Answers to Concepts in Review

Transcription

1 Answers to Concepts in Review 1. In addition to providing low cost investing, the Internet supplies a multitude of information sources designed to assist the individual investor in the decision making process. Investment education sites range from the tutorials and online classes that educate the novice investors to the financial calculators and worksheets used by experienced investors. 2. The four types of online investment tools are as follows: (a) Planning. Online calculators and worksheets help you find answers to your financial planning and investing questions. (b) Screening. Screening tools help you sort through huge databases of stocks and mutual funds to find those that have specific characteristics. (c) Charting. This technique allows you to plot the performance of a stock or a group of stocks over a specified time period. (d) Stock Quotes and Portfolio Tracking. This tool allows the investor to track his or her investment, to be alerted whenever an analyst changes the rating, or to indicate how well the portfolio is diversified among major asset classes. 3. As for the advantages of online investing, it is now possible for even novice investors to participate in the stock markets with a huge amount of information available at their fingertips to assist in making their decisions to invest. On the con side, trading on the Internet requires that investors exercise the same caution they would if they were getting information from a human broker. Furthermore, you don t have the safety net of dealing with a human who may be suggesting that you exercise additional caution. The ease of the point-and-click investing can be the financial downfall of inexperienced investors. Transaction costs add up and margin trading results in interest payments on the loan that will reduce possible gains. 4. Descriptive information is factual information on past behavior of the economy, the market, or a given investment vehicle. Analytical information, on the other hand, tends to analyze existing data and make projections and is quite often a source of recommendations for potential investments. The investor must evaluate whether the costs of acquiring the information are justified by the potential increase in return. There are either direct or indirect costs associated with information gathering. Direct costs include subscription fees and advisor s fees. Indirect costs include the time involved to gather information. 5. The Wall Street Journal, published by the Dow Jones, is perhaps the most popular source of financial news in this country. Published daily, it provides daily price quotations on a multitude of securities. It also has a wealth of world reports, national reports, and regional and corporate news. Regular features, like Your Money Matters, address topics of interest to individual investors. Barron s, on the other hand, is a weekly publication also published by Dow Jones. However, the articles in Barron s are generally more in-depth and directed to financial issues than those in The Wall Street Journal. Barron s also has special interest columns like Up and Down Wall Street. In addition, there are current price quotations and summary statistics on a wider variety of investment vehicles. Other sources of financial news include Investor s Business Daily and the Financial Times.

2 General news is available from a variety of published sources, especially daily newspapers in the local community. Many business people also rely on daily papers that have national reputations in the political and economic arena such as The New York Times and the Los Angeles Times. USA Today is a national daily newspaper containing a Money section devoted to business and personal financial news. Time and Newsweek are also major periodicals in the general news category. Business news articles and statistics on general business and economic activities in the United States and abroad can be found in The Wall Street Journal and in such magazines as Newsweek, Time, U.S. News & World Report, BusinessWeek, Fortune, The Economist, Federal Reserve Bulletin, and the Survey of Current Business. A variety of articles discussing the activities of securities markets and corporations can be found in The Wall Street Journal, Barron s, Investor s Business Daily, Forbes, Kiplinger s Personal Finance, Money, and Smart Money. The last three are oriented toward individual investors and managing personal finances. Local metropolitan newspapers also provide information on securities of local interest. There has been a blurring of the distinctions between print sources and online sources, because many of the print sources now make their information available online. Two advantages of the online sources is the limited amount of advertising and ability to be continually updated. Of course, online sources generally require readers to be at a terminal, and carrying a computer with you is not as convenient as simply grabbing the printed material. 6. (a) The stockholder s report, also called the annual report, is an annual publication of publicly held corporations. These reports are usually free and contain a wealth of descriptive and analytical information, including financial statements, about the firm. Stockholder reports are just one of the pieces of information that can be downloaded from company web sites. (b) Comparative data sources enable investors to analyze the financial condition of companies and are typically grouped by industry and size of firm. These include Dun & Bradstreet s Key Business Ratios, RMA s Annual Statement Studies, the Quarterly Financial Report for U.S. Manufacturing, Mining, and Wholesale Trade Corporations, and the Almanac of Business & Industrial Financial Ratios. (c) Standard and Poor s Stock Reports is a major service of the Standard and Poor s Corporation. It contains up-to-date reports on numerous firms, including a summary of the firm s financial history, its current financial situation, and for NYSE companies, an opinion on the firm s future prospects. (d) Mergent provides detailed financial information on companies and industries. (e) Value Line Investment Survey offers ratings for all widely held stocks with full-page reports including financial data, descriptions, analysis, and advice. 7. (a) The prospectus is part of the registration statement required by the SEC on a new security issue. It describes in detail the key aspects of the issuer, its management and financial position, and the security to be issued. Brokerage firms provide prospectuses at no cost to their clients. (Note: This information source is available only when a firm is making an issue of new securities.)

