Chapter 3

3Online Investing, Information, and Trading

CHAPTER OUTLINE

Learning Goals

I. ONLINE INVESTINGA. The Growth of Online Investing

1. Investment Education Sites2. Investment Tools

a. Planningb. Screeningc. Chartingd. Tracking

3. Using the Internet Wisely

Concepts in Review

II. TYPES AND SOURCES OF INVESTMENT INFORMATIONA. Types of InformationB. Sources of Information

1. Economic and Current Event Informationa. Financial Journalsb. General Newspapersc. Institutional Newsd. Business Periodicalse. Government Publications

49

50 Chapter 3

f. Special Subscription Services2. Industry and Company Information

a. Fair Disclosure Rulesb. Stockholders’ Reportsc. Comparative Data Sourcesd. Subscription Servicese. Brokerage Reportsf. Investment Letters

3. Price Information4. Other Online Investment Information Sources

a. Financial Portalsb. Bond Sitesc. Mutual Fund Sitesd. International Sitese. Investment Discussion Forums

5. Avoiding Online Scams

Concepts in Review

III. UNDERSTANDING MARKET AVERAGES AND INDEXESA. Stock Market Averages and Indexes

1. The Dow Jones Averages2. Standard & Poor’s Indexes3. NYSE, AMEX, and Nasdaq Indexes4. Value Line Indexes5. Other Averages and Indexes

B. Bond Market Indicators1. Bond Yields2. Dow Jones Bond Averages3. NYSE Bond Diary

Concepts in Review

IV. MAKING SECURITIES TRANSACTIONSA. The Role of Stockbrokers

1. Brokerage Services2. Types of Brokerage Firms3. Selecting a Stockbroker4. Opening an Account

Online Investing, Information, and Trading 51

a. Single or Jointb. Cash or Marginc. Wrap

5. Odd-Lot or Round-Lot TransactionsB. Basic Types of Orders

1. Market Order2. Limit Order3. Stop-Loss Order4. Online Transactions

a. Stocks1. Day Trading2. Technical and Service Problems3. Tips for Successful Online Trades

b. Bondsc.Mutual Funds

C. Transaction CostsD. Investor Protection: SIPC and Arbitration

Concepts in Review

V. INVESTMENT ADVISORS AND INVESTMENT CLUBSA. Using Investment Advisors

1. Regulation of Advisors2. Online Investment Advice3. The Cost and Use of Investment Advice

B. Investment Clubs

Concepts in Review

SummaryDiscussion QuestionsProblemsCase Problems

3.1 The Perezes’ Good Fortune3.2 Peter and Deborah’s Choices of Brokers and Advisors

Web Exercises

52 Chapter 3

MAJOR TOPICS

1. The Internet empowers individual investors, provides savings in time and money, and offers current information formerly available only to investing professionals. Tools such as financial planning calculators and more are free, making buying and selling online convenient, relatively simple, inexpensive, and fast.

2. The role, types, and uses of investment information for making investment deci-sions.

3. Some of the key sources of investment information for economic and current events.

4. Sources of information to assess the performance of specific industries/compa-nies.

5. The most commonly cited market averages and indexes, their interpretation, and their use in assessing market conditions.

6. The role of the stockbroker in making security transactions, the types of broker-age services available, and the various types of brokerage accounts.

7. The basic types of orders—market, limit, and stop-loss, their use in making secu-rity transactions, and transaction costs.

8. The products and services offered, regulation, types, and cost of investment advi-sors.

9. The investment club as a device for pooling knowledge and money to create and manage a jointly owned portfolio.

CHAPTER OVERVIEW

1. The Internet and online investing offer the individual investor advantages once enjoyed by only the professional investor. The challenge now is to use the tools offered by the Internet wisely.

2. Investment information is broadly classified into descriptive and analytical infor-mation. It is important that students understand the difference between these two kinds of information and the investor’s need for both types.

