Textbook Questions

Investment Research and Planning

1. LG 1

Facebook’s IPO Frenzy

Not too long ago, when investors wanted to buy or sell securities or to conduct research on different investment options, they called their full-service stockbrokers. Those brokers charged relatively high (by today’s standards) commissions for processing customers’ orders, but they also had access to a great deal of information that was either very expensive or completely impossible for individual investors to acquire. The fees that customers paid compensated their brokers not only for executing trades but also for providing access to information and research.

Today the Internet is a major force in the investing environment. It offers an extremely low-cost means for executing trades and provides access to tools formerly restricted to professionals. With these tools you can find and process a wealth of information and trade many types of securities. This information ranges from real-time stock prices to securities analysts’ research reports to techniques for investment analysis. The time and money savings from online investing are huge. Instead of wading through reams of paper, you can quickly sort through vast databases to determine appropriate investments, make securities transactions to acquire your investments, and monitor the progress of your investments—all without leaving your computer. In this section, we introduce the wide range of options that you have for conducting investment research.

Getting Started in Investment Research

Although exceedingly valuable, the vast quantity of investment information available can be overwhelming and intimidating. The good news is that this chapter can help you begin to work through the maze of information and become a more informed investor. Educational sites are a good place to start. By mastering the basic concepts presented by these sites, you will be better prepared to identify the types of information that you will need to improve your investment decision-making skills.

Investment Education Sites

The Internet offers many articles, tutorials, and online classes to educate the novice investor. Even experienced investors can find sites that will expand their investing knowledge. Here are a few good sites that feature investing fundamentals.

· Investing Online Resource Center ( http://www.investingonline.org ) provides abundant information for those getting started online as well as those already investing. It includes an online quiz that, based on your answers, will categorize your readiness for trading. There is even an investment simulator that creates an interactive learning experience that allows the user to “test drive” online trading.

· InvestorGuide.com  ( http://www.investorguide.com ) offers InvestorGuide University, which is a collection of educational articles about investing and personal finance. In addition, the site provides access to quotes and charts, portfolio tracking software, research, news and commentary, and an extensive glossary of investment-related terms.

· The Motley Fool (  http://www.fool.com ) has sections on investing basics, mutual fund investing, choosing a broker, and investment strategies and styles, as well as lively discussion boards and more.

· Investopedia (  http://www.investopedia.com ) features tutorials on numerous basic and advanced investing and personal finance topics, a dictionary of investing terms, and other useful investment aids.

· WSJ.com  (  http://www.wsj.com ), a free site from the Wall Street Journal, is an excellent starting place to learn what the Internet can offer investors.

· Nasdaq (  http://www.nasdaq.com ) has both an Investing and a Personal Finance section that provide links to a number of investment education resources.

Other good educational resources include leading personal finance magazines such as Money, Kiplinger’s Personal Finance Magazine, and Smart Money.

Investment Tools

Once you are familiar with investing basics, you can begin to develop financial plans and set investment goals, find securities that meet your objectives, analyze possible investments, and organize your portfolio. Many tools once used only by professional investment advisors are now free online. You can find financial calculators and worksheets, screening and charting tools, and stock quotes and portfolio trackers at general financial sites and at the sites of larger brokerage firms. You can even set up a personal calendar that notifies you of forthcoming earnings announcements and can receive alerts when one of your stocks has hit a predetermined price target.

Planning

Online calculators and worksheets help you find answers to your financial planning and investing questions. Using them, you can determine how much to save each month for a particular goal, such as the down payment for your first home, a college education for your children, or a comfortable retirement at age 65. For example, the brokerage firm Fidelity has a number of planning tools: college planning, retirement planning, and research tools. One of the best sites for financial calculators is the Financial Industry Regulatory Authority (FINRA). It includes numerous tools that enable investors to perform tasks such as evaluating mutual funds, determining how much money to save for college expenses or retirement, or calculating the monthly payment on a loan.  Figure 3.1  shows the Tools & Calculators page of FINRA’s website. For example, if you click the Loan Calculator link, the site will ask you to submit a loan amount, an interest rate, and a term for the loan (in months), and then you simply click the CALCULATE button to find the monthly loan payment.

Screening

With screening tools, you can quickly sort through huge databases of stocks, bonds, and mutual funds to find those that have specific characteristics. For stocks, you can select stocks based on their price-to-earnings ratios, market capitalizations, dividend yields, revenue growth rates, debt-to-equity ratios, and many other characteristics. For bonds, you can create screens based on the bond issuer’s industry, as well as the bond’s maturity date or yield. For mutual funds, you might identify funds based on the required minimum investment, a particular industry or geographic sector, or the fees that a fund investor must pay. For example, one tool asks you to specify the type of stock or fund, performance criteria, cost parameters, or other characteristics and then it provides a list of securities that meet your investment criteria. Each screening tool uses a different method to sort. If necessary you can do additional research on the individual stocks, bonds, or mutual funds to determine which ones best meet your investment objectives.

Zacks Investment Research provides some of the best free tools on its website.  Figure 3.2  shows the opening page of Zacks “Stock Screener” and some of the ways you can sort stocks based on their characteristics. For example, you could identify a set of very large, dividend-paying companies by using the “Market Cap” item to select only those companies with a market capitalization (price per share times number of shares outstanding) greater than $100 billion and the “Div. Yield %” item

Figure 3.1 FINRA Tools & Calculators

At sites like  http://www .finra.org  you’ll find many tools and calculators that you can use to solve specific investment problems. Below is the Tools & Calculators screen from the Financial Industry Regulatory Authority’s website that offers several investment-related calculators.

(Source: ©2015 FINRA. All rights reserved. FINRA is a registered trademark of the Financial Industry Regulatory Authority, Inc. Reprinted with permission from FINRA.)

Figure 3.2 Zacks Stock Screener

Search for stocks based on a wide variety of characteristics such as a stock’s market capitalization, price/earnings ratio, and dividend yield. Zacks’s stock-screening tool will give you a list of stocks that meet your specifications.

(Source: Zacks,  http://www.zacks .com . ©Zacks Investment Research, Inc. Reprinted with permission.)

to include only those companies with a dividend yield greater than some small figure (say 0.25%). Google also offers a stock screener that allows you to select stocks based on dozens of characteristics and includes a graphic interface that shows the distribution of each characteristic (for example, the price/earnings ratio) across all of the stocks in Google’s database. You can search by entering numerical values for particular characteristics or selecting an upper or lower boundary from the distribution. Yahoo! Finance and Morningstar offer screening tools for stocks, mutual funds, and bonds.

Charting

Charting is a technique that plots the performance of securities over a specified time period, from a single day to a decade or longer. By creating charts, you can compare one company’s price performance to that of other companies, industries, sectors, or market indexes, over almost any time period. Several good sites are Yahoo! Finance (  http://finance.yahoo.com ), Barchart (  http://barchart .com ), BigCharts (  http://bigcharts.marketwatch.com ), and Stock Charts (  http://stockcharts.com ).

Stock Quotes and Portfolio Tracking

Almost every investment-related website includes stock quotations and portfolio-tracking tools. Simply enter the stock symbol to get the price, either in real time or delayed several minutes. Once you create a portfolio of stocks in a portfolio tracker, the tracker automatically updates your portfolio’s value every time you check. Usually, you can even link to more detailed information about each stock; many sites let you set up multiple portfolios. The features, quality, and ease of use of stock and portfolio trackers vary, so check several to find the one that meets your needs. Yahoo! Finance, MSN Money, and Morningstar have portfolio trackers that are easy to set up and customize.

An Advisor’s Perspective

Ryan McKeown Senior VP–Financial Advisor, Wealth Enhancement Group

“Technology on the Internet allows us to trade much faster.”

MyFinanceLab

Pros and Cons of the Internet as an Investment Tool

The power of the Internet as an investing tool is alluring. Do-it-yourself investing is readily available to the average investor, even to novices who have never before bought and sold securities. However, always remember that investing involves risk. Trading on the Internet requires that investors exercise the same caution as they would if they were getting information from and placing orders with a human broker. In fact, more caution is better because you don’t have the safety net of a live broker suggesting that you rethink your trade. The ease of point-and-click investing may tempt inexperienced investors to trade too often, thereby driving up their transaction costs. Drawn by stories of others who have made lots of money, many novice investors take the plunge before they acquire an understanding of both the risks and the rewards of investing—sometimes with disastrous results.

The basic rules for smart investing are the same whether you trade online or through a broker. Do your homework to be sure that you understand the risks of any investment that you make. Be skeptical. If an investment sounds too good to be true, it probably is. Always do your own research; don’t accept someone else’s word that a security is a good buy. Perform your own analysis before you buy, using the skills you will develop as you work through this text.

Investor Facts

Too Much of a Good Thing Researchers studied the investment performance of a group of individual investors who switched from trading by phone to trading online in the mid-1990s. As phone traders, these investors did very well, earning returns that were well above average. But after switching to online trading, they traded more often and more aggressively, generating much higher transactions costs in the process. As a result, their returns after going online dropped by roughly 5% per year.

(Source: Brad M. Barber & Terrance Odean. (2002). “Online Investors: Do the Slow Die First?” Review of Financial Studies, 15(2), 455–487.)

Here is some additional advice:

· Don’t let the speed and ease of making transactions blind you to the realities of online trading. More frequent trades mean higher total transaction costs. Although some brokers advertise costs as low as $3 per trade, the average online transaction fee is higher (generally about $10 to $15). If you trade often, it will take longer to recoup your costs. Studies reveal that the more often you trade, the harder it is to beat the market. In addition, on short-term trades of less than one year, you’ll pay taxes on profits at the higher, ordinary income tax rates, not the lower capital gains rate.

· Don’t believe everything you read. It’s easy to be impressed with a screen full of data touting a stock’s prospects or to act on a hot tip you read on a discussion board or see on an investment-oriented television show. Ask yourself, what do I know about the person who is recommending this investment? When conducting your research, stick to the sites of major brokerage firms, mutual funds, academic institutions, and well-known business and finance publications.

· If you get bitten by the online buying bug, don’t be tempted to use margin debt to increase your stock holdings. As noted in  Chapter 2  , you may instead magnify your losses.

We will return to the subject of online investment fraud and scams and will discuss guidelines for online transactions in subsequent sections of this chapter.

Concepts in Review

Answers available at  http://www.pearsonhighered.com/smart

1. 3.1 Discuss the impact of the Internet on the individual investor and summarize the types of resources it provides.

2. 3.2 Identify the four main types of online investment tools. How can they help you become a better investor?

3. 3.3 What are the pros and cons of using the Internet to choose and manage your investments?

Types and Sources of Investment Information

1. LG 2

As you learned in  Chapter 1 , becoming a successful investor starts with developing investment plans and meeting your liquidity needs. Once you have done that, you can search for the right investments to implement your investment plan and monitor your progress toward your goals. Whether you use the Internet or print sources, you should examine various kinds of investment information to formulate expectations of the risk and return behaviors of possible investments. This section describes the key types and sources of investment information.

Investment information can be either descriptive or analytical.  Descriptive information  presents factual data on the past behavior of the economy, the market, the industry, the company, or a given investment.  Analytical information  presents projections and recommendations about possible investments based on current data. The sample page from Yahoo! Finance included in  Figure 3.3  provides descriptive and analytical information on McDonald’s Corporation. The figure highlights that McDonald’s is a very large company, with a market capitalization of nearly $93 billion (as of April 15, 2015), revenues in excess of $27 billion, and net income available to common stockholders (i.e., net profits) of $4.76 billion. Notice that McDonald’s stock has a beta of 0.76, which is less than the average stock’s beta of 1.0. Beta is an important measure of risk, specifically systematic or market risk, that we will discuss how to develop and use later in this text, but until then it is nice to know that various financial websites provide security betas online.

Some forms of investment information are free; others must be purchased individually or by annual subscription. You’ll find free information on the Internet, in newspapers, in magazines, at brokerage firms, and at public, university, and brokerage firm libraries. Alternatively, you can subscribe to free and paid services that provide periodic reports summarizing the investment outlook and recommending certain actions. Many Internet sites now offer free e-mail newsletters and alerts. You can even set up your own personalized home page at many financial websites so that stock quotes, portfolio tracking, current business news, and other information on stocks of interest to you appear whenever you visit the site or are sent automatically to you via e-mail. Other sites charge for premium content, such as brokerage research reports, whether in print or online.

