fund resources.
http://www.secapl.com/secapl/quoteser market watch, indexes every 3 minutes
ver/mw.html
http://www.muller.com/muni.html Muller price vendor
http://www.jjkenny.com/ J.J.Kenny price vendor
http://www.bourse.be Belgium stock exchange
http://www.bourse-de-paris.fr Bourse de Paris
http://www.sec.gov/consumer/weisktc.h What Every Investor Should Know
tm
http://www.sec.gov/index.html The U.S. Securities and Exchange
Commission
http://www.whitehouse.gov/ white house
http://www.whitehouse.gov/fsbr/esbr.ht Economic Statistics Briefing Room
ml (ESBR)