GETTING TO KNOW MEG WHITMAN FROM EBAY

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Getting to Know David and Tom Gardner of the Motley Fool. The profile at the beginning of the chapter focuses on brothers DAVID AND TOM GARDNER, founders of the Motley Fool, one of the most successful multimedia financial-education firms in the nation.

I. THE FUNCTION OF SECURITIES MARKETS.

LEARNING GOAL 1

Identify and explain the functions of securities markets, and discuss the role of investment bankers.

A. Securities markets are financial marketplaces for stocks and bonds.

1. Securities markets serve TWO MAJOR FUNCTIONS:

a. To assist businesses find LONG-TERM FUNDING.

b. To provide private investors a place to BUY AND SELL SECURITIES (INVESTMENTS) such as stocks, bonds, and mutual funds.

2. Securities markets are divided into TWO MARKETS:

a. PRIMARY MARKETS handle the sale of NEW securities.

i. Corporations only make money on the sale of their securities once, when they are first sold on the primary market.

ii. An INITIAL PUBLIC OFFERING (IPO) is the first public offering of a corporation’s stock.

b. SECONDARY MARKETS handle the trading of securities between investors; the proceeds of the sale go to the investor selling the stock, not to the corporation.

3. THE IMPORTANCE OF LONG-TERM FUNDING.

a. Many new companies start without sufficient capital.

b. Businesses normally prefer to meet long-term financial needs by using retained earnings or by borrowing from a lending institution.

c. If such forms are not available, the company may be able to raise capital by issuing corporate bonds (debt) or selling stock (ownership).

d. Getting approval for bond or stock issues requires extensive financial disclosures and scrutiny by the SEC.

e. These forms of debt or equity financing are not available to all companies.

B. THE ROLE OF INVESTMENT BANKERS.

1. INVESTMENT BANKERS are specialists who assist in the issue and sale of new securities.

2. Investment bankers also UNDERWRITE NEW ISSUES of bonds or stocks, buying the entire bond or stock issue at a discount then selling the issue to investors.

3. INSTITUTIONAL INVESTORS are large investors—such as pension funds, mutual funds, insurance companies, and banks—that invest their own funds or the funds of others.

4. The integrity of investment banking came under fire in the early 2000s.

II. DEBT FINANCING BY SELLING BONDS.

LEARNING GOAL 2

Compare the advantages and disadvantages of debt financing by issuing bonds, and identify the classes and features of bonds.

A. A BOND is a corporate certificate indicating that a person has lent money to a firm.

1. A company that issues bonds has a legal obligation to make regular interest payments to investors and to repay the entire bond principal.

B. LEARNING THE LANGUAGE OF BONDS.

1. INTEREST is the payment the issuer of the bond makes to the bondholders to pay for use of the borrowed money.

a. The BOND’S INTEREST RATE may be called the bond’s COUPON RATE, a term from when bonds were issued as bearer bonds and the holder was considered the owner.

b. Today bonds are REGISTERED, and changes in ownership are recorded electronically.

c. The interest rate paid on a bond varies based on factors such as the state of the economy,

the reputation of the company, and the going interest rate for bonds.

2. Bonds are also rated in terms of their risk by independent firms such as Standard and Poor’s and Moody’s Investor Services.

a. The DENOMINATION is the amount of debt represented by one bond, usually in multiples of $1,000.

b. PRINCIPAL is the face value of a bond.

c. MATURITY DATE is the exact date the issuer of bond must pay the principal to the bondholder.

3. Bond interest is usually paid semiannually.

C. ADVANTAGES AND DISADVANTAGES OF SELLING BONDS.

1. ADVANTAGES OF BONDS INCLUDE:

a. BONDHOLDERS are creditors, not owners, and SELDOM HAVE A VOTE on corporate affairs.

b. Interest paid on bonds is TAX-DEDUCTIBLE.

c. Bonds are a TEMPORARY SOURCE OF FUNDING; they are eventually repaid and the debt obligation eliminated.

d. Bonds can be repaid before the maturity date.