Although free information is more widely available today than ever before, it may still make sense to pay for services that save you time and money by gathering and processing relevant investment information for you. But first consider the value of information: For example, paying $40 for information that increases your return by $27 would not be economically sound. The larger your investment portfolio, the easier it is to justify information purchases because they are usually applicable to a number of investments.

Figure 3.3 A Report Containing Descriptive Information

The Yahoo! Finance report on McDonald’s Corporation from April 15, 2015, contains descriptive information drawn from the company’s financial statements as well as the stock’s price performance.

(Source: Courtesy of Yahoo! Inc.)

Types of Information

Investment information can be divided into five types, each concerned with an important aspect of the investment process.

· Economic and current event information includes background and forecast data related to economic, political, and social trends on both domestic and global scales. Such information provides a basis for assessing the environment in which decisions are made.

· Industry and company information includes background and forecast data on specific industries and companies. Investors use such information to assess the outlook for a given industry or a specific company. Because of its company orientation, it is most relevant to stock, bond, or options investments.

· Information on alternative investments includes background and forecast data for securities other than stocks, bonds, and cash, such as real estate, private equity, and commodities.

· Price information includes price quotations on investment securities. These quotations are commonly accompanied by statistics on the recent price behavior of the security.

· Information on personal investment strategies includes recommendations on investment strategies or specific purchase or sale recommendations. In general, this information tends to be educational or analytical rather than descriptive.

Sources of Information

The discussion in this section focuses on the most common online and traditional sources of information on economic and current events, industries and companies, and prices, as well as other online sources. Beyond the discussion in this section, however, there are countless sources of investment information available to investors.

An Advisor’s Perspective

Mary Kusske President, Kusske Financial Management

“I want you to steer clear of the nighttime news.”

MyFinanceLab

Economic and Current Event Information

Investors who are aware of current economic, political, and business events tend to make better investment decisions. Popular sources of economic and current event information include financial journals, general newspapers, institutional news, business periodicals, government publications, and special subscription services. These are available in print and online versions; often the online versions are free but may have limited content. Most offer free searchable archives and charge a nominal fee for each article downloaded.

Financial Journals

The  Wall Street Journal  is the most popular source of financial news. Published daily Monday through Saturday in U.S., European, and Asian editions, the Journal also has an online version called WSJ Online, which is updated frequently throughout the day including the weekends. In addition to giving daily price quotations on thousands of investment securities, the Journal reports world, national, regional, and corporate news. Both the published and online versions of the WSJ contain a column called “Heard on the Street” that focuses on specific market and company events both in the United States and abroad. The WSJ also includes articles that address personal finance issues in the Family Finances section. WSJ Online includes features such as quotes and news that provide stock and mutual fund charting, company profiles, financials, and analyst ratings, article searches, special online-only articles, and access to the Dow Jones article archives.

A second popular source of financial news is  Barron’s  , which is published weekly. Barron’s generally offers lengthier articles on a variety of topics of interest to individual investors. Probably the most popular column in Barron’s is “Up & Down Wall Street,” which provides a critical, and often humorous, assessment of major developments affecting the stock market and business. Barron’s also includes current price quotations and a summary of statistics on a range of investment securities. Subscribers to WSJ Online also have access to Barron’s online edition because both are published by Dow Jones & Company (a subsidiary of Rupert Murdoch’s News Corporation).

Investor’s Business Daily is a third national business newspaper published Monday through Friday. It is similar to the Wall Street Journal but contains more detailed price and market data. Its website has limited free content. Another source of financial news is the Financial Times, with U.S., U.K., European, and Asian editions.

General Newspapers

Major metropolitan newspapers such as the New York Times, Washington Post, Los Angeles Times, and Chicago Tribune provide investors with a wealth of financial information in their print and online editions. Most major newspapers contain stock price quotations for major exchanges, price quotations on stocks of local interest, and a summary of the major stock market averages and indexes. Local newspapers are another convenient source of financial news. In most large cities, the daily newspaper devotes at least a few pages to financial and business news.

Another popular source of financial news is USA Today, the national newspaper published daily Monday through Friday. It is available in print and online versions. Each issue contains a “Money” section devoted to business and personal financial news and to current security price quotations and summary statistics. On Mondays the “Money” section publishes an interesting graphic showing the performance of different industry groups against the S&P 500 index.

Investor Facts

Beware the Spin Companies sometimes hire outside investor relations (IR) firms to help generate media coverage of their press releases. A recent study found that IR firms tend to “spin” company news by generating more media coverage when companies disclose favorable information, and that the spin created by IR firms increased the stock prices of their clients on days when press releases occurred. However, when these same IR clients released their earnings, a type of hard, quantitative news that is hard to spin, their stock returns were worse than those of companies that did not hire IR firms to help disseminate information.

(Source: “Selective Publicity and Stock Prices,” Journal of Finance, Vol. 67, Issue 2, pp. 599–638.)

Institutional News

The monthly economic letters of the nation’s leading banks, such as Bank of America (based in Charlotte, North Carolina), Northern Trust (Chicago), and Wells Fargo (San Francisco), provide useful economic information. Wire services such as Dow Jones, Bloomberg Financial Services, AP (Associated Press), and UPI (United Press International) provide economic and business news feeds to brokerages, other financial institutions, and websites that subscribe to them. Bloomberg has its own comprehensive site. Websites specializing in financial news include CNNMoney and MarketWatch.

Business Periodicals

Business periodicals vary in scope. Some present general business and economic articles, others cover securities markets and related topics, and still others focus solely on specific industries. Regardless of the subject matter, most business periodicals present descriptive information, and some also include analytical information. They rarely offer recommendations.

The business sections of general-interest periodicals such as Newsweek, Time, and U.S. News & World Report cover business and economic news. Strictly business- and finance-oriented periodicals, including Business Week, Fortune, and The Economist, provide more in-depth articles. These magazines also have investing and personal finance articles.

Some financial periodicals specialize in securities and marketplace articles. The most basic, commonsense articles appear in Forbes, Kiplinger’s Personal Finance, Money, Smart Money, and Worth. Published every two weeks, Forbes is the most investment oriented. Kiplinger’s Personal Finance, Money, Smart Money, and Worth are published monthly and contain articles on managing personal finances and on investments.

All these business and personal finance magazines have websites with free access to recent, if not all, content. Most include a number of other features. For example, Smart Money has interactive investment tools, including a color-coded “Market Map 1000” that gives an aerial view of 1,000 U.S. and international stocks so that you can see the sectors and stocks whose prices are rising (or falling).

Government Publications

A number of government agencies publish economic data and reports useful to investors. The annual Economic Report of the President, which can be found at the U.S. Government Printing Office, provides a broad view of the current and expected state of the economy. This document reviews and summarizes economic policy and conditions and includes data on important aspects of the economy.

The Federal Reserve Bulletin, published monthly by the Board of Governors of the Federal Reserve System, and periodic reports published by each of the 12 Federal Reserve District Banks provide articles and data on various aspects of economic and business activity. Visit  http://www.federalreserve.gov  to read many of these publications.

A useful Department of Commerce publication is the Survey of Current Business. Published monthly, it includes indicators and data related to economic and business conditions. A good source of financial statement information on all manufacturers, broken down by industry and asset size, is the Quarterly Financial Report for U.S. Manufacturing, Mining, and Wholesale Trade Corporations published by the Department of Commerce.

Special Subscription Services

Investors who want additional insights into business and economic conditions can subscribe to special services. These reports include business and economic forecasts and give notice of new government policies, union plans and tactics, taxes, prices, wages, and so on. One popular service is the Kiplinger Washington Letter, a weekly publication that provides a wealth of economic information and analyses.

Industry and Company Information

Of special interest to investors is information on particular industries and companies. Many trade magazines provide in-depth coverage of business trends in just one industry. Trade publications such as Chemical Week, American Banker, Computerworld, Industry Week, Oil and Gas Journal, and Public Utilities Fortnightly provide highly focused industry and company information. For example, Red Herring, CIO Magazine, Business 2.0, and Fast Company are magazines that can help you keep up with the high-tech world; all have good websites. Often, after choosing an industry in which to invest, an investor will want to analyze specific companies. General business periodicals such as Business Week, Forbes, the Wall Street Journal, and Fortune carry articles on the activities of specific industries and individual companies. In addition, company websites typically offer a wealth of information about the company—investor information, annual reports, filings, and financial releases, press releases, and more.  Table 3.1  presents several free and subscription resources that emphasize industry and company information.

Fair Disclosure Rules

In August 2000 the SEC passed the  fair disclosure rule , known as  Regulation FD , requiring senior executives to disclose material information such as earnings forecasts and news of mergers and new products simultaneously to investment professionals and the public via press releases or SEC filings. Companies may choose to limit contact with professional stock analysts if they are unsure whether the particular

Table 3.1 Online Sources for Industry and Company Information

Website	Description	Cost
Hoover’s Online ( http://www.hoovers.com )	Reports and news on public and private companies with in-depth coverage of 43,000 of the world’s top firms.	Varies according to level of service
CNET ( http://news.cnet.com )	One of the best sites for high-tech news, analysis, and breaking news. Has great search capabilities and links.	Free
Yahoo! Finance ( http://finance.yahoo.com )	Provides information on companies gathered from around the web: stock quotes, news, investment ideas, research, financials, analyst ratings, insider trades, and more.	Free
Market Watch ( http://www.marketwatch.com )	Latest news from various wire services. Searchable by market or industry. Good for earnings announcements and company news.	Free

information requires a press release. However, Regulation FD does not apply to communications with journalists and securities ratings firms like Moody’s Investors Service and Standard & Poor’s. In other words, firms may disclose information to members of the media without simultaneously disclosing it publicly via a press release. The law takes the view that the media has a mission to disclose the information that they learn from companies, not to trade on that information as analysts might. Violations of the rule carry injunctions and fines but are not considered fraud.

Stockholders’ Reports

An excellent source of data on an individual firm is the  stockholders’ report , or  annual report , published yearly by publicly held corporations. These reports contain a wide range of information, including financial statements for the most recent period of operation, along with summarized statements for several prior years. These reports are free and are usually also available on a company’s website. An excerpt from AT&T’s 2014 Annual Report appears in  Figure 3.4 . These pages show AT&T’s growth rates and revenues for their different lines of business, and detailed financial statements are also available elsewhere in this report. If you don’t want to search for annual reports one company at a time,  AnnualReports.com  boasts having “the most complete and up-to-date listing of annual reports on the Internet.”

Tesla Motors 2014 Annual Meeting

In addition to the stockholders’ report, many serious investors review a company’s  Form 10-K , which is a statement that firms with securities listed on a securities exchange or traded in the OTC market must file annually with the SEC. Finding 10-K and other SEC filings is now a simple task, thanks to SEC/EDGAR (Electronic Data Gathering and Analysis Retrieval), which has reports filed by all companies traded on a major exchange. You can read them free either at the SEC’s website or at EDGAR’s FreeEdgar site.

Comparative Data Sources

Sources of comparative data, typically broken down by industry and firm size, are a good tool for analyzing the financial condition of companies. Among these sources are Dun & Bradstreet’s Key Business Ratios, RMA’s Annual Statement Studies, the Quarterly Financial Report for U.S. Manufacturing, Mining, and Wholesale Trade Corporations (cited earlier), and the Almanac of Business & Industrial

Figure 3.4 Pages from AT&T’s Stockholders’ Report

The excerpt from AT&T’s 2014 Annual Report quickly acquaints the investor with some key information on the firm’s operations over the past year.

(Source: AT&T annual report,  http://www.att.com/gen/ investor-relations?pid=9186 , April 15, 2015.)

Financial Ratios. These sources, which are typically available in public and university libraries, provide useful benchmarks for evaluating a company’s financial condition.

Subscription Services

A variety of subscription services provide data on specific industries and companies. Generally, a subscriber pays a basic fee to access the service’s information and can also purchase premium services for greater depth or range. The major subscription services provide both descriptive and analytical information, but they generally do not make recommendations. Most investors, rather than subscribe to these services, access them through their stockbrokers or a large public or university library. The websites for most services offer some free information and charge for the rest.