3 (b) Back office research reports present analyses and recommendations on the current and future prospects for the security markets, specific industries, and specific securities. These are prepared by brokerage firm research staffs and are available (usually free of charge) to existing as well as potential clients. Several information vendors, such as Reuters and Zacks, consolidate research from many companies and put it on the web. (c) Investment letters provide the conclusions and recommendations of various analysts. Common examples of investment letters are Blue Chip Advisor, The Dines Letter, Dow Theory Letters, the Growth Stock Outlook, and Zack s Advisor. Although some investment letters concentrate on specific types of securities, others are concerned solely with assessing the economy and/or security markets. The cost varies between $75 and $400 per year for a subscription to these (generally) weekly or monthly letters. The Hulbert Financial Digest monitors the performance of investment letters. (d) Price quotations include the current prices and price statistics for various types of securities. Almost all brokerage houses have automated devices for obtaining up-to-the-minute quotations. Many firms still use a ticker, a lighted screen on which stock transactions made on the floor of the exchange are reported immediately as they occur. The stock names are shown in an abbreviated form called ticker symbols. Recently, more firms have acquired sophisticated computer terminals to more efficiently provide up-to-the-minute stock price information. The most common sources of such information, however, are the daily newspaper and The Wall Street Journal, which contains current quotations on numerous investment vehicles. Barron s and Investor s Daily also provide a wealth of security price quotations, which is especially useful for bond quotations. 8. Electronic and on-line investment information allows individual investors to get timely historical and current information such as stock quotes and economic and financial information. In addition, investors may use their personal computer (PC) to access CD-ROM and diskettes for investment information, financial data, and/or analysis software. Most of the online services charge initial, monthly, and/or usage fees. Charges sometimes vary depending on the time of day the service is accessed. Table 3.4 provides a listing of popular sites and a description of the unique data found there. 9. Stock market averages and indexes are used to measure the general behavior of securities markets. Averages reflect the arithmetic average price behavior of a certain group of stocks at a given point in time, whereas indexes measure the current price behavior of the group relative to a base value set at an earlier point in time. Averages and indexes provide a convenient way of capturing the general mood of the market. When the averages or indexes reflect an upward trend in prices, a bull market is said to exist. Likewise, when these measures exhibit a downward trend, a bear market exists. 10. (a) The four Dow Jones Averages include the Dow Jones Industrial Average (thirty widelyheld stocks issued by large firms), the Dow Jones Transportation Average (twenty transportation stocks), the Dow Jones Utility Average (fifteen public utility stocks), and the Dow Jones U.S. Total Market Index (includes all of the above).