3. The chapter next mentions the benefits and costs of obtaining investment informa-tion. The instructor should drive home the point that although an informed in-vestor may perform better in the long run, obtaining and analyzing information costs the investor money and time. Therefore, an investor should analyze the worth of information.

4. Five different types of information are delineated, and the instructor should point out that an investor usually needs all five types. For example, knowledge about a particular company alone would be insufficient for investment decision-making. The investor would also require information about the economy, current events, the industry, and market prices in order to be able to make a good decision.


5. The text mentions a number of specific sources of information, appropriately be-ginning with The Wall Street Journal. Various other financial publications pro-vide information of different types. The instructor might require students to bring their own copies of the WSJ to class and go through various sections with them. This is a good way to demonstrate how to read stock price quotations, as well as bond, option, mutual fund, commodity, and other quotations. The instructor might also find it useful to bring a company stockholder’s report to class and explain its contents.

6. The popular market averages and indices are presented next. Movements in mar-ket averages are important indicators of the state of the economy; the instructor should describe, in class, stock market indices such as the Dow Jones, the S&P, and the NYSE index, specifying what these indices measure, and showing how to find recent listings in the WSJ. The bond yield, which provides additional infor-mation about the market and the economy, should be defined and the listing of various yields pointed out in the WSJ.

7. The next part examines the role of stockbrokers and the services they provide. Students usually encounter difficulties with the concepts of margin trading, mar-ket, limit, stop-loss orders, and short selling. Therefore, the instructor should de-vote adequate time to cover these topics and use examples for clarification.

8. The role of the SIPC in protecting investors and procedures for settling disputes be-tween investors and brokerage firms is explained.

9. The nature and functions of investment advisors are discussed next. The structure and regulation of their activities and the types of information they provide are de-scribed.

KEY CONCEPTS

1. The role of online investing and information provided by the Internet.2. The need for investment information and its relevance to the investment process.3. Types of information available and their sources.4. The structure, use, and popular sources of market averages and indexes for stocks,

bonds, and small investor portfolios.5. The role of brokers and dealers.6. Types of brokerage accounts.7. Market, limit, and stop-loss orders.8. The services, regulation, and costs of professional investment advice, including

investment clubs.

54 Chapter 3

ANSWERS TO CONCEPTS IN REVIEW

3.1 The Internet only a few years ago was used to locate the lowest transaction costs, but today the Internet not only provides low cost investing, but also a multitude of information sources designed to assist the individual investor in the decision mak-ing process.

3.2 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. 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.

3.3 As for the advantages of online investing, it is now possible for even the 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. Fur-thermore, you don’t have the safety net of dealing with a human who may be sug-gesting that you exercise additional caution. The ease of the point-and-click in-vesting can be the financial downfall of inexperienced investors.

3.4 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 in-crease in return. There are either direct or indirect costs associated with informa-tion gathering. Direct costs include subscription fees and advisor’s fees. Indirect costs include the time involved to gather information.


3.5 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 thousands of securities. It also has a wealth of world reports, na-tional 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 is-sues than those in The Wall Street Journal. Barron’s also has special interest col-umns like “Up and Down Wall Street.” In addition, there are current price quota-tions and summary statistics on a variety of investment vehicles. Other sources of financial news include Investor’s Daily, the Commercial and Financial Chronicle and the Journal of Commerce.

General news is available from a variety of published sources, especially daily newspapers in the local community. Many business people also rely on daily pa-pers 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 news-paper containing a “Money” section devoted to business and personal financial news. Time and Newsweek are also major periodicals in the general news cate-gory.