2. DISADVANTAGES OF BONDS INCLUDE:

a. Bonds are an INCREASE IN DEBT.

b. Paying interest on bonds is a LEGAL OBLIGATION.

c. The face value of the bonds MUST BE REPAID on the maturity date.

D. DIFFERENT CLASSES OF BONDS.

1. UNSECURED BONDS are not backed by any collateral.

a. DEBENTURE BONDS are bonds that are unsecured (i.e., not backed by any collateral such as equipment).

b. Debenture bonds are issued only by well-respected firms with excellent credit ratings.

2. SECURED BONDS are backed by some tangible asset (collateral) that is pledged to the bondholder if interest or principal is not paid.

3. MORTGAGE BONDS are secured by company assets such as land and buildings.

E. SPECIAL BOND FEATURES.

1. Companies often establish a reserve account, called a sinking fund, to ensure that funds are available to repay bondholders on the maturity date.

a. A SINKING FUND is a reserve account in which the issuer of a bond periodically retires some part of the bond principal prior to maturity so that enough capital will be accumulated by the maturity date to pay off the bond.

b. Advantages of sinking funds:

i. They provide for an orderly retirement (repayment) of a bond issue.

ii. They reduce the risk the bond will not be repaid.

iii. The market price for the bond is supported.

2. A CALLABLE BOND is a bond that permits the issuer to pay off the bond principal before its maturity date.

a. Call provisions must be included when a bond is issued.

b. Callable bonds give companies some discretion in their long-term forecasting.

3. Convertibility.

a. A CONVERTIBLE BOND is one that can be converted into shares of common stock in the issuing company.

b. Bond holders must weigh the potential stock profit with the loss of the interest from the bond.

III. EQUITY FINANCING BY SELLING STOCK.

LEARNING GOAL 3

Compare the advantages and disadvantages of equity financing by issuing stock, and explain the differences between common and preferred stock.

A. EQUITY FINANCING is the obtaining of funds through the sale of ownership in the corporation.

B. LEARNING THE LANGUAGE OF STOCK.

1. STOCKS are shares of ownership in a company.

2. A STOCK CERTIFICATE is evidence of stock ownership that specifies the name of the company, the number of shares it represents, and the type of stock being issued.

3. PAR VALUE is a dollar amount assigned to each share of stock by the corporation’s charter.

a. Some states use par value as a basis for the state’s incorporation fees.

b. Most companies issue NO-PAR STOCK.

4. DIVIDENDS are a part of the firm’s profits that may be distributed to shareholders as either cash payments or additional shares of stock.

C. ADVANTAGES AND DISADVANTAGES OF ISSUING STOCK.

1. ADVANTAGES OF ISSUING STOCK INCLUDE:

a. As owners of the business, stockholders investment NEVER HAS TO BE REPAID.

b. There is NO LEGAL OBLIGATION to pay dividends to stockholders, so profits can be invested in the firm.

c. Selling stock can IMPROVE THE CONDITION OF THE FIRM’S BALANCE SHEET since no debt is incurred.

2. DISADVANTAGES OF ISSUING STOCK INCLUDE:

a. As owners, stockholders have the RIGHT TO VOTE and can alter the direction of the firm.

b. Dividends are PAID OUT OF PROFIT AFTER TAXES and are not tax deductible.

c. Management decision making can be affected by the need to keep stockholders happy.

D. ISSUING SHARES OF PREFERRED STOCK.

1. PREFERRED STOCK is stock that gives its owners preference in the payment of dividends and an earlier claim on assets than common stockholders if the company is forced out of business and its assets sold.

a. It does not include voting rights.

b. Preferred stock may be called a hybrid investment.

2. Preferred stock dividends DIFFER FROM COMMON STOCK DIVIDENDS in several ways:

a. The PAR VALUE is the basis for the dividend the firm is willing to pay.

b. Dividends on preferred stock must be paid in full before any common stock dividends can be paid.

3. SIMILARITIES BETWEEN PREFERRED STOCK AND BONDS.

a. Both have a face (or par) value, and both have a fixed rate of return.

b. Preferred stocks are rated according to risk by Standard & Poor and Moody’s just like bonds.