4 (b) The six Standard and Poor s (S&P) Indexes include the S&P 400 Industrial Index (400 industrial firms), the Transportation Index (twenty transportation companies), the Utilities Index (forty public utility stocks), the Financials Index (forty financial stocks), the Composite Index (includes the five hundred stocks in the S&P indexes mentioned above), the MidCap Index (four hundred medium-sized companies), the SmallCap index (made up of six hundred small-sized companies); and the fifteen hundred SuperComp index, which includes all stocks in the Composite, MidCap, and SmallCap indexes. Nearly all these indexes can be found in financial newspapers such as The Wall Street Journal, Barron s, Investor s Business Daily, and local newspapers in major metropolitan areas. 11. (a) The New York Stock Exchange Index includes the 2,100 stocks listed on the New York Stock Exchange. It is calculated in a manner similar to the S&P Indexes. This index reflects the value of the stocks listed on the NYSE relative to a base of 5000 set on December 31, (b) The American Stock Exchange Index reflects the price of shares on the American Stock Exchange relative to a base of 550 set on December 29, (c) The Nasdaq Stock Market Indexes reflect the behavior of the Nasdaq stock market. The most popular, the Nasdaq Composite Index is calculated using more than 4,000 domestic common stocks traded on the Nasdaq system. The index is based on a value of 100 set on February 5, Another popular Nasdaq index is the Nasdaq 100, which includes one hundred of the largest domestic and international non-financial companies that are listed on the Nasdaq. (d) The Value Line Composite Average includes the approximately 1,700 stocks in the Value Line Investment Survey and traded on a broad cross section of exchanges as well as in the over-the-counter market. The base of 100 reflects the June 30, 1961, average of the stocks. 12. (a) Bond yields capture the behavior of market interest rates and represent a type of summary measure of the return an investor would receive on a bond if it were held to maturity. Barron s quotes the yields on the Dow Jones bond average of ten high-grade corporate bonds and ten medium-grade corporate bonds, a ratio of the high-grade yield to the medium-grade yield is calculated and known as the confidence index. (b) The Dow Jones Corporate Bond Index, quoted in The Wall Street Journal and Barron s, is the mathematical average of the closing prices of thirty-two industrial, thirty-two financial, and thirty-two utility/telecom bonds. 13. Stockbrokers help investors buy and sell securities. Besides this major role, full-service stockbrokers provide clients with several other benefits. For example, most brokerage firms offer their clients a wide variety of information. Many of them have research staffs that periodically review published economic, market, industry, or company behavior forecasts and make recommendations to their clients as to which securities they should buy or sell. Every month they mail investors a record of transactions for that month with a total ending balance. Some brokerage firms also make arrangements to transfer funds from the sale of securities directly to an investor s savings account, where the funds can earn interest. Many brokers have reference libraries that clients can use to research securities. They can provide up-to-the-minute stock price quotations. Many brokerage firms will also hold certificates for safekeeping to protect against loss.

5 The major role of a stockbroker is to execute a client s transactions at the best possible price. While it is not necessary to know your stockbroker personally, he or she should understand your investment goals. This should avoid potential conflicts. You should also make sure that the broker does not charge you too much for the services provided, and that you are not paying for services that you do not need. 14. (a) A brokerage account may be either single or joint. Joint accounts are typically between married couples or between parent and child. (b) A custodial account is one in which a parent or a guardian will take responsibility for all transactions undertaken on behalf of a minor. (c) A cash account is one in which a customer can only use cash to make transactions. This is perhaps the most common type of account. (d) A customer who wishes to trade in securities using borrowed money establishes a margin account. By leaving the securities with the brokerage firm as collateral, the customer can borrow a pre-specified amount to trade in securities. Needless to say, the brokerage firm will first verify the customer s creditworthiness before opening a margin account in that customer s name. (e) A wrap account is an account in which customers with large portfolios pay the brokerage firm a flat annual fee, typically between 2 and 3 percent of their portfolio s total asset value, to cover the combined costs of a money manager s services and the cost of commissions on their trades. These accounts allow the wealthy investor to conveniently shift the burden of stock-selection decisions to a professional either inhouse or independent money manager. 15. A market order is an order to buy or sell a security at the best price available at the time the order is placed. It is the quickest way to make securities transactions. A limit order is an order to buy stock at or below or to sell stock at or above a specified price. It is best used when securities prices fluctuate widely. A stop-loss order is an order to buy or sell the stock when its market price reaches or drops below a specified level. It is used primarily by investors who wish to protect themselves from a rapid decline in the price of the stock. The stop-loss order gives them the opportunity to sell the stock when the price declines to the stop price, thereby reducing their potential losses. It becomes a market order and may in fact be executed at a lower price than the price at which the order was initiated. 16. Typically, brokers charge fixed commissions in return for facilitating the purchase or sale of securities. Negotiated commissions are also available to investors who maintain large accounts with the broker. The commissions usually vary depending on the services the broker provides to the investor. The major difference between a full-service and discount broker is the full-service broker provides investment advice. Because investing through a discount or deep-discount broker can save from 30 to 80 percent of the commission, the investor must weigh the benefit of advice against the higher commission. Online brokers are typically deep discount brokers through whom investors can execute trades electronically online. These brokers charge very low commissions but offer little or no individualized research, information, or investment advice. Full service brokers provide personalized, timely research and information. Basic discounters provide low costs and fast trades. Premium discount brokers are in between these extremes.