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, Business Week, Fortune, Business Month, Nation’s Business, Federal Reserve Bulletin, and the Survey of Current Business. A variety of articles discussing the activities of secu-rities markets and corporations can be found in The Wall Street Journal, Barron’s, Investor’s Daily, Forbes, Kiplinger’s Personal Finance Magazine, Money, and Smart Money (a new WSJ publication). The last three are oriented toward individ-ual investors and managing personal finances. Local metropolitan newspapers also provide information on securities of local interest

3.6 a. The stockholder’s report, also called the “annual report,” is an annual publica-tion of publicly held corporations. These reports are usually free and contain a wealth of descriptive and analytical information, including financial state-ments, about the firm.

b. Comparative data sources enable investors to analyze the financial condition of companies and are typically grouped by industry and size of firm. These in-clude Dun & Bradstreet’s Key Business Ratios, Robert Morris and Associates’ Annual Statement Studies, the Quarterly Financial Report for Manufacturing Corporations, and the Almanac of Business and Industrial Financial Ratios.

56 Chapter 3

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, includ-ing 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. The Moody’s Handbook of Common Stocks provides detailed financial infor-mation on over 1,000 common stocks.

e. Value Line Investment Survey offers ratings for over 1,700 of the most widely held stocks with full-page reports including financial data, descriptions, analy-sis, and advice.

3.7 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 man-agement 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.)

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.

c. Investment letters are the analysts’ conclusions, and recommendations of vari-ous experts. Common examples of investment letters are The Dines Letter, the Wellington Letter, The Zweig Forecast, and Holt Investment Advisory. Al-though some investment letters concentrate on specific types of securities, others are concerned solely with assessing the economy and/or security mar-kets. The cost varies between $75 and $300 per year for a subscription to these (generally) weekly or monthly 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 re-ported immediately as they occur. The stock names are shown in an abbrevi-ated form called ticker symbols. Recently, more firms have acquired sophisti-cated 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 short-investment vehicles. Barron’s and Investor’s Daily also provide a wealth of security price quotations.


3.8 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. One of the more popular on-line services is the Dow Jones News/Retrieval service that gives investors access to The Wall Street Journal and Barron's articles among others. CompuServe subscribers can access SEC filings, corporate insider trading information and articles from more than 800 periodicals. Most of the electronic on-line services charge either initial, monthly, and/or usage fees. Charges sometimes vary depending on the time of day the service is ac-cessed.

3.9 Phony press releases containing information that appears detrimental to the prof-itability of the firm and thus its stocks are but one form of on-line scam. Also some hot tips are posted on bulletin boards or places like Yahoo and invite un-knowing investors to buy on bogus information. In addition the text refers to peo-ple who will pan a stock and represent themselves as an investment expert. The best advice to avoid these types of scams is to follow the rules of good investing and always do the research to know what you are buying.

3.10 Stock market averages and indexes are used to measure the general behavior of securities markets. Averages reflect the arithmetic average price behavior of a cer-tain 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.

3.11 a. The four Dow Jones Averages include the Dow Jones Industrial Average (thirty high-quality industrial stocks), the Dow Jones Transportation Average (twenty transportation stocks), the Dow Jones Utility Average (fifteen public utility stocks), the Dow Jones 65 Stocks Composite Average (includes all of the above) and Global-US (market weighted index that reflects 80% of the to-tal market value for nine specific economic sectors).

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 In-dex (forty financial stocks), the Composite Index (includes the 500 stocks in the S&P indexes mentioned above), the Midcap Index (400 medium-sized

58 Chapter 3

companies), the small-cap index (made up of 600 small-sized companies); and the 1500 index, which includes all stocks in the composite, midcap, and small-cap indexes.

Nearly all these indexes can be found in financial newspapers such as The Wall Street Journal, Barron’s, Investor’s Daily, and local newspapers in major metro-politan areas.

3.12 a. The New York Stock Exchange Index includes all of the over 2,800 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 50 set at December 31, 1965.

b. The American Stock Exchange Index reflects the price of shares on the Ameri-can Stock Exchange relative to a base of 100 set on August 31, 1973.

c. The Nasdaq Indexes reflect the behavior of the over-the-counter market. The most popular, the OTC Composite Index, is calculated using more than 6,400 domestic common stocks traded on the Nasdaq system. The index is based on a value of 100 set on February 5, 1971. Other Nasdaq indexes include indus-trials, insurance, banking, national market composite, and national market in-dustrials.