The dominant subscription services are those offered by Standard & Poor’s, Bloomberg, Mergent, and Value Line.  Table 3.2  summarizes the most popular services of these companies.  Standard & Poor’s Corporation (S&P)  offers a large number of financial reports and services. Through its acquisition of Business Week, Bloomberg

Table 3.2 Popular Offerings of the Major Subscription Services

Subscription Service/Offerings	Coverage	Frequency of Publication
Standard & Poor’s Corporation (http://www.standardandpoors.com)
Corporation Records	Detailed descriptions of publicly traded securities of public corporations.	Annually with updates throughout the year
Stock Reports	Summary of financial history, current finances, and future prospects of public companies.	Annually with updates throughout the year
Stock Guide	Statistical data and analytical rankings of investment desirability for major stocks.	Monthly
Bond Guide	Statistical data and analytical rankings of investment desirability of bonds.	Monthly
The Outlook	Analytical articles with investment advice on the economy, market, and investments.	Weekly magazine
Mergent (http://www.mergent.com)
Mergent’s Manuals	Eight reference manuals—Bank and Finance, Industrial, International, Municipal and Government, OTC Industrial, OTC Unlisted, Public Utility, and Transportation—with historical and current financial, organizational, and operational data on major firms.	Annually with monthly print updates (weekly online updates)
Handbook of Common Stocks	Common stock data on NYSE-listed companies.	Quarterly
Dividend Record	Recent dividend announcements and payments on publicly listed securities.	Twice weekly, with annual summary
Bond Record	Price and interest rate behavior of bond issues.	Monthly
Value Line Investment Survey (http://www.valueline.com)
Includes three reports:		Weekly
Ratings and Reports	Full-page report including financial data, descriptions, analyses, and ratings for stocks.
Selection and Opinion	A 12- to 16-page report featuring a discussion of the U.S. economy and the stock market, sample portfolios for different types of investors, and an in-depth analysis of selected stocks.
Summary and Index	A listing of the most widely held stocks. Also includes a variety of stock screens.

offers an excellent resource for individual investors to complement its products for institutional investors. Although basic news and market commentary is free, Business Week subscribers obtain access to premium online services. Mergent (formerly Moody’s Financial Information Services Division) also publishes a variety of material, including its equity and bond portraits, corporate research, well-known reference manuals on eight industries, and numerous other products. The  Value Line Investment Survey  is one of the most popular subscription services used by individual investors. It is available at most libraries and provides online access to additional services including data, graphing, portfolio tracking, and technical indicators.

Brokerage Reports

Brokerage firms often make available to their clients reports from the various subscription services and research reports from their own securities analysts. They also provide clients with prospectuses for new security issues and  back-office research reports . As noted in  Chapter 2 , a prospectus is a document that describes in detail the key aspects of the issue, the issuer, and its management and financial position. The cover of the preliminary prospectus describing the 2015 stock issue of Shake Shack is shown in  Figure 2.1 .  Back-office research reports  include the brokerage firm’s analyses of and recommendations on prospects for the securities markets, specific industries, or specific securities. Usually a brokerage firm publishes lists of securities classified by its research staff as “buy,” “hold,” or “sell.” Brokerage research reports are available on request at no cost to existing and prospective clients.

Securities analysts’ reports are now available on the web, either from brokerage sites or from sites that consolidate research from many brokerages. At  Reuters.com , a leading research site, analysts’ reports on companies and industries from most brokerage and research firms are available. Investors can use Zacks’s Investment Research to find and purchase analyst reports on widely followed stocks or to read free brokerage report abstracts with earnings revisions and recommendations.

Investment Letters

Investment letters  are newsletters that provide, on a subscription basis, the analyses, conclusions, and recommendations of experts in securities investment. Some letters concentrate on specific types of securities; others are concerned solely with assessing the economy or securities markets. Among the more popular investment letters are Blue Chip Advisor, Dick Davis Digest, The Dines Letter, Dow Theory Letters, and The Prudent Speculator. Most investment letters come out weekly or monthly. Advertisements for many of these investment letters can be found in Barron’s and in various business periodicals. The Hulbert Financial Digest monitors the performance of investment letters. It is an excellent source of objective information on investment letters and a good place to check out those that interest you.

Price Information

Price information about various types of securities is contained in their  quotations , which include current price data and statistics on recent price behavior. The web makes it easy to find price quotes for actively traded securities. Most of these sites ask you to locate a stock by entering its ticker symbol.  Table 3.3  lists the ticker symbols for some well-known companies.

Investors can easily find the prior day’s security price quotations in the published news media, both nonfinancial and financial. They also can find delayed or real-time quotations for free at numerous websites, including financial portals (described below), most business periodical websites, and brokerage sites. The website for CNBC TV has real-time stock quotes, as do sites that subscribe to their news feed.

Other Online Investment Information Sources

Many other excellent websites provide information of all sorts to increase your investment knowledge and skills. Let’s now

Table 3.3 Symbols for Some Well-Known Companies

Company	Symbol	Company	Symbol
Amazon.com	AMZN	Lucent Technologies	LU
Apple	AAPL	McDonald’s Corporation	MCD
AT&T	T	Microsoft	MSFT
Bank of America	BAC	Nike	NKE
Cisco Systems	CSCO	Oracle	ORCL
The Coca-Cola Company	KO	PepsiCo, Inc.	PEP
Dell	DELL	Ralph Lauren	RL
Estee Lauder Companies	EL	Sears Holdings	SHLD
ExxonMobil	XOM	Starbucks	SBUX
FedEx	FDX	Target	TGT
General Electric	GE	Texas Instruments	TXN
Google	GOOG	Time Warner	TWX
Hewlett-Packard	HPQ	United Parcel Service	UPS
Intel	INTC	Walmart Stores	WMT
Int’l. Business Machines	IBM	Yahoo!	YHOO

look at financial portals, sites for bonds and mutual funds, international sites, and investment discussion forums.  Table 3.4  lists some of the most popular financial portals, bond sites, and mutual fund sites. We’ll look at online brokerage and investment advisor sites later in the chapter.

Financial Portals

Financial portals  are supersites that bring together a wide range of investing features, such as real-time quotes, stock and mutual fund screens, portfolio trackers, news, research, and transaction capabilities, along with other personal finance features. These sites want to be your investing home page.

Some financial portals are general sites, such as Yahoo! Finance and Google Finance, that offer a full range of investing features along with their other services, or they may be investing-oriented sites. You should check out several to see which suits your needs because their strengths and features vary greatly. Some portals, to motivate you to stay at their site, offer customization options so that your start page includes the data you want. Although finding one site where you can manage your investments is indeed appealing, you may not be able to find the best of what you need at one portal. You’ll want to explore several sites to find the ones that meet your needs.  Table 3.4  summarizes the features of several popular financial portals.

Bond Sites

Although many general investment sites include bond and mutual fund information, you can also visit sites that specialize in these investments. Because individuals generally do not trade bonds as actively as they trade stocks, there are fewer resources focused on bonds for individuals. Some brokerage firms are starting to allow clients access to bond information that formerly was restricted to investment professionals. In addition to the sites listed in  Table 3.4 , other good sites for bond and interest rate information include Bloomberg and the Wall Street Journal.

The sites of the major bond ratings agencies—Moody’s, Standard & Poor’s, and Fitch—provide ratings lists, recent ratings changes, and information about how they determine ratings.

Table 3.4 Popular Investment Websites

The following websites are just a few of the thousands of sites that provide investing information. Unless otherwise mentioned, all are free.

Website	Description
Financial Portals
Daily Finance ( http://dailyfinance.com )	Includes investing and personal finance areas containing business news, market and stock quotes, stocks, mutual funds, investment research, retirement, saving and planning, credit and debt, banking and loans, and more.
MSN Money ( http://www.money.msn.com )	More editorial content than many sites; good research and interactive tools. Can consolidate accounts in portfolio tracker.
Motley Fool ( http://www.fool.com )	Comprehensive and entertaining site with educational features, research, news, and message boards. Model portfolios cover a variety of investment strategies. Free but offers premium services such as its Stock Advisor monthly newsletter for a fee.
Yahoo! Finance ( http://finance.yahoo.com )	Simple design, content-rich; easy to find information quickly. Includes financial news, price quotes, portfolio trackers, bill paying, personalized home page, and a directory of other major sites.
Yodlee ( http://www.yodlee.com )	Aggregation site that collects financial account data from banking, credit card, brokerage, mutual fund, mileage, and other sites. One-click access saves time and enables users to manage and interact with their accounts. Offers e-mail accounts; easy to set up and track finances. Security issues concern potential users; few analytical tools.
Bond Sites
Investing in Bonds (http://www.investinginbonds.com)	Developed by the Securities Industry and Financial Markets Association; good for novice investors. Bond education, research reports, historical data, and links to other sites. Searchable database.
BondsOnline (http://www.bondsonline.com)	Comprehensive site for news, education, free research, ratings, and other bond information. Searchable database. Some charges for newsletters and research.
CNN Money ( http://www.money.cnn.com )	Individual investors can search for bond-related news, market data, and bond offerings.
Bureau of the Public Debt Online ( http://www.publicdebt.treas.gov )	Run by U.S. Treasury Department. Information about U.S. savings bonds and Treasury securities. Can buy Treasury securities online through Treasury Direct program.
Mutual Fund Sites
Morningstar ( http://www.morningstar.com )	Profiles mutual funds with ratings; screening tools, portfolio analysis and management; fund manager interviews, e-mail newsletters; educational sections. Advanced screening and analysis tools are available for a fee.
Mutual Fund Investor’s Center ( http://www.mfea.com )	Not-for-profit, easy-to-navigate site from the Mutual Fund Education Alliance with investor education, search feature, and links to profiles of funds, calculators for retirement, asset allocation, and college planning.
Mutual Fund Observer ( http://mutualfundobserver.com )	A free, independent site offering information and analysis of mutual funds and the fund industry.
MAXfunds ( http://www.maxfunds.com )	Offers several custom metrics and data points to help find the best funds and give investors tools other than past performance to choose funds. Covers more funds than any other on- or offline publication. MAXadvisor Powerfund Portfolios, a premium advisory service, is available for a fee.
IndexFunds.com  ( http://www.indexfunds.com )	Comprehensive site covering only index funds.
Personal Fund ( http://www.personalfund.com )	Especially popular for its Mutual Fund Cost Calculator that shows the true cost of ownership, after fees, brokerage commissions, and taxes. Suggests lower-cost alternatives with similar investment objectives.

Mutual Fund Sites

With thousands of mutual funds, how do you find the ones that match your investment goals? The Internet makes this task much easier, offering many sites not tied to specific fund companies with screening tools and worksheets. Every major mutual fund family has its own site as well. Some allow visitors to hear interviews or participate in chats with fund managers. Fidelity has one of the most comprehensive sites, with educational articles, fund selection tools, fund profiles, and more. Portals and brokerage sites also offer these tools.  Table 3.4  includes some independent mutual fund sites that are worth checking out.

International Sites

The international reach of the Internet makes it a natural resource to help investors sort out the complexity of global investing, from country research to foreign currency exchange. Site-By-Site! International Investment Portal & Research Center is a comprehensive portal just for international investing. Free daily market data, news, economic insights, research, and analysis and commentary covering numerous countries and investment vehicles are among this site’s features. For more localized coverage, check out  Euroland.com ,  UK-Invest.com ,  Latin-Focus.com , and similar sites for other countries and regions. J P. Morgan provides a site devoted exclusively to American Depositary Receipts (ADRs), one of the most popular ways for investors to diversify their portfolios internationally. For global business news, the Financial Times gets high marks. Dow Jones’s MarketWatch has good technology and telecommunications news, as well as coverage of global markets.

Investment Discussion Forums

Investors can exchange opinions about their favorite stocks and investing strategies at the online discussion forums (message boards and chat rooms) found at most major financial websites. However, remember that the key word here is opinion. You don’t really know much about the qualifications of the person posting the information. Always do your own research before acting on any hot tips! The Motley Fool’s discussion boards are among the most popular, and Fool employees monitor the discussions. Message boards at Yahoo! Finance are among the largest online, although many feel that the quality is not as good as at other sites. The Raging Bull includes news and other links along with its discussion groups. Technology investors flock to Silicon Investor, a portal site whose high-tech boards are considered among the best.