4. Differences between preferred stock and bonds.

a. Preferred stock dividends do not legally have to be paid.

b. Stock never has to be repurchased.

5. Both types increase in market value, but stocks generally increase at a higher percentage than bonds.

E. SPECIAL FEATURES OF PREFERRED STOCK.

1. Preferred stock can be CALLABLE, meaning a company could require preferred stockholders to sell back their shares.

2. Preferred stock could also be CONVERTIBLE to shares of common stock.

3. With CUMULATIVE PREFERRED STOCK the missed dividends can be accumulated if they are not paid.

F. ISSUING SHARES OF COMMON STOCK.

1. COMMON STOCK is the MOST BASIC FORM of ownership in a firm; it confers voting rights and the right to share in the firm’s profits through dividends, if offered by the firm’s board of directors.

2. Common stock includes the RIGHTS:

a. To vote for a company’s board of directors and on important issues.

b. To share in the firm’s profits through dividends, if approved by the firm’s board of directors.

3. With voting rights common stock holders can influence policy.

4. With PREEMPTIVE RIGHT, common stockholders have the first right to purchase any new shares of common stock.

IV. STOCK EXCHANGES.

LEARNING GOAL 4

Describe the various stock exchanges where securities are traded.

A. A STOCK EXCHANGE is an organization whose members can buy and sell (exchange) securities for companies and investors.

1. Brokerage firms purchase memberships, or SEATS, on the exchanges.

2. The New York Stock Exchange has a fixed number of memberships.

3. Membership price varies with the strength of the market.

B. U.S. EXCHANGES.

1. The LARGEST STOCK EXCHANGE in the U.S., the NEW YORK STOCK EXCHANGE, was founded in 1792.

a. The NYSE is a floor-based exchange (trades take place on the floor of the stock exchange.)

b. The NYSE is often referred to as the Big Board.

2. The second-largest U.S. exchange is the AMERICAN STOCK EXCHANGE (AMEX).

3. There are several REGIONAL EXCHANGES in Chicago, San Francisco, Philadelphia, Cincinnati, Spokane, and Salt Lake City that deal with regional issues.

4. THE OVER-THE-COUNTER (OTC) MARKET.

a. The OVER-THE-COUNTER (OTC) MARKET is an exchange that provides a means to trade stocks not listed on the national exchanges.

b. The NATIONAL ASSOCIATION OF SECURITIES DEALERS AUTOMATED QUOTATION SYSTEM (NASDAQ) is a nationwide electronic system that communicates over-the-counter trades to brokers.

c. Originally, the over-the-counter market dealt with small firms that could not qualify for listing on the two nation exchanges.

d. Today, firms such as Intel and Microsoft have their stock traded on the OTC market.

e. The OTC market also handles corporate and government bonds.

f. The NASDAQ lists approximately 3,800 companies including many technology companies.

g. Stocks can be delisted from an exchange if a company fails to hold up the exchange’s minimum requirements.

C. SECURITIES REGULATIONS AND THE SECURITIES AND EXCHANGE COMMISSION.

1. The SECURITIES ACT OF 1933 protects investors by requiring full disclosure of financial information by firms selling new stocks or bonds.

2. The SECURITIES AND EXCHANGE COMMISSION (SEC) is the federal agency that has responsibility for regulating the various exchanges.

a. Companies trading on the national exchanges must register with the SEC and provide annual updates.

b. Companies must follow established specific guidelines when issuing bonds or stock.

3. A PROSPECTUS is a condensed version of economic and financial information that a company must file with the SEC before issuing stock; the prospectus must be sent to prospective investors.

4. INSIDER TRADING involves the use of knowledge or information that individuals gain through their position that allows them to benefit unfairly from fluctuations in security prices.

a. The key words are BENEFIT UNFAIRLY.

b. The term INSIDER has been broadened to include anyone with information about a security not available to the general public.

c. Penalties for insider trading can include fines or imprisonment.

D. Global Stock Exchanges.

1. Stock exchanges operate globally, even in former communist-bloc countries.

2. Investors can now buy securities from companies almost anywhere in the world.

3. 470 foreign firms from 51 countries were listed on the NYSE in 2003.