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.

e. The Wilshire 5000 Index, represents the total dollar value (in billions of dol-lars) of 5,000 actively traded stocks, including those on the NYSE and the AMEX in addition to active OTC stocks.

3.13 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. They are reported as an annual rate of return.

b. The Dow Jones Bond Averages, quoted in The Wall Street Journal and Bar-ron’s,include a utility bond average, an industrial bond average, and a com-posite bond average. Each of these averages reflects the simple mathematical average of the closing prices rather than yields for each group of bonds in-cluded.

c. Since the New York Stock Exchange is the dominant organized exchange for bond trading, the New York Stock Exchange Bond Statistics, such as the num-ber of issues traded; the number that advanced, declined, or remained un-changed; the number of new highs and new lows; and total sales volume in


dollars, provide valuable information to present and potential bond market in-vestors.

3.14 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 in-vestors 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 securi-ties directly to an investor’s savings account, where they 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.

The major role of the stockbroker is to execute the clients’ 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 con-flicts. 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.

3.15 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 responsi-bility 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 transac-tions. This is perhaps the most common type of account.

d. A customer who wishes to trade in securities using borrowed money estab-lishes a margin account. By leaving the securities with the brokerage firm as collateral, the customer can borrow a pre-specified amount to trade in securi-ties. Needless to say, the brokerage firm will first verify the customer’s credit-worthiness 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 man-ager’s services and the cost of commissions on their trades. These accounts al-low the wealthy investor to conveniently shift the burden of stock-selection decisions to a professional—either in-house or independent—money manager.

60 Chapter 3

3.16 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 speci-fied price. It is best used when securities prices fluctuate widely. A stop-loss or-der is an order to buy or sell the stock when its market price reaches or drops be-low a specified level. It is used primarily by investors who wish to protect them-selves 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.

3.17 Typically, brokers charge either fixed commissions or negotiated commissions—commissions mutually agreed upon by the client and broker. Negotiated commis-sions 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 commis-sion, the investor must weigh the benefit of advice against the higher commission. Online brokers (also called Internet brokers or Electronic 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 re-search, information or investment advice.

3.18 The steps in making an online stock transaction can be summarized as follows:

1. Go to the brokerage site with your account number and PIN.

2. At your personal trading page, review the information you need.

3. Using the order form, place the order.

4. After placing the order, click to see a preview or confirmation.

5. Click on the “Place Order” button to confirm receipt of your order.

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 equip-ment.


3.19 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.

3.20 First, know how to place and confirm your order before you begin trading. Sec-ond, verify the stock symbol of the security you wish to buy. Third, use limit or-ders. 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.

3.21 Few electronic bond trading accounts are available to online investors. Typically, you must find the information on your own and then phone your broker to fill the order. Many firms are developing online bond-trading capabilities in response to customer demand.

3.22 The Securities Investor Protection Corporation (SPIC), a nonprofit membership corporation, was authorized to protect customer accounts against the conse-quences 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 dis-putes. 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 be-fore a panel of third party individuals.

3.23 Investment advisors are individuals or firms who advise clients about portfolio management. This may be done on a discretionary basis, in which case the advi-sor 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. How-ever, those who provide investment advice in addition to their primary job respon-sibility – 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

62 Chapter 3

portfolios an annual fee ranging from 2 to 3 percent of the dollar amount of funds managed.

3.24 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 uninitiated investor a club can provide an excellent mechanism for learning key aspects of portfolio construction and investment man-agement.

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.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONSQ3.1 to Q3.4 and Q3.6 will have answers that will vary depending on the choices made by the student.

Q3.5 A suggested list of questions would include the following:1. While it is not necessary to personally know your stockbroker, he or she

should understand your investment goals.2. What experience does the broker have?3. Does he or she handle smaller or larger customer accounts?

Q3.7 The conservative investor with very high risk aversion would probably make use of the limit order more often than the other two. In this order, he or she is assured the transaction will take place at the desired price. The other two types of orders would be more common to a less risk averse type.