Avoiding Scams

The ease with which information is available to all investors today makes it easier for scam artists and others to spread false news and manipulate information. Anyone can sound like an investment expert online, posting stock tips with no underlying substance. As mentioned earlier, you may not know the identity of the person touting or panning a stock on the message boards. The person panning a stock could be a disgruntled former employee or a short seller. For example, the ousted former chief executive of San Diego’s Avanir Pharmaceuticals posted negative remarks on stock message boards, adversely affecting the firm’s share price. The company sued and won a court order prohibiting him from ever posting derogatory statements about the company.

In the fast-paced online environment, two types of scams turn up frequently: “pump-and-dump” and “get-rich-quick” scams. In pump-and-dump scams, perpetrators buy select stocks and then falsely promote or hype the stocks to the public. The false promotion tends to push up the stock price, at which point the scam artist dumps the stock at an inflated price. In get-rich-quick scams, promoters sell worthless investments to naïve buyers.

One well-publicized pump-and-dump scam demonstrates how easy it is to use the Internet to promote stocks. In December 2011 the SEC charged Daniel Ruettiger, the man who inspired the film Rudy, in a pump-and-dump scam involving his company, Rudy Nutrition. Ruettiger’s company promoted a sports drink called “Rudy,” which was designed to compete with Gatorade. The SEC alleged that Ruettiger sent false e-mails claiming that his sports drink outperformed Gatorade and Powerade by a 2-to-1 margin in taste tests. The SEC further alleged that Ruettiger engaged in manipulative trading to artificially inflate his company’s stock price while selling unregistered securities to investors.

To crack down on cyber-fraud, in 1998 the SEC formed the Office of Internet Enforcement, which was merged into the Office of Market Intelligence in 2010. Its staff members quickly investigate reports of suspected hoaxes and prosecute the offenders. At  http://www.sec.gov , you can find specific instructions about how to spot and avoid Internet investment scams. Among other pieces of advice, the SEC recommends that you ask the following five key questions before making any investment.

· Is the seller licensed? Do some research on the background of the person recommending an investment to you. For example, you can investigate a broker’s background at FINRA.

· Is the investment registered? You can learn whether an investment is registered by searching the SEC’s EDGAR database.

· How do the risks compare with the potential rewards? Investment opportunities pitched as offering high potential returns without much risk are likely to be frauds.

· Do you understand the investment? A good rule of thumb, one followed even by sophisticated investors such as Warren Buffett, is to never invest in something that you do not understand.

· Where can you turn for help? The SEC urges investors to conduct investment research on the SEC’s website, as well as sites provided by FINRA and state securities regulators.

Asking these questions cannot ensure that you will never fall victim to an investment scam, but it tilts the odds in your favor.

Concepts in Review

Answers available at  www.pearsonhighered.com/smart

1. 3.4 Differentiate between descriptive information and analytical information. How might one logically assess whether the acquisition of investment information or advice is economically justified?

2. 3.5 What popular financial business periodicals would you use to follow the financial news? General news? Business news? Would you prefer to get your news from print sources or online, and why?

3. 3.6 Briefly describe the types of information that the following resources provide.

a. Stockholders’ report

b. Comparative data sources

c. Standard & Poor’s Corporation

d. Mergent

e. Value Line Investment Survey

4. 3.7 How would you access each of the following types of information, and how would the content help you make investment decisions?

a. Prospectuses

b. Back-office research reports

c. Investment letters

d. Price quotations

5. 3.8 Briefly describe several types of information that are especially well suited to publication on the Internet. What are the differences between the online and print versions, and when would you use each?

Understanding Market Averages and Indexes

1. LG 3

The investment information we have discussed in this chapter helps investors understand when the economy is moving up or down and how individual investments have performed. You can use this and other information to formulate expectations about future investment performance. It is also important to know whether market behavior is favorable or unfavorable. The ability to interpret various market measures should help you to select and time investment actions.

A widely used way to assess the behavior of securities markets is to study the performance of market averages and indexes. These measures allow you to conveniently (1) gauge general market conditions; (2) compare your portfolio’s performance to that of a large, diversified (market) portfolio; and (3) study the market’s historical performance and use that as a guide to understand future market behavior. Here we discuss key measures of stock and bond market activity. In later chapters, we will discuss averages and indexes associated with other investment securities. Like price quotations, measures of market performance are available at many websites.

Stock Market Averages and Indexes

Stock market averages and indexes measure the general behavior of stock prices over time. Although the terms average and index tend to be used interchangeably when people discuss market behavior, technically they are different types of measures.  Averages  reflect the arithmetic average price behavior of a representative group of stocks at a given point in time.  Indexes  measure the current price behavior of a representative group of stocks in relation to a base value set at an earlier point in time.

Averages and indexes provide a convenient method of capturing the general mood of the market. Investors can also compare these measures at different points in time to assess the relative strength or weakness of the market. Current and recent values of the key averages and indexes are quoted daily on financial websites, in the financial news, in most local newspapers, and on many radio and television news programs.

The Dow Jones Averages

The S&P Dow Jones Indices prepares four different stock averages and several stock indexes. The most well known of these is the  Dow Jones Industrial Average (DJIA) . This average is made up of 30 stocks, most of which are issued by large, well-respected companies with long operating histories. The DJIA represents a broad sample of the U.S. economy and includes stocks from sectors such as technology, transportation, banking, energy, health care, consumer products, and many others. The DJIA is a price-weighted index, meaning that stocks with higher prices get more weight in the index than do stocks with lower prices.

Occasionally, a merger or bankruptcy causes a change in the makeup of the average. For example, Kraft Foods replaced American International Group (AIG) in September 2008 after AIG experienced a liquidity crisis and required an $85 billion credit facility from the U.S. Federal Reserve. Kraft was replaced in 2012 by UnitedHealth Group after Kraft announced plans to spin off its North American Grocery Business. Changes to the 30 stocks also occur when Dow Jones believes that the average does not reflect the broader market. In 2015, AT&T was dropped from the average in favor of Apple. In part this change reflected Apple’s tremendous growth. By 2015, Apple had become the largest U.S. company measured by its market capitalization. But Apple’s addition to the index was also influenced by the company’s decision in 2014 to split its stock 7-for-1. After the split, Apple’s stock price was roughly one-seventh of what it had been before the split when its shares traded for roughly $600 each. Because the Dow is a price-weighted index, a stock with a price as high as $600 would have a disproportionate influence on the index, so the index almost never includes companies with extremely high stock prices. When a new stock is added to the Dow, the average is adjusted so that it continues to behave in a manner consistent with the immediate past.

The value of the DJIA is calculated each business day by substituting the closing share prices of each of the 30 stocks in the DJIA into the following equation:

DJLA=ClosingsharepriceClosingsharepriceClosingshareprice++⋅⋅⋅+ofstock1ofstock2ofstock30DJLAdivisorDJLA=Closing share priceClosing share priceClosing share price++  ⋅⋅⋅  +of stock 1of stock 2of stock 30DJLA divisorEquation3.1

The value of the DJIA is merely the sum of the closing share prices of the 30 stocks included the Dow, divided by a “divisor.” The purpose of the divisor is to adjust for stock splits, company changes, or other events that have occurred over time. Without the divisor, whose calculation is very complex, the DJIA value would be totally distorted. The divisor makes it possible to use the DJIA to track the performance of the 30 stocks on a consistent basis over time. On April 15, 2015, the DJIA divisor was 0.14985889030177, and the sum of the closing prices of the Dow 30 stocks that day was 2,702.96. Using  Equation 3.1 , you can divide the sum of the closing prices of the 30 industrials by the DJIA divisor and arrive at that day’s DJIA closing value of 18,036.70.

Because the DJIA results from summing the prices of the 30 stocks, higher-priced stocks tend to affect the index more than do lower-priced stocks. For example, a 5% change in the price of a $50 stock (i.e., $2.50) has less impact on the index than a 5% change in a $100 stock (i.e., $5.00) or a 5% change in a $600 stock (i.e., $30). Many experts argue that because the Dow is price weighted, it is not a particularly good indicator of the direction of the overall stock market. In spite of this and other criticisms leveled at the DJIA, it remains the most widely cited stock market indicator.

The actual value of the DJIA is meaningful only when compared to earlier values. For example, the DJIA on April 15, 2015, closed at 18,112.61. This value is meaningful only when compared to the previous day’s closing value of 18,036.70, a change of about 0.42%. Many people mistakenly believe that one DJIA “point” equals $1 in the value of an average share. Actually, 1 point currently translates into about 0.25 cents in average share value, but that figure varies widely over time.

Three other widely cited Dow Jones averages are the transportation, utilities, and composite. The Dow Jones Transportation Average is based on 20 stocks, including railroads, airlines, freight forwarders, and mixed transportation companies. The Dow Jones Utilities Average is computed using 15 public-utility stocks. The Dow Jones Composite Average is made up of the 30 industrials, the 20 transportations, and the 15 utilities. Like the DJIA, each of the other Dow Jones averages is calculated using a divisor to allow for continuity of the average over time. The transportation, utilities, and 65-stock composite are often cited along with the DJIA.

Dow Jones also publishes numerous indexes including the U.S. Total Stock Market Index, which tracks the performance of all equities with readily available prices. Dow Jones also publishes indexes for various sectors based on company size (e.g., large cap, mid cap, small cap) or industry. Dow Jones’s index products are not limited to U.S. markets. The company provides indexes that track the global equities market, developed and emerging stock markets, and regional markets in Asia, Europe, the Americas, the Middle East, and Africa.

Standard & Poor’s Indexes

Standard & Poor’s Corporation, another leading financial publisher, publishes six major common stock indexes. One oft-cited S&P index is the  S&P 500 Stock Index,  which is calculated each business day by substituting the closing market value of each stock (closing price × number of shares outstanding) into the following equation:

S & P 500 Index=Current closing market value of stock 1+Current closing market value of stock 2+...+Current closingmarket value of last stockDivisorS & P 500 Index=Current closing market value of stock 1+Current closing market value of stock 2 + ...+ Current closing market value of last stockDivisorEquation3.2

The value of the S&P 500 Index is found by dividing the sum of the market values of all stocks included in the index by a divisor. The divisor is a number that serves two functions. First, it provides a scaling factor to make the index value easier to work with. The scaling factor works by measuring the current market value of stocks in the index relative to a base period value (for the S&P 500, the base period is 1941–1943). For example, the total market value of all stocks in the S&P 500 Index is several trillion dollars. No one wants to work with an index in the trillions, so the divisor brings the index value down to a more manageable value (for example, the S&P 500 Index value was 2,106.63 on April 15, 2015). The divisor’s second function is to adjust the index to account for changes in the composition of the S&P 500 stocks, such as when a company in the index is deleted due to a merger or bankruptcy and another company is added in its place. In these instances, the index value should not “jump” simply because the list of companies in the index changed. Likewise, certain corporate events such as new share issues or share repurchases can change the market value of a firm in the index. The divisor is calculated in a manner such that these events by themselves do not cause movement in the S&P 500 Index.

Investor Facts

Google Not “All in” S&P 500 Standard & Poor’s does not count all of a company’s shares as part of the S&P 500 Index if some shares are not publicly traded. For example, Google has a class of shares (Class B) with special voting rights that is not publicly traded and is held by the company’s founders, Sergey Brin and Larry Page. These shares are not counted in the S&P 500 Index calculation, so Google’s weight in the index is actually less than its true market capitalization.

Certain of the S&P indexes contain many more shares than the Dow averages do, and all of them are based on the market values (shares outstanding price per share) of the companies in the indexes rather than the share prices. Therefore, many investors feel that the S&P indexes provide a more broad-based and representative measure of general market conditions than do the Dow averages. Although some technical computational problems exist with these indexes, they are widely used—frequently as a basis for estimating the “market return,” an important concept that we introduce later.

Some of the widely followed stock indexes published by Standard & Poor’s are the following:

· The S&P 500 Index comprises 500 large companies (but not necessarily the largest 500).

· The S&P 100 Index comprises 100 large companies, each of which must have stock options available for investors to trade.

· The S&P 400 MidCap Index comprises 400 medium-sized companies, accounting for about 7% of the U.S. equity market.