6 17. Day trading is the opposite of a buy-and-hold strategy since true day traders do not even own stocks overnight. The method is highly risky since it often involves margin and short transactions that may result in total loss. In addition, day traders have high expenses for brokerage commissions, training, and computer equipment. There are several important factors you should consider before trading securities. First, know how to place and confirm your order before you begin trading. Second, verify the stock symbol of the security you wish to buy. Third, use limit orders. Fourth, don t ignore the online reminders that ask you to check and recheck. Fifth, don t get carried away. Sixth, open accounts with two brokers. Lastly, double-check orders for accuracy. Many investors set aside an amount of their capital that is designated for purely speculative purposes and not required for day-to-day survival. In this way, they are not jeopardizing themselves or their loved ones if they suffer heavy losses. 18. Most firms use a fixed-commission schedule for individual investors with accounts less than $50,000. Traditional brokers generally charge on the basis of the number of shares and price per share (e.g., market value of the purchase). They sometimes charge an annual management fee and lower commissions. Online brokers, by comparison, charge a flat rate for transactions of up to 1,000 shares. Online investors will pay a surcharge if they seek personalized broker assistance. 19. The Securities Investor Protection Corporation (SPIC), a nonprofit membership corporation, was authorized to protect customer accounts against the consequences of financial failure of the brokerage firm. Mediation is an informal, voluntary approach in which you and the broker agree to a third party who facilitates negotiations between the two of you to resolve disputes. If mediation is not pursued or it fails, you may choose arbitration, a formal process whereby you and your broker present the two sides of the argument before a panel of third party individuals. 20. Investment advisors are individuals or firms who advise clients about portfolio management. This may be done on a discretionary basis, in which case the advisor has complete control over the client s portfolio. In other cases, the advisor provides investment information and advice, and the client makes his or her own investment decisions. Professional investment advisors are required to register and file regular reports with the SEC under the Investment Advisers Act of 1940; a 1960 amendment gave the SEC broader powers to monitor their activities. However, those who provide investment advice in addition to their primary job responsibility such as financial planners, stockbrokers, bankers, and accountants are not regulated by the Act. Many states have similar legislation. It is important to remember that these laws only protect against fraud and unethical practices. They do not provide the investor any indication of the quality of investment advice. Professional investment advice usually costs between one-quarter of 1 percent and 3 percent annually of the amount of money being managed. For larger portfolios, the fee is in the range of one-quarter percent to three-quarters percent; for small portfolios the annual fee ranges from 2 to 3 percent of the dollar amount of funds managed.

7 21. Investment clubs offer the individual investor access to information and/or advice from a broad range of differently experienced people who have similar attitudes, investments strategies, and goals. Also, through the investment club the individual investor can participate in a larger, and probably more diversified, investment portfolio, therefore increasing the probability of earning a favorable return on his or her investments. For the novice investor, a club can provide an excellent mechanism for learning key aspects of portfolio construction and investment management. Investment clubs regularly outperform the market and the professional money managers because they buy stocks for the long term instead of trying to time the market.