Q3.8 Answers will vary with each student’s research.

Q3.9 The advice given by the large investment brokerages such as Prudential Securities and Morgan Stanley Dean Witter is backed by a back office of analysts and a full line of services for the investor. For the investor who has little time to do the re-search and to monitor his or her portfolio, this type of advice is usually preferable. On the other hand, novices and an army of do-it yourselfers would probably pre-


fer the online advice sites. Membership in an investment club is often attractive to the investors who have relatively small amounts to invest but who have high risk aversion.

SOLUTIONS TO PROBLEMS

P3.1 a. Cost of research: 10 hours at $10 per hour $100Research data 75

Total $175b. Increase in expected return:

New return of 10% – Current return of 8% = 2% increase$10,000 investment .02 increase = $200

c. Yes; the expected increase in return is greater than the cost of doing the re-search.

P3.2 Mini-Dow Average (MCA) = Closing Price Closing Priceof Stock 1 +. . .+ of Stock 5MCA Divisor

a. MDA — = $65 + $37 + $110 + $73 + $96 = 381 = 498.04Today .765 .765

MDA — = $74 + $34 + $96 + $72 + $87 = 363 = 459.491 Year Ago .790 .790

b. The value of the MDA today is 38.55 points higher than one year ago (498.04 – 459.49); this general upward trend indicates a bull (rising) market.

P3.3 SP-6 Index = Current Closing Market Current Closing Market Value of Stock1 +. . .+ Value of Stock 5 Base Period Closing Base Period Closing

Market Value of Stock 1+. . .+ Market Value of Stock 5

a. SP-6 Index = $460 + $1120 + $990 + $420 + $700 + $320 = $4010Jan. 1, 2002 $240 + $ 630 + $450 + $150 + $320 + $ 80 1870

= 2.144 100 = 214.4

SP-6 Index = $430 + $1150 + $980 + $360 + $650 + $290 = 3860June 30, 2002 $240 + $ 630 + $450 + $150 + $320 + $ 80 1870

= 2.064 100 = 206.4

64 Chapter 3

b. The SP-6 Index has moved from 100 in the base year to 214.4 on Jan 1,2002 and 206.4 on June 30, 2002, which represents a gain of 114.4% and 106.4% respectively. The SP-6 Index fell 8 points, from 214.4 on January 1, 2002, to 206.4 on June 30, 2002. The general downward trend indicates a bear (falling) market.

P3.4 Market Average = Closing Price of Stock A +. . .+ Closing Price of Stock FDivisor

a.Market Average1978 = $50 + $10 + $7 + $26 + $45 + $32 = $170 = 170

1.0 1.00Market Average1999 = $40 + $36 + $23 + $61 + $70 + $30 = $260 = 361.11

.72 .72Market Average2002 = $46 + $37 + $20 + $59 + $82 + $32 = $276 =394.29

.70 .70

b. Current Closing Market Current Closing MarketMarket Index = Value of Stock A +. . .+ Value of Stock F

Base Period Current Base Period CurrentMarket Value of Market Value ofStock A +. . .+ Stock F

Market Index1978 = $50 + $10 + $7 + $26 + $45 + $32 = $170 = 1$50 + $10 + $7 + $26 + $45 + $32 $170

= 1 10 = 10

Market Index1999 = $40 + $36 + $23 + $61 + $70 + $30 = $260 = 1.529$50 + $10 + $7 + $26 + $45 + $32 $170

= 1.529 10 = 15.29

Market Index2002 = $46 + $37 + $20 + $59 + $82 + $32 = $276 = 1.624$50 + $10 + $7 + $26 + $45 + $32 $170

= 1.624 10 = 16.24

c. Both the market average and the market index show a general upward trend,


indicating a bull market.

d. Change in average: 9.19% (from 361.11 to 394.29)Change in index: 6.21% (from 15.29 to 16.24)

The numbers differ because one is an average of stock prices on a particular day and the other is an index compared to a base period value.