· The S&P 600 SmallCap Index comprises 600 small-sized companies, accounting for about 3% of the U.S. equity market.

Figure 3.5The DJIA Average Compared to the S&P 500 Index from April 16, 2013, to April 15, 2015

During this period, both indexes followed a rising trend, with the DJIA gaining about 23% and the S&P 500 gaining about 34%.

(Source: Yahoo! Finance screenshot,  http://www.finance.yahoo.com .)

· The S&P Total Market Index comprises all stocks listed on the NYSE (including NYSE Arca and NYSE MKT) and Nasdaq (including NASDAQ Global Select Market, the NASDAQ Global Market, and the NASDAQ Capital Market).

Although the Dow Jones averages and S&P indexes tend to behave in a similar fashion over time, their day-to-day magnitude and even direction (up or down) can differ significantly because of the differences in how the indexes are constructed.  Figure 3.5  plots the performance of the DJIA and the S&P 500 from April 16, 2013, to April 15, 2015. During this period, both indexes followed a rising trend, with the DJIA gaining about 23% while the S&P 500 gained about 34%. This figure highlights that the two indexes do not move perfectly in sync, but they experience similar movements more often than not.

NYSE, NYSE MKT, and Nasdaq Indexes

Three indexes measure the daily results of the New York Stock Exchange (NYSE), the NYSE MKT Exchange (formally the American Stock Exchange), and the National Association of Securities Dealers Automated Quotation (Nasdaq) system. Each reflects the movement of stocks listed on its exchange.

Famous Failures in Finance PIIGS Feast on Wall Street

In the summer of 2011 an economic crisis gripped Europe, particularly Portugal, Italy, Ireland, Greece, and Spain, the so-called PIIGS nations. Their fiscal problems made investors doubt that governments would be able to repay their debts without massive cuts in government spending, and investors feared that deep budget cuts might trigger a recession that might sweep across the globe. The DJIA fell by nearly 15% in less than two weeks before a series of rescue packages from the European Union nations reassured investors, at least temporarily. That story repeated itself on a smaller scale in October 2014 when the Dow fell 5.2% over a span of less than two weeks.

The  NYSE Composite Index  includes about 1,900 or so stocks listed on the “Big Board.” In addition to the composite index, the NYSE publishes indexes for financial and other subgroups. The behavior of the NYSE composite index is normally similar to that of the DJIA and the S&P 500 indexes. The NYSE MKT Composite Index reflects the price of all shares traded on the NYSE MKT Exchange. Although it does not always closely follow the S&P and NYSE indexes, the NYSE MKT index tends to move in the general direction they do.

The  Nasdaq Stock Market indexes  reflect Nasdaq stock market activity. The most comprehensive of the Nasdaq indexes is the composite index, which is calculated using the almost 3,000 common stocks traded on the Nasdaq stock market. The index includes other types of securities such as real estate investment trusts (REITs) and American Depositary Receipts. Also important is the Nasdaq 100, which includes 100 of the largest domestic and international nonfinancial companies listed on Nasdaq. The other two commonly quoted Nasdaq indexes are the biotech and computer  indexes . The Nasdaq indexes tend to move in the same direction at the same time as the other major indexes, but movements in Nasdaq indexes are often sharper than those of the other major indexes. The companies listed on the Nasdaq tend to be smaller and operate in riskier industries (such as technology) than those included in indexes such as the DJIA and the S&P 500.

Value Line Indexes

Value Line publishes a number of stock indexes constructed by equally weighting the price of each stock included. This is accomplished by considering only the percentage changes in stock prices. This approach eliminates the effects of varying market price and total market value on the relative importance of each stock in the index. The  Value Line Composite Index  includes the nearly 1,700 stocks in the Value Line Investment Survey that are traded on the NYSE, NYSE MKT, and OTC markets. In addition to its composite index, Value Line publishes other specialized indexes.

Other Averages and Indexes

A number of other indexes are available. Frank Russell Company, a pension advisory firm, publishes three primary indexes. The Russell 1000 includes the 1,000 largest companies, the most widely quoted Russell 2000 includes 2,000 small to medium-sized companies, and the Russell 3000 includes all 3,000 companies in the Russell 1000 and 2000.

In addition, the Wall Street Journal publishes a number of global and foreign stock market indexes. Included are Dow Jones indexes for countries in the Americas, Europe, Africa, Asia, and the Pacific region. About 35 foreign stock market indexes are also given for major countries, including a World Index and the Europe/Australia/Far East (EAFE MSCI) Index. Like the purely domestic averages and indexes, these international averages and indexes measure the general price behavior of the stocks that are listed and traded in the given market. Useful comparisons of the market averages and indexes over time and across markets are often made to assess both trends and relative strengths of foreign markets throughout the world.

Bond Market Indicators

A number of indicators are available for assessing the general behavior of the bond markets. However, there are fewer indicators of overall bond market behavior than of stock market behavior. In part this is because many bonds do not trade as actively as stocks do. Even so, it is not hard to find several useful measures related to bond-market performance. The key measures of overall U.S. bond market behavior are bond yields and bond indexes.

Famous Failures in Finance Bond Yields Hit Historic Lows

Concerns about disappointing retail sales in the U.S economy pushed the yield on the 30-year U.S. Treasury bond to a record low of 2.395% in January 2015. Investors who purchased Treasury bonds at these yields earned almost nothing, so why would they invest? One answer is safety. Investors have long viewed U.S. Treasury bonds as the safest investment in the world, so when fears of a recession or other economic crisis grip the market, investors will buy Treasury bonds even if the return that they offer is barely above zero. Monetary policy may also push interest rates down when policy makers want to encourage investors to hold riskier assets. An extreme example of this occurred in the spring of 2015 when government bonds in countries such as Switzerland, Germany, and Denmark were sold with negative yields. Investors who bought these bonds were paying the government for the privilege to hold their bonds.

Bond Yields

A  bond yield  is the return an investor would receive on a bond if it were purchased and held to maturity. Bond yields are reported as annual rates of return, and they reflect both the interest payments that bond investors receive as well as any gain or loss in the bond’s value from the date the bond is purchased until it is redeemed. For example, a bond with a yield of 5.50% would provide its owner with a total return (including interest and capital gains or losses) that would be equivalent to a 5.50% annual rate of earnings on the amount invested (i.e., the bond’s purchase price), if the bond were purchased and held to maturity.

Typically, bond yields are quoted for a group of bonds that are similar with respect to type and quality. For example, Barron’s quotes the yields on the Dow Jones bond averages of 10 high-grade corporate bonds, 10 medium-grade corporate bonds, and a confidence index that is calculated as a ratio of the high-grade to medium-grade indexes. In addition, like the Wall Street Journal, it quotes numerous other bond indexes and yields, including those for Treasury and municipal bonds. Similar bond yield data are available from S&P, Moody’s, and the Federal Reserve. Like stock market averages and indexes, bond yield data are especially useful when viewed over time.

Bond Indexes

There is a variety of bond indexes. The  Dow Jones Corporate Bond Index , which is an equal-weighted index of U.S.-issued corporate bonds, includes 96 bonds—48 industrial, 36 financial, and 12 utility bonds. It reflects the simple mathematical average of the closing prices for the bonds. Dow Jones’s stated objective for the index is to represent the market performance, on a total-return basis, of investment-grade bonds issued by leading U.S. companies and to minimize the pricing and liquidity problems associated with most corporate bond indexes. The index is published daily in the Wall Street Journal and summarized weekly in Barron’s.

Concepts in Review

Answers available at  http://www.pearsonhighered.com/smart

1. 3.9 Describe the basic philosophy and use of stock market averages and indexes. Explain how the behavior of an average or index can be used to classify general market conditions as bull or bear.

2. 3.10 List each of the major averages or indexes prepared by (a) Dow Jones & Company and (b) Standard & Poor’s Corporation. Indicate the number and source of the securities used in calculating each average or index.

3. 3.11 Briefly describe the composition and general thrust of each of the following indexes.

a. NYSE Composite Index

b. NYSE MKT Composite Index

c. Nasdaq Stock Market indexes

d. Value Line Composite Index

4. 3.12 Discuss each of the following as they are related to assessing bond market behavior.

a. Bond yields

b. Bond indexes

Making Securities Transactions

1. LG 4

2. LG 5

Now that you know how to find information to help you locate attractive security investments, you need to understand how to make securities transactions. Whether you decide to start a self-directed online investment program or to use a traditional stockbroker, you must first open an account with a brokerage service. In this section, we will look at the role stockbrokers play and how that role has changed in recent years. We will also explain the basic types of orders you can place, the procedures required to make regular and online securities transactions, the costs of investment transactions, and investor protection.

The Role of Stockbrokers

Stockbrokers —also called account executives, investment executives, and financial consultants—act as intermediaries between buyers and sellers of securities. They typically charge a commission to facilitate these securities transactions. Stockbrokers must be licensed by both the SEC and the securities exchanges, and they must follow the ethical guidelines of those bodies.

Although the procedures for executing orders in different stock markets may vary, stock trades often start the same way: An investor places an order with his or her stockbroker. The broker works for a brokerage firm that maintains memberships on the securities exchanges, and members of the securities exchange execute orders that the brokers in the firm’s various sales offices transmit to them. For example, one of the largest U.S. brokerage firms, Bank of America’s Merrill Lynch, transmits orders for listed securities from its offices in most major cities throughout the country to the main office of Merrill Lynch and then to the floor of an exchange, such as the NYSE, where Merrill Lynch exchange members execute the orders. Confirmation of the order goes back to the broker placing the order, who relays it to the customer. This process can take a matter of seconds with the use of sophisticated telecommunications networks and Internet trading.

For securities transactions in markets such as Nasdaq, brokerage firms typically transmit orders to market makers. Normally, these transactions are executed rapidly, since there is considerable competition among dealers for the opportunity to execute brokerage orders. The revenue that market makers generate from executing orders is offset by the cost of maintaining inventories of the securities in which they deal.

Brokerage Services

The primary activity of stockbrokers is to route clients’ buy and sell orders to the markets where they will be executed at the best possible price. The speed with which brokers can get clients’ orders executed is enhanced by the fact that brokerage firms typically hold their clients’ security certificates for safekeeping. Securities kept by the firm in this manner are held in  street name . Because the brokerage house issues the securities in its own name and holds them in trust for the client (rather than issuing them in the client’s name), the firm can transfer the securities at the time of sale without the client’s signature. Street name is actually a common way of buying securities because most investors do not want to be bothered with the handling and safekeeping of stock certificates. In such cases, the brokerage firm records the details of the client’s transaction and keeps track of his or her investments through a series of bookkeeping entries. Dividends and notices received by the broker are forwarded to the client who owns the securities.

In addition to order routing and certificate storage, stockbrokers offer clients a variety of other services. For example, the brokerage firm normally provides free information about investments. Quite often, the firm has a research staff that periodically issues reports on economic, market, industry, or company behavior and makes recommendations to buy, sell, or hold certain securities. Clients also receive a statement describing their transactions for the month and showing commission and interest charges, dividends and interest received, and detailed listings of their current holdings.

Today most brokerage firms invest surplus cash left in a client’s account in a money market mutual fund, allowing the client to earn a reasonable rate of interest on these balances. Such arrangements help the investor earn as much as possible on temporarily idle funds.

Types of Brokerage Firms

Just a few years ago, there were three distinct types of brokerage firm: full-service, premium discount, and basic discount. No longer are the lines between these categories clear-cut. Most brokerage firms, even the most traditional ones, now offer online services. And many discount brokers now offer services, like research reports for clients, that were once available only from a full-service broker.

The traditional broker, or  full-service broker , in addition to executing clients’ transactions, offers investors a full array of brokerage services: providing investment advice and information, holding securities in street name, offering online brokerage services, and extending margin loans.

Investors who wish merely to make transactions and are not interested in taking advantage of other services should consider either a premium or basic discount broker.

Premium discount brokers  focus primarily on making transactions for customers. They charge low commissions and provide limited free research information and investment advice. The investor visits the broker’s office, calls a toll-free number, or accesses the broker’s website to initiate a transaction. The broker confirms the transaction in person or by phone, e-mail, or regular mail. Premium discount brokers like Charles Schwab, the first discount broker, now offer many of the same services that you’d find at a full-service broker. Other premium discounters are similar.