V. HOW TO INVEST IN SECURITIES MARKETS.

LEARNING GOAL 5

Explain how to invest in securities markets and various investment objectives such as long-term growth, income, cash, and protection from inflation.

A. HOW TO BUY STOCKS, BONDS, OR OTHER SECURITIES.

1. PROCEDURE:

a. The investor must find a registered representative authorized to trade the security.

b. A STOCKBROKER is a registered representative who works as a market intermediary to buy and sell securities for clients.

c. The stockbroker places an order with a stock exchange member.

d. That member goes to the place where the bond or stock is traded and negotiates a price.

e. The completed transaction is reported to the broker and then to the investor.

f. Large brokerage firms have automated order systems that allow brokers to instantly place and confirm orders.

2. The same procedure is followed if you want to SELL STOCKS AND BONDS.

a. Today brokers keep most records of bond or stock ownership electronically, and transactions are instantaneous.

b. The broker can also be a source of information about what stocks or bonds meet your objectives.

c. However, you can learn about and follow stocks or bonds on your own.

B. INVESTING ONLINE.

1. Investors can use ONLINE TRADING SERVICES to buy and sell stocks and bonds instead of using traditional broker services.

a. The commissions for these trading services are less than those of regular stockbroker commissions.

b. Traditional brokerage companies have introduced their own online capabilities.

c. The number of online brokerage accounts declined in the early 2000s.

2. These services are targeted primarily at investors willing to do their own research and make their own investment decisions.

a. The leading online services do provide key market information about companies.

b. Some online brokers are exploring other financial services alternatives such as banking services and credit cards.

3. Investing means committing (and risking) money with the expectation of profit–a risky undertaking.

4. The first step in any investment program is to analyze such factors as desired income, cash requirements, level of risk, and so on.

C. CHOOSING THE RIGHT INVESTMENT STRATEGY.

1. INVESTMENT OBJECTIVES change over the course of a person’s life.

a. A young person can afford more high-risk investment options than a person nearing retirement.

b. An older person has different objectives, including steady return and additional income.

c. There is a risk/return trade-off regarding strategies such as growth, income, inflation protection, and liquidity.

2. You should consider FIVE CRITERIA FOR SELECTING AN INVESTMENT VEHICLE:

a. INVESTMENT RISK, the chance that an investment and its entire yield will be worth less at some future time.

b. YIELD, the expected rate of return on an investment, such as interest or dividends.

c. DURATION, or the length of time your money is committed.

d. LIQUIDITY, how quickly you can get back your invested funds when desired.

e. TAX CONSEQUENCES, how the investment will affect your tax situation.

3. An investment planner such as a chartered financial analyst (CFA) or a certified financial planner (CFP) can help choose an investment strategy.

VI. INVESTING IN BONDS.

LEARNING GOAL 6

Analyze the opportunities bonds offer as investments.

A. Bonds are a relatively SAFE INVESTMENT.

1. U.S. GOVERNMENT BONDS are backed by the full faith and credit of the federal government.

2. MUNICIPAL BONDS offered by local governments often have advantages such as tax-free interest.

3. Corporate bonds are more risky.

B. If you purchase a corporate bond, you do not have to hold it until maturity because bonds are bought and sold daily on major securities exchanges.

1. However, you are not guaranteed to get the FACE VALUE of the bond.

2. If your bond does not have attractive features, you may be forced to sell your bond at a DISCOUNT, a price less than the face value.

3. If your bond is highly valued, you may be able to sell it at a PREMIUM, a price above the face value.

4. As interest rates go up, bond prices fall, and vice versa.

C. Standard & Poor’s and Moody’s Investor Service rate the level of risk of many corporate and government bonds.

VII. INVESTING IN STOCKS.

LEARNING GOAL 7

Explain the opportunities stocks offer as investments.

A. STOCK INVESTMENTS provide an opportunity for investors to participate in the success of emerging or expanding companies.

1. As owners, however, stockholders can also lose money if a company does not do well or the overall stock market is declining.

a. The market price (and growth potential) of common stock depends heavily on the

overall performance of the corporation.

b. CAPITAL GAINS are the positive difference between purchase price of a stock and its sale price.

c. Stocks can be subject to a high degree of risk.