P3.5 Mr. Cromwell’s market order to buy would have been filled at the lowest price available at the time, while a sell order would have been filled at the highest price available at that time. However, since market orders are executed quickly, it is reasonable to expect that Mr. Cromwell would have paid $5,000 for his market order to buy a round lot (100 shares at $50 a share).

He would also have realized $5,000 for his market order to sell common stock. Of course, we have ignored brokerage commissions and other incidental costs. On the NYSE, only one price is quoted, and both buy and sell orders could be exe-cuted at that price.

P3.6 a. The order will not be executed. The limit order will be executed only if the stock price falls to $38 or below. However, since there are two more months before the limit order expires, it is still conceivable that the stock price might fall to $38.

b. At a price of $38 per share, your broker will buy 100 shares of Sallisaw Tool stock at a total cost of $3,800.

c. This example illustrates that a limit order, while effective, can also prevent an investor from engaging in a transaction. Since the stock price did not go below $38.50, the limit order expired without being executed. Consider what would have happened if you had bought the stock at $41 instead of placing a limit or-der. You could have sold the stock for $47.50 per share, realizing a profit of $650 over the same time period (i.e., 100 shares at $6.50 profit per share).

P3.7 The minimum loss that you would experience in this case is $3.50 per share, or $175, on the total investment (50 shares at $3.50 per share). It is important to real-ize that this is a minimum loss. This is because when the stock price falls to $23, the stop-loss order is converted to a market order to sell at the best price available at that time. However, it is possible that the actual stock price might plunge down further, in which case the stock would be sold below $23 per share (possibly at $20.50 in this example).

66 Chapter 3

SOLUTIONS TO CASE PROBLEMS

Case 3.1 The Perezes’ Good Fortune

This case allows the student to choose sources of information for an investor who has no time or budget constraints. This case should provide a good discussion and review of all the information sources.

a. Since Angel wants to concentrate exclusively on stocks and bonds, both The Wall Street Journal and Barron’s would be excellent sources of information. The Wall Street Journal is published daily and provides price quotations on thousands of securities and provides world, national, regional, and corporate news. In addition, it has special articles on different financial topics. Barron’s is published weekly and also has very interesting articles. It too has current price quotations and pro-vides the reader with a summary of statistics for a wide variety of investment ve-hicles. Even if Angel does not choose to read Barron’s, he should at least read The Wall Street Journal. Angel could also read other general financial articles in news magazines such as Time, Newsweek, or U.S. News & World Report, and business periodicals such as Forbes, Fortune, or Business Week. The television fi-nancial news will provide economic and current event information on the markets and often individual companies. Of course, an excellent source of information is the Web, where numerous sites are available to provide real time update.

b. Since there are no budget constraints for Angel and he is willing to spend a sub-stantial amount on getting information, he should consider the S&P Financial Re-ports and Services. The S&P Stock Reports, for example, contain up-to-date re-ports on numerous firms. Their trade and security service provides background in-formation on specific industries. The S&P Stock and Bond Guides provide addi-tional information about stocks and bonds. In addition, Outlook includes several interesting articles that Angel might find to have great educational value. Moody’s Investors Services also publishes a variety of material that could be use-ful to Angel. Moody’s Manuals, for example, contain historical and current finan-cial and operation data about all major firms within certain business groupings. Moody’s Handbook of Common Stocks and Dividend Record also provide useful information on stocks and dividend payments. The Moody’s Bond Survey is a weekly publication that gives information about bond market conditions. The Value Line Investment Survey is an extremely popular information source which is updated weekly. It covers approximately 1,700 companies and provides ratings of timeliness, safety, and financial strength for each company. Value Line periodi-cally issues a list of recommended stocks, which Angel may find useful.