Basic discount brokers , also called online brokers or electronic brokers, are typically deep-discount brokers through whom investors can execute trades electronically online via a commercial service, on the Internet, or by phone. The investor accesses the basic discount broker’s website to open an account, review the commission schedule, or see a demonstration of the available transactional services and procedures. Confirmation of online trades can take mere seconds, and most trades occur within one minute. Most basic discount brokers operate primarily online but also provide telephone and live broker backup in case there are problems with the website or the customer is away from his or her computer. In response to the rapid growth of online investors, most brokerage firms now offer online trading. These firms usually charge higher commissions when live broker assistance is required.

Table 3.5 Select Full-Service, Premium Discount, and Basic Discount Brokers

Full-Service Broker	Premium Discount Broker	Basic Discount Broker
Morgan Stanley	Bank of America	Firstrade
Merrill Lynch	Charles Schwab	Scottrade
UBS Financial Services	E*Trade	Thinkorswim
Wells Fargo	Fidelity.com	TradeKing
	TD Ameritrade	Wall Street*E
	Wells Trade

The rapidly growing volume of business done by both premium and basic discount brokers attests to their success. Today, many full-service brokers, banks, and savings institutions are making discount and online brokerage services available to their customers and depositors who wish to buy stocks, bonds, mutual funds, and other investment securities. Some of the full-service, premium discount, and basic discount brokers are listed in  Table 3.5 . (Brokerage Review ( http://brokerage-review.com ) is a good online source for finding the right brokerage service to fit your needs.)

The SEC’s Advice on Selecting a Broker

Selecting a Stockbroker

If you decide to start your investing activities with the assistance of either a full-service or premium discount stockbroker, select the person you believe best understands your investment goals. Choosing a broker whose disposition toward investing is similar to yours is the best way to establish a solid working relationship. Your broker should also make you aware of investment possibilities that are consistent with your objectives and attitude toward risk.

You should also consider the cost and types of services available from the firm with which the broker is affiliated, in order to receive the best service at the lowest possible cost to you. The premium discount brokerage service is primarily transactional, and the basic discount brokerage service is purely transactional. Contact with a broker for advice or research assistance is generally only available at a higher price. Investors must weigh the added commissions they pay a full-service broker against the value of the advice they receive because the amount of available advice is the only major difference among the three types of brokers.

Referrals from friends or business associates are a good way to begin your search for a stockbroker. (Don’t forget to consider the investing style and goals of the person making the recommendation.) However, it is not important—and often not even advisable—to know your stockbroker personally. In this age of online brokers, you may never meet your broker face to face. A strictly business relationship eliminates the possibility that personal concerns will interfere with the achievement of your investment goals. For an example of how a stockbroker got into trouble through a personal relationship with a friend, see the following Famous Failures in Finance feature.

Your broker’s main interest should not be commissions. Responsible brokers do not engage in  churning —that is, causing excessive trading of their clients’ accounts to increase commissions. Churning is both illegal and unethical under SEC and exchange rules, although it is often difficult to prove.

Opening an Account

To open an account, you will fill out various forms that establish a legal relationship between you and the brokerage firm. The stockbroker should have

Famous Failures in Finance Hello, I Am Tim, an Insider Trader

In May 2012 the SEC charged stockbroker Timothy McGee with using inside information to buy shares in Philadelphia Consolidated Holding Corporation (PHLY) just before the company was acquired by Tokio Marine. McGee purchased 10,250 shares of PHLY for less than $39 per share. One day later, after Tokio announced its plan to buy the company, PHLY’s stock price jumped to almost $60, leaving Mr. McGee with a profit of more than $200,000. In addition, federal prosecutors alleged that McGee passed along information about the acquisition to a friend, who also bought Philadelphia Consolidated stock.

McGee learned about the impending takeover after attending an Alcoholics Anonymous meeting with a friend who was an executive at PHLY. In its indictment, the SEC claimed that McGee owed the executive “fiduciary and other duties of trust and confidence” stemming from their long friendship through Alcoholics Anonymous. To obtain an insider trading conviction, the government would have to prove that the person conveying the information and the person receiving it had a history of maintaining confidentiality regarding other personal or professional matters. This point is crucial because it is not illegal to trade based on material, nonpublic information unless doing so involves a breach of fiduciary duty to someone or a breach of trust and confidence. For the first time, the government hoped to prove that such a breach had occurred based on a shared membership in Alcoholics Anonymous.

(Source: Based on Alan Farnham, “Insider Trading Case Involves Secrets Shared Among AA Members,” March 15, 2012,  http://abcnews.com .)

Critical Thinking Question

1. Suppose you are on an airplane and you overhear two executives of a company talking about a merger that is about to take place. If you buy stock based on what you overheard, are you committing insider trading?

a reasonable understanding of your personal financial situation to assess your investment goals—and to be sure that you can pay for the securities purchased. You also provide the broker with instructions regarding the transfer and custody of securities. Customers who wish to borrow money to make transactions must establish a margin account (described following). If you are acting as a custodian, a trustee, an executor, or a corporation, the brokerage firm will require additional documents.

Investors may have accounts with more than one stockbroker. Many investors establish accounts at different types of firms to obtain the benefit and opinions of a diverse group of brokers and to reduce their overall cost of making buy and sell transactions.

Next you must select the type of account best suited to your needs. We will briefly consider several of the more popular types.

Single or Joint

A brokerage account may be either single or joint. Joint accounts are most common between husband and wife or parent and child. The account of a minor (a person younger than 18 years) is a  custodial account , in which a parent or guardian must be part of all transactions. Regardless of the form of the account, the name(s) of the account holder(s) and an account number are used to identify it.

Cash or Margin

A  cash account , the more common type, is one in which the customer can make only cash transactions. Customers can initiate cash transactions via phone or online and are given three business days in which to transmit the cash to the brokerage firm. The firm is likewise given three business days in which to deposit the proceeds from the sale of securities in the customer’s cash account.

A  margin account  is an account in which the brokerage firm extends borrowing privileges to a creditworthy customer. By leaving securities with the firm as collateral, the customer can borrow a prespecified proportion of the securities’ purchase price. The brokerage firm will, of course, charge the customer a stated rate of interest on borrowings.

Wrap

The  wrap account  (also called a managed account) allows brokerage customers with large portfolios (generally $100,000 or more) to shift stock selection decisions conveniently to a professional money manager, either in-house or independent. In return for a flat annual fee, commonly between 1% and 3% of the portfolio’s total asset value, the brokerage firm helps the investor select a money manager, pays the manager’s fee, and executes the money manager’s trades. Initially the investor, broker, and/or manager discuss the client’s overall goals.

Wrap accounts are appealing for a number of reasons other than convenience. The annual fee in most cases covers commissions on all trades, virtually eliminating the chance of the broker churning the account. In addition, the broker monitors the manager’s performance and provides the investor with detailed reports, typically quarterly.

Odd-Lot and Round-Lot Transactions

Investors can buy stock in either odd or round lots. An  odd lot  consists of fewer than 100 shares of a stock. A  round lot  is a 100-share unit. You would be dealing in an odd lot if you bought, say, 25 shares of stock, but in round lots if you bought 200 shares. A trade of 225 shares would be a combination of one odd lot and two round lots.

Transactions in odd lots once required either additional processing by the brokerage firm or the assistance of a specialist, but now computerized trading systems make trading odd lots much easier. As a result, trading odd lots usually does not trigger higher fees, as was once the case. Small investors in the early stages of their investment programs are primarily responsible for odd-lot transactions since they often lack the financial resources to purchase round lots.

Basic Types of Orders

Investors can use different types of orders to make security transactions. The type placed normally depends on the investor’s goals and expectations. The three basic types of orders are the market order, the limit order, and the stop-loss order.

Market Order

An order to buy or sell stock at the best price available at the time the investor places the order is a  market order . It is generally the quickest way to fill orders because market orders are usually executed as soon as they reach the exchange floor or are received by the market maker. Because of the speed with which market orders are executed, the buyer or seller of a security can be sure that the price at which the order is transacted will be very close to the market price prevailing at the time the order was placed.

Limit Order

A  limit order  is an order to buy at or below a specified price (a limit buy order) or to sell at or above a specified price (a limit sell order). When the investor places a limit order, the broker transmits it to a market maker dealing in the security. The market maker notes the number of shares and price of the limit order in his or her book and executes the order as soon as the specified limit price (or better) exists. The market maker must first satisfy all other orders with precedence—similar orders received earlier, buy orders at a higher specified price, or sell orders at a lower specified price. Investors can place a limit order in one of the following forms:

· A fill-or-kill order, which is canceled if not immediately executed.

· A day order, which if not executed is automatically canceled at the end of the day.

· A good-’til-canceled (GTC) order, which generally remains in effect for 30 to 90 days unless executed, canceled, or renewed.

Example

Suppose that you place a limit order to buy, at a limit price of $30, 100 shares of a stock currently selling at $30.50. Once the specialist clears all similar orders received before yours, and once the market price of the stock falls to $30 or lower, he or she executes your order. It is possible, of course, that your order might expire before the stock price drops to $30.

Although a limit order can be quite effective, it can also keep you from making a transaction. If, for instance, you wish to buy at $30 or less and the stock price moves from its current $30.50 price to $42 while you are waiting, you have missed the opportunity to make a profit of $11.50 per share. If you had placed a market order to buy at the best available price of $30.50, the profit of $11.50 would have been yours. Limit orders for the sale of a stock are also disadvantageous when the stock price closely approaches but does not attain the minimum sale price limit before dropping substantially. Generally speaking, limit orders are most effective when the price of a stock fluctuates greatly because there is then a better chance that the order will be executed.

Stop-Loss Order

When an investor places a  stop-loss order , or  stop order , the broker tells the market maker to sell a stock when its market price reaches or drops below a specified level. Stop-loss orders are suspended orders placed on stocks; they are activated when and if the stock reaches a certain price. The stop-loss order is placed on the market maker’s book and becomes active once the stock reaches the stop price. Like limit orders, stop-loss orders are typically day or GTC orders. When activated, the stop order becomes a market order to sell the security at the best price available. Thus it is possible for the actual price at which the sale is made to be well below the price at which the stop was initiated. Investors use these orders to protect themselves against the adverse effects of a rapid decline in share price.

Example

Assume you own 100 shares of Ballard Industries, which is currently selling for $35 per share. Because you believe the stock price could decline rapidly at any time, you place a stop order to sell at $30. If the stock price does in fact drop to $30, the market maker will sell the 100 shares at the best price available at that time. If the market price declines to $28 by the time your stop-loss order comes up, you will receive less than $30 per share. Of course, if the market price stays above $30 per share, you will have lost nothing as a result of placing the order because the stop order will never be initiated. Often investors raise the level of the stop as the price of the stock rises. Such action helps to lock in a higher profit when the price is increasing.

Investors can also place stop orders to buy a stock, although buy orders are far less common than sell orders. For example, you may place a stop order to buy 100 shares of MJ Enterprises, currently selling for $70 per share, once its price rises to, say, $75 (the stop price). These orders are commonly used either to limit losses on short sales (discussed in  Chapter 2 ) or to buy a stock just as its price begins to rise.

An Advisor’s Perspective

Ryan McKeown Senior VP–Financial Advisor, Wealth Enhancement Group

“I encourage clients to use limit and stop-loss orders.”

MyFinanceLab

To avoid the risk of the market moving against you when your stop order becomes a market order, you can place a stop-limit order rather than a plain stop order. This is an order to buy or sell stock at a given or better price once a stipulated stop price has been met. For example, in the Ballard Industries example, had a stop-limit order been in effect, then when the market price of Ballard dropped to $30, the broker would have entered a limit order to sell your 100 shares at $30 a share or better. Thus you would have run no risk of getting less than $30 a share for your stock—unless the price of the stock kept right on falling. In that case, as is true for any limit order, you might miss the market altogether and end up with stock worth much less than $30. Even though the stop order to sell was triggered (at $30), the stock will not be sold, with a stop-limit order, if it keeps falling in price.