Perhaps the best of these services for Angel is the Value Line Investment Survey. Value Line seems best because Angel does not currently possess the technical ex-pertise needed to interpret all the information he can get. Because Value Line pro-vides certain specific recommendations, Angel might be best off using this infor-mation until he learns how to analyze securities on his own.

c. While the basic role of the stockbroker would be to buy and sell securities on An-gel’s behalf, stockbrokers also provide additional services. For example, stockbro-kers often advise clients and supply them with various types of information in-cluding prospectuses on new issues and back-office research reports. Often, stock-brokers analyze their clients’ portfolios. Securities can also be held by the broker "in street name" and Angel need not worry about safekeeping the share certifi-cates. It is extremely important for a client to establish a good rapport with a bro-ker. Once a broker understands the client’s investment needs and objectives, the broker is in a better position to offer meaningful investment advice.

d. Angel can obtain investment advice from a variety of sources: stockbrokers, bankers, subscription services, and individual advisors and advisory firms. At this point, it is very difficult to advise him as to whether or not he should hire the ser-vices of an investment advisor. The use of an investment advisor removes the bur-den of managing the portfolio. On the other hand, Angel will have to pay for this service. Angel should first try to assess the extent to which he will benefit from using an advisor. If he believes this benefit is greater than the cost of getting the advice, he should hire the advisor. If the cost exceeds what he perceives to be the potential benefits, Angel should manage his own portfolio.

In this case, it seems that Angel could become more proficient at managing his own portfolio. He will have more time to devote to it than most advisors. With the help of a good stockbroker and the sources of information mentioned above, An-gel probably can do without the advisory service.

e. First, Angel must obtain sources of economic and business news. Then, financial news should be obtained from selected periodicals and subscription services. Se-curity price information should be available from his stockbroker as well. Another option is to use a personal computer to access one or more of the news/retrieval and database services for the financial and economic information Angel requires.

By using these resources and the information and advisory services provided free from his brokerage firm, Angel should become adequately informed relative to the behavior of the markets, specific industries, and the firms issuing the securi-ties he holds or is considering for inclusion and/or substitution into their portfolio.

68 Chapter 3

Angel must also take advantage of tax shelters, which would help increase his af-ter-tax returns. Finally Angel must be diligent, persistent, rational and invest in the long-term.

Case 3.1 Peter and Deborah’s Choices of Brokers and Advisors

a. Peter would best be served by online services such as Ameritrade because they give him the access to information he may want but the freedom to execute his trades over the internet.

Deborah would probably be more comfortable with full service brokers such as Merrill Lynch, Dean Witter or Prudential Securities because they not only have a vast amount of research available to advise her, but they also offer the human touch which seems to mean more to her than Peter. Both Peter and Deborah should ask questions about costs, fees, and accessibility to their accounts.

b. Both of them should go with the brokerage that answers their needs. While Peter gets the speed, freedom and low cost commissions, Deborah is paying higher commission fees as well as slower trading speed, but with greater advice from a trained expert.

c. Deborah would still prefer someone who did not offer online trading of any kind.

d. Day trading is a highly risky strategy that is meant for those who have the ability to focus 100% of their time and research on the markets. It is not a strategy for someone like Deborah. If Peter fits these criteria, he should probably try it.

OUTSIDE PROJECT

Chapter 3:The Library is a Great Source of Investment Information and Advice

Many investors, especially when they are starting out, cannot afford to hire pro-

fessional managers or pay for expensive financial advice. Yet they need help as much or

more than those with greater means. Libraries come to the rescue by subscribing to many

financial publications and services and making this information available to the public.

The purpose of this project is to acquaint you with the sources of investment information

and advice available at public and university libraries. Go to both the public and univer-


sity library in your area and find out which business periodicals and subscription services

each subscribes to. Make a copy of the introductory page or first page of each of these

services. At least one of these should be a periodical or service that you feel is unusual or

rare. Compare available sources of investment information and advice that you’ve found

with the sources you feel would be needed by (a) the beginning investor and (b) the expe-

rienced investor. Comment on the role that public and university libraries might play in

your investment program.

Chapter 3

Documents

types of information

current information

company information

different types of information

information of different

price information

kinds of information

analytical information