Online Transactions

The competition for your online business increases daily as more players enter an already crowded arena. Brokerage firms are encouraging customers to trade online and offering a variety of incentives to get their business, including free trades! However, low cost is not the only reason to choose a brokerage firm. As with any financial decision, you must consider your needs and find the firm that matches them. One investor may want timely information, research, and quick, reliable trades from a full-service broker like Bank of America or a premium discounter like Charles Schwab or TD Ameritrade. Another, who is an active trader, will focus on cost and fast trades rather than research and so will sign up with a basic discounter like Firstrade or Wall Street*E. Ease of site navigation is a major factor in finding a basic discount broker to use in executing online transactions. Some online brokers also offer online trading of bonds and mutual funds.

Day Trading

For some investors, online stock trading is so compelling that they become day traders. The opposite of buy-and-hold investors with a long-term perspective,  day traders  buy and sell stocks quickly throughout the day. They hope that their stocks will continue to rise in value for the very short time they own them—sometimes just seconds or minutes—so they can make quick profits. Some also sell short, looking for small price decreases. True day traders do not own stocks overnight—hence the term “day trader”—because they believe that the extreme risk of prices changing radically from day to day will lead to large losses.

Day trading is not illegal or unethical, but it is highly risky. To compound their risk, day traders usually buy on margin in order to leverage their potential profits. But as we already know, margin trading also increases the risk of large losses.

Because the Internet makes investment information and transactions accessible to the masses, day trading has grown in popularity. It’s a very difficult task—essentially a very stressful, full-time job. Although sales pitches for day trading make it seem like an easy route to quick riches, quite the reverse is more generally true. About twice as many day traders lose money as make money. In addition, they have high expenses for brokerage commissions, training, and computer equipment. They must earn sizable trading profits annually to break even on fees and commissions alone. Some never achieve profitability.

Technical and Service Problems

As the number of online investors increases, so do the problems that beset brokerage firms and their customers. During the past few years most brokerage firms have upgraded their systems to reduce the number of service outages. But the potential problems go beyond the brokerage sites. Once an investor places a trade at a firm’s website, it goes through several other parties to be executed. Most online brokers don’t have their own trading desks and have agreements with other trading firms to execute their orders on the New York Stock Exchange or Nasdaq Stock Market. Slowdowns at any point in the process can create problems confirming trades. Investors, thinking that their trades had not gone through, might place the order again—only to discover later that they have bought the same stock twice. Online investors who don’t get immediate trade execution and confirmation use the telephone when they can’t get through online or to solve other problems with their accounts, and they often face long waiting times on hold.

Tips for Successful Online Trades

Successful online investors take additional precautions before submitting their orders. Here are some tips to help you avoid some common problems:

Watch Your Behavior

What’s in a Name? Confusion over ticker symbols can cause investors to make embarrassing and costly mistakes. One study discovered that investors who intended to buy shares in a company called MCI Communications (which was widely known simply by the initials MCI but traded under the ticker symbol MCIC) mistakenly purchased shares in Massmutual Corporate Investors. The reason for this error was that Massmutual’s ticker symbol is MCI. More recently, FINRA changed the ticker symbol of Tweeter Home Entertainment Group, which previously had been TWTRQ, to avoid confusion with Twitter. Just after Twitter announced its plan to go public in an IPO, trading in TWTRQ soared and its price rose 1,400%.

(Source: “Massively Confused Investors Making Conspicuously Ignorant Choices (MCI-MCIC),” Journal of Finance, October 2001.)

· Know how to place and confirm your order before you begin trading. This simple step can keep you from having problems later.

· Verify the stock symbol of the security you wish to buy. Two very different companies can have similar symbols. Some investors have bought the wrong stock because they didn’t check before placing their order.

· Use limit orders. The price you see on your computer screen may not be the one you get. With a limit order, you avoid getting burned in fast-moving markets. Although limit orders cost more, they can save you thousands of dollars. For example, it is not uncommon for customers eager to get shares of a hot IPO stock to place market orders. Instead of buying the stock near the offering price in the IPO prospectus, these customers may be shocked to find that their orders are filled at much higher prices during the stock’s first trading day. Investors who learn of the price run-up and try to cancel orders may not always be able to get through to brokers. Because of this, some brokers accept only limit orders for online IPO purchases on the first day of trading.

· Don’t ignore the online reminders that ask you to check and recheck. It’s easy to make a typo that adds an extra digit to a purchase amount.

· Don’t get carried away. It’s easy to churn your own account. In fact, new online investors trade about twice as much as they did before they went online. To control impulse trading, have a strategy and stick to it.

· Open accounts with two brokers. This protects you if your online brokerage’s computer system crashes. It also gives you an alternative if one brokerage is blocked with heavy trading volume.

· Double-check orders for accuracy. Make sure each trade was completed according to your instructions. It’s very easy to make typos or use the wrong stock symbol, so review the confirmation notice to verify that the right number of shares was bought or sold and that the price and commissions or fees are as quoted. Check your account for “unauthorized” trades.

Transaction Costs

Making transactions through brokers or market makers is considerably easier for investors than it would be to negotiate directly, trying to find someone who wants to buy what you want to sell (or vice versa). To compensate the broker for executing the transaction, investors pay transaction costs, which are usually levied on both the purchase and the sale of securities. When making investment decisions, you must consider the structure and magnitude of transaction costs because they affect returns.

Since the passage of the Securities Acts Amendments of 1975, brokers have been permitted to charge whatever brokerage commissions they deem appropriate. Most firms have established  fixed commissions  that apply to small transactions, the ones most often made by individual investors. On large institutional transactions, the client and broker may arrange a negotiated commission—a commission to which both parties agree.  Negotiated commissions  are also available to individual investors who maintain large accounts, typically above $50,000. The commission structure varies with the type of security and the type of broker. In subsequent chapters we’ll describe the basic commission structures for various types of securities.

Because of the way brokerage firms charge commissions on stock trades, it is difficult to compare prices precisely. Traditional brokers generally charge on the basis of number of shares and the price of the stock at the time of the transaction. Internet brokers usually charge flat rates, often for transactions up to 1,000 shares, with additional fees for larger or more complicated orders. However, many traditional brokerage firms have reduced their commissions on broker-assisted trades and have instituted annual flat fees (on wrap accounts) set as a specified percentage of the value of the assets in the account. Unless you are a very active trader, you are probably better off paying commissions on a per-transaction basis.

Obviously, premium and basic discount brokers charge substantially less than full-service brokers for the same transaction. However, some discounters charge a minimum fee to discourage small orders. The savings from the discounter can be substantial. Depending on the size and type of transaction, premium and basic discount brokers can typically save investors between 30% and 80% of the commission charged by the full-service broker.

Investor Protection: SIPC and Arbitration

Although most investment transactions take place safely, it is important to know what protection you have if things don’t go smoothly. As a client, you are protected against the loss of the securities or cash held by your broker. The  Securities Investor Protection Corporation (SIPC) , a nonprofit membership corporation, was authorized by the Securities Investor Protection Act of 1970 to protect customer accounts against the consequences of financial failure of the brokerage firm. The SIPC currently insures each customer’s account for up to $500,000, with claims for cash limited to $250,000 per customer. Note that SIPC insurance does not guarantee that the investor will recover the dollar value of the securities. It guarantees only that the securities themselves will be returned. Some brokerage firms also insure certain customer accounts for amounts in excess of $500,000. Certainly, in light of the diversity and quality of services available among brokerage firms, this may be an additional service you should consider when you select a firm and an individual broker.

The SIPC provides protection in case your brokerage firm fails. But what happens if your broker gave you bad advice and, as a result, you lost a lot of money on an investment? Or what if you feel your broker is churning your account? In either case, the SIPC won’t help. It’s not intended to insure you against bad investment advice or churning. Instead, if you have a dispute with your broker, the first thing you should do is discuss the situation with the managing officer at the branch where you do business. If that doesn’t resolve the problem, then contact the firm’s compliance officer and the securities regulator in your home state.

If you still don’t get any satisfaction, you can use litigation (judicial methods in the courts) to resolve the dispute. Alternative dispute-resolution processes that may avoid litigation include mediation and arbitration.  Mediation  is an informal, voluntary approach in which you and the broker agree to a professional mediator, who facilitates negotiations between the two of you to resolve the case. The mediator does not impose a solution on you and the broker. The Financial Industry Regulatory Authority and securities-related organizations encourage investors to mediate disputes rather than arbitrate them because mediation can reduce costs and time for both investors and brokers.

If mediation is not pursued or if it fails, you may have no choice but to take the case to  arbitration , a formal process whereby you and your broker present the two sides of the argument before an arbitration panel. The panel then decides the case. Many brokerage firms require you to resolve disputes by binding arbitration; in this case, you don’t have the option to sue. You must accept the arbitrator’s decision, and in most cases you cannot go to court to resolve your case. Before you open an account, check whether the brokerage agreement contains a binding-arbitration clause.

Mediation and arbitration proceedings typically cost less and are resolved more quickly than litigation. Recent legislation has given many investors the option of using either securities industry panels or independent arbitration panels such as those sponsored by the American Arbitration Association (AAA). Independent panels are considered more sympathetic toward investors. In addition, only one of the three arbitrators on a panel can be connected with the securities industry. On its website, FINRA reports that in 2014 it brought 1,397 disciplinary actions against registered brokers and firms, levied $134 million in fines, and ordered $32.3 million in restitution to harmed investors.

Probably the best thing you can do to avoid the need to mediate, arbitrate, or litigate is to select your broker carefully, understand the financial risks involved in the broker’s recommendations, thoroughly evaluate the advice he or she offers, and continuously monitor the volume of transactions that he or she recommends and executes. Clearly, it is much less costly to choose the right broker initially than to incur later the financial and emotional costs of having chosen a bad one.

If you have a problem with an online trade, immediately file a written—not e-mail—complaint with the broker. Cite dates, times, and amounts of trades, and include all supporting documentation. File a copy with the Financial Industry Regulatory Authority ( http://www.finra.org ) and with your state securities regulator. If you can’t resolve the problems with the broker, you can try mediation and then resort to arbitration, with litigation being the last resort.

Concepts in Review

Answers available at  http://www.pearsonhighered.com/smart

1. 3.13 Describe the types of services offered by brokerage firms, and discuss the criteria for selecting a suitable stockbroker.

2. 3.14 Briefly differentiate among the following types of brokerage accounts:

a. Single or joint

b. Custodial

c. Cash

d. Margin

e. Wrap

3. 3.15 Differentiate among market orders, limit orders, and stop-loss orders. What is the rationale for using a stop-loss order rather than a limit order?

4. 3.16 Differentiate between the services and costs associated with full-service, premium discount, and basic discount brokers. Be sure to discuss online transactions.

5. 3.17 What is day trading, and why is it risky? How can you avoid problems as an online trader?

6. 3.18 In what two ways, based on the number of shares transacted, do brokers typically charge for executing transactions? How are online transaction fees structured relative to the degree of broker involvement?

7. 3.19 What protection does the Securities Investor Protection Corporation (SIPC) provide for securities investors? How are mediation and arbitration procedures used to settle disputes between investors and their brokers?

Investment Advisors and Investment Clubs

1. LG 6

Many investors feel that they have neither the time nor the expertise to analyze financial information and make decisions on their own. Instead, they turn to an  investment advisor , an individual or firm that provides investment advice, typically for a fee. Alternatively, some small investors join  investment clubs . Here we will discuss using an investment advisor and then briefly cover the key aspects of investment clubs.

Using an Investment Advisor

The “product” provided by an investment advisor ranges from broad, general advice to detailed, specific analyses and recommendations. The most general form of advice is a newsletter published by the advisor. These letters comment on the economy, current events, market behavior, and specific securities. Investment advisors also provide complete individualized investment evaluation, recommendation, and management services.

Regulation of Advisors

The Investment Advisors Act of 1940 ensures that investment advisors make full disclosure of information about their backgrounds, conflicts of interest, and so on. The act requires professional advisors to register and file periodic reports with the SEC. A 1960 amendment permits the SEC to inspect the records of investment advisors and to revoke the registration of those who violate the act’s provisions. However, financial planners, stockbrokers, bankers, lawyers, and accountants who provide investment advice in addition to their main professional activity are not regulated by the act. Many states have also passed similar legislation, requiring investment advisors to register and to abide by the guidelines established by the state law.

Be aware that the federal and state laws regulating the activities of professional investment advisors do not guarantee competence. Rather, they are intended to protect the investor against fraudulent and unethical practices. It is important to recognize that, at present, no law or regulatory body controls entrance into the field. Therefore, investment advisors range from highly informed professionals to totally incompetent amateurs. Advisors who possess a professional designation are usually preferred because they have completed academic courses in areas directly or peripherally related to the investment process. Such designations include CFA (Chartered Financial Analyst), CIMA (Certified Investment Management Analyst), CIC (Chartered Investment Counselor), CFP® (Certified Financial Planner™), ChFC (Chartered Financial Consultant), CLU (Chartered Life Underwriter), and CPA (Certified Public Accountant).

Online Investment Advice

You can also find investment advice online. Whether it’s a retirement planning tool or advice on how to diversify your assets, automated investment advisors may be able to help you. If your needs are specific rather than comprehensive, you can find good advice at other sites. For example, T. Rowe Price has an excellent college planning section ( http://www.troweprice.com/college ). Financial Engines ( http://www .financialengines.com ), AdviceAmerica ( http://www.adviceamerica.com ), and DirectAdvice ( http://www.directadvice.com ) are among several independent advice sites that offer broader planning capabilities. Many mutual fund websites have online financial advisors. For example, The Vanguard Group ( http://www.vanguard.com ) has a personal investors section that helps you choose funds for specific investment objectives, such as retirement or financing a college education.

Investor Facts

You can lead a horse to water, but you can’t make it drink In an interesting experiment, a large German brokerage house offered free, unbiased (i.e., unrelated to the brokerage’s monetary incentives) financial advice to a pool of more than 8,000 randomly selected clients. Only 5% of the firm’s clients accepted the offer, and on average they were wealthier than clients who didn’t accept the offer. In other words, it appears that the investors who most needed financial advice were least likely to accept it.

(Source: “Is Unbiased Financial Advice to Retail Investors Sufficient? Answers from a Large Field Study,” Review of Financial Studies, Vol. 25, Issue 4, pp. 975–1032.)

The Cost and Use of Investment Advice

The annual costs of obtaining professional investment advice typically run between 0.25% and 3% of the dollar amount of money being managed. For large portfolios, the fee is typically in the range of 0.25% to 0.75%. For small portfolios (less than $100,000), an annual fee ranging from 2% to 3% of the dollar amount of funds managed would not be unusual. These fees generally cover complete management of a client’s money. The cost of periodic investment advice not provided as part of a subscription service could be based on a fixed-fee schedule or quoted as an hourly charge for consultation. Online advisors are much less expensive; they either are free or charge an annual fee.

Whether you choose a traditional investment advisory service or decide to try an online service, some are better than others. More expensive services do not necessarily provide better advice. It is best to study carefully the track record and overall reputation of an investment advisor before purchasing his or her services. Not only should the advisor have a good performance record, but he or she also should be responsive to your personal goals.

How good is the advice from online advisors? It’s very hard to judge. Their suggested plans are only as good as the input. Beginning investors may not have sufficient knowledge to make wise assumptions on future savings, tax, or inflation rates or to analyze results thoroughly. A good face-to-face personal financial planner will ask lots of questions to assess your investing expertise and explain what you don’t know. Automated tools for these early-stage questions may take too narrow a focus and not consider other parts of your investment portfolio. For many investors, online advisors lack what leads them to get help in the first place—the human touch. They want personal guidance, expertise, and encouragement to follow through on their plans.

Investment Clubs

Another way to obtain investment advice and experience is to join an investment club. This route can be especially useful for those of moderate means who do not want to incur the cost of an investment advisor. An investment club is a legal partnership binding a group of investors (partners) to a specified organizational structure, operating procedure, and purpose. The goal of most clubs is to earn favorable long-term returns by making investments in accordance with the group’s investment objectives.

Individuals with similar goals usually form investment clubs to pool their knowledge and money in a jointly owned and managed portfolio. Certain members are responsible for obtaining and analyzing data on a specific investment strategy. At periodic meetings, the members present their findings for discussion and further analysis by the members. Once discussed, the group decides whether to pursue the proposed strategy. Most clubs require members to make scheduled contributions to the club’s treasury, thereby regularly increasing the pool of investable funds. Although most clubs concentrate on investments in stocks and bonds, some may concentrate on specialized investments such as options or futures. Membership in an investment club provides an excellent way for the novice investor to learn the key aspects of portfolio construction and investment management while (one hopes) earning a favorable return on his or her funds.

Investor Facts

Too Many Cooks? Though investment clubs are a popular way to learn about investing, research shows that investment clubs, on average, do not perform especially well. One study examined the results of 166 investment clubs and found that they earned average returns that trailed broad market indexes by 3% per year.

(Source: Brad M. Barber & Terrance Odean, 2000. “Too Many Cooks Spoil the Profits: The Performance of Investment Clubs.” Financial Analyst Journal (January/February 2000), 17–25.)

As you might expect, investment clubs have also joined the online investing movement. By tapping into the Internet, clubs are freed from geographical restrictions. Now investors around the world, many who have never met, can form a club and discuss investing strategies and stock picks just as easily as if they gathered in person. Finding a time or place to meet is no longer an issue. Some clubs are formed by friends. Other clubs are made up of people who have similar investing philosophies and may have met online. Online clubs conduct business via e-mail or set up a private website. Members of the Better Investing Community, a not-for-profit organization, have access to educational materials, investment tools, and other investment features.

Better Investing, which has over 200,000 individual and club investors and over 16,000 investment clubs, publishes a variety of useful materials and also sponsors regional and national meetings. To learn how to start an investment club, visit the Better Investing website.

Concepts in Review

Answers available at  http://www.pearsonhighered.com/smart

1. 3.20 Describe the services that professional investment advisors perform, how they are regulated, online investment advisors, and the cost of investment advice.

2. 3.21 What benefits does an investment club offer the small investor? Would you prefer to join a regular or an online club, and why?

MyFinanceLab

Here is what you should know after reading this chapter. will help you identify what you know and where to go when you need to practice.

What You Should Know	Key Terms	Wheat to Practice
LG 1 Discuss the growth in online investing and the pros and cons of using the Internet as an investment tool. The Internet has empowered individual investors by providing information and tools formerly available only to investing professionals and by simplifying the investing process. The time and money it saves are huge. Investors get the most current information, including real-time stock price quotes, market activity data, research reports, educational articles, and discussion forums. Tools such as financial planning calculators, stock-screening programs, charting, stock quotes, and portfolio tracking are free at many sites. Buying and selling securities online is convenient, relatively simple, inexpensive, and fast.		MyFinanceLab Study Plan 3.1
LG 2 Identify the major types and sources of investment information. Investment information, descriptive or analytical, includes information about the economy and current events, industries and companies, and alternative investment vehicles, as well as price information and personal investment strategies. It can be obtained from financial journals, general newspapers, institutional news, business periodicals, government publications, special subscription services, stockholders’ reports, comparative data sources, subscription services, brokerage reports, investment letters, price quotations, and electronic and online sources. Most print publications also have websites with access to all or part of their content. Financial portals bring together a variety of financial information online. Investors will also find specialized sites for bond, mutual fund, and international information, as well as discussion forums that discuss individual securities and investment strategies. Because it is hard to know the qualifications of those who make postings on message boards, participants must do their own homework before acting on an online tip.	1. analytical information,  p.  80 2. back-office research reports,  p.  89 3. Barron’s,  p.  83 4. descriptive information,  p.  80 5. fair disclosure rule (Regulation FD),  p.  84 6. financial portals,  p.  90 7. Form 10-K,  p.  85 8. investment letters,  p.  89 9. Mergent,  p.  89 10. quotations,  p.  89 11. Standard & Poor’s Corporation (S&P),  p.  88 12. stockholders’ (annual) report,  p.  85 13. Value Line Investment Survey,  p.  89 14. Wall Street Journal,  p.  82	MyFinanceLab Study Plan 3.2
LG 3 Explain the key aspects of the commonly cited stock and bond market averages and indexes. Investors commonly rely on stock market averages and indexes to stay abreast of market behavior. The most often cited are the Dow Jones averages, which include the Dow Jones Industrial Average (DJIA). Also widely followed are the Standard & Poor’s indexes, the NYSE Composite Index, the NYSE MKT Composite Index, the Nasdaq Stock Market indexes, and the Value Line indexes. Numerous other averages and indexes, including a number of global and foreign market indexes, are regularly reported in financial publications. Bond market indicators are most often reported in terms of bond yields and bond indexes. The Dow Jones Corporate Bond Index is among the most popular. Yield and price index data are also available for various types of bonds and various domestic and foreign markets. Both stock and bond market statistics are published daily in the Wall Street Journal and summarized weekly in Barron’s.	1. averages,  p.  94 2. bond yield,  p.  99 3. Dow Jones Corporate Bond Index,  p.  99 4. Dow Jones Industrial Average (DJIA),  p.  94 5. indexes,  p.  94 6. Nasdaq Stock Market indexes,  p.  98 7. NYSE Composite Index,  p.  98 8. Standard & Poor’s 500 Stock Index,  p.  96 9. Value Line Composite Index,  p.  98	MyFinanceLab Study Plan 3.3 Video Learning Aid for Problem P3.2
LG 4 Review the role of stockbrokers, including the services they provide, selection of a stockbroker, opening an account, and transaction basics. Stockbrokers facilitate buying and selling of securities, and provide other client services. An investor should select a stockbroker who has a compatible disposition toward investing and whose firm offers the desired services at competitive costs. Today the distinctions among full-service, premium discount, and basic discount (online) brokers are blurring. Most brokers now offer online trading capabilities, and many no-frills brokers are expanding their services to include research and advice. Investors can open a variety of types of brokerage accounts, such as single, joint, custodial, cash, margin, and wrap. Transactions take place in odd lots (less than 100 shares) or round lots (100 shares or multiples thereof).	1. basic discount broker,  p.  101 2. cash account,  p.  103 3. churning,  p.  102 4. custodial account,  p.  103 5. full-service broker,  p.  101 6. margin account,  p.  103 7. odd lot,  p.  104 8. premium discount broker,  p.  101 9. round lot,  p.  104 10. stockbrokers,  p.  100 11. street name,  p.  101 12. wrap account,  p.  104	MyFinanceLab Study Plan 3.4
LG 5 Describe the basic types of orders, online transactions, transaction costs, and the legal aspects of investor protection. A market order is an order to buy or sell stock at the best price available. A limit order is an order to buy at a specified price or below, or to sell at a specified price or above. Stop-loss orders become market orders as soon as the minimum sell price or the maximum buy price is hit. Limit and stop-loss orders can be placed as fill-or-kill orders, day orders, or good-’til-canceled (GTC) orders. On small transactions, most brokers have fixed commission schedules; on larger transactions, they will negotiate commissions. Commissions also vary by type of security and type of broker. The Securities Investor Protection Corporation (SIPC) insures customers’ accounts against the brokerage firm’s failure. Mediation and arbitration procedures are frequently employed to resolve disputes. These disputes typically concern the investor’s belief that the broker either gave bad advice or churned the account.	1. arbitration,  p.  109 2. day trader,  p.  106 3. fixed commissions,  p.  108 4. limit order,  p.  104 5. market order,  p.  104 6. mediation,  p.  109 7. negotiated commissions,  p.  108 8. Securities Investor Protection Corporation (SIPC),  p.  108 9. stop-loss (stop) order,  p.  105	MyFinanceLab Study Plan 3.5 Video Learning Aid for Problem P3.10
LG 6 Discuss the roles of investment advisors and investment clubs. Investment advisors charge an annual fee ranging from 0.25% to 3% of the dollar amount being managed and are often regulated by federal and state law. Websites that provide investment advice are now available as well. Investment clubs provide individual investors with investment advice and help them gain investing experience. Online clubs have members in various geographical areas and conduct business via e-mail or at a private website.	1. investment advisor,  p.  110 2. investment club,  p.  110	MyFinanceLab Study Plan 3.6

Log into MyFinanceLab, take a chapter test, and get a personalized Study Plan that tells you which concepts you understand and which ones you need to review. From there, will give you further practice, tutorials, animations, videos, and guided solutions. Log into  http://www.myfinancelab.com