2. Stock investors are often called BULLS and BEARS depending upon their perceptions of the market.

a. BULLS are investors who believe that stock prices are going to rise.

b. When overall stock prices are rising, the market is called a bull market.

c. BEARS are investors who expect stock prices to decline.

d. When the price of stocks declined, the market is called a bear market.

3. INVESTMENT OPPORTUNITIES IN STOCK.

a. GROWTH STOCKS are stocks of corporations whose earnings are expected to grow at a faster rate those other stocks.

i. These are often technology, biotechnology, or Internet-related firms.

ii. These stocks are often risky but offer the potential for high returns.

b. INCOME STOCKS are stocks that offer a rather high dividend yield (i.e. public utilities.)

c. BLUE CHIP STOCKS are stocks of high-quality companies that pay regular dividends and generally experience consistent growth in the company’s stock price.

d. PENNY STOCKS are stocks that sell for less than $2, and are considered very risky investments.

4. BUYING STOCK: MARKET AND LIMIT ORDERS.

a. MARKET ORDERS are instructions to a broker to buy stock immediately at the best price available.

b. LIMIT ORDERS tell a broker to buy or sell a stock at a specific price, if that price becomes available.

B. STOCK SPLITS.

1. Companies and brokers prefer to have stock purchases conducted in ROUND LOTS, purchases of 100 shares at a time.

2. Investors often buy stock in ODD LOTS, or purchases of less than 100 shares at a time.

3. A STOCK SPLIT is an action by a company that gives stockholders two or more shares of stock for each one they own.

4. There is no change in the firm’s ownership structure and no change in the investment’s value after the stock split.

5. The advantage to shareholders is that the demand for the stock may be greater.

6. A company cannot be forced to split its stock.

VIII. INVESTING IN MUTUAL FUNDS.

LEARNING GOAL 8

Explain the opportunities in mutual funds as investments and the benefits of diversifying investments.

A. A MUTUAL FUND is an organization that buys stocks and bonds and then sells shares in those securities to the public.

1. A mutual fund pools investors’ money and then buys stocks or bonds in many companies.

2. Investors can buy mutual fund shares and GET OWNERSHIP OF MANY DIFFERENT COMPANIES that they could not afford to invest in individually and thus diversify.

3. Mutual funds are the best way for small investors to get started.

a. Very conservative funds invest only in government securities or secure corporate bonds.

b. Others specialize in high-tech firms, Internet companies, foreign companies, precious metals, and other investments with greater risk.

c. Some mutual funds even invest exclusively in socially responsible companies.

4. Beginners can start with a few index funds and diversify.

a. An INDEX FUND is a fund that invests in a certain kind of stock.

b. To diversify means to invest in a variety of index funds.

c. A stockbroker, certified financial planner, or banker can help you choose mutual fund investments.

5. You can buy most funds directly and save any fees.

a. A NO-LOAD FUND is one that charges no commission to buy or sell its shares.

b. A LOAD FUND would charge a commission to investors to buy shares in the fund or commissions when the shares are sold.

c. OPEN-END FUNDS will accept the investments of any interested investors.

d. CLOSED-END FUNDS offer a specific number of shares; once issued, no further investors can buy into the fund.

5. Mutual funds offer the small investor a way to spread the risk of stock ownership.

B. DIVERSIFYING INVESTMENTS.

1. DIVERSIFICATION means buying several different investments alternatives to spread the risk of investing.

2. By diversifying, investors decrease the chance of losing everything they have invested.

3. This investment strategy is often called a PORTFOLIO STRATEGY or ALLOCATION MODEL.

4. The more investors study the market on their own, the higher their potential for gain.

5. Investors need to consider the risk/return tradeoff.

IX. INVESTING IN HIGHER-RISK INVESTMENTS.

LEARNING GOAL 9

Discuss specific high-risk investments, including junk bonds, buying stock on margin, and commodity trading.

A. Some investors like safer investments—others want to take more market risk.

B. INVESTING IN HIGH RISK (JUNK) BONDS.

1. JUNK BONDS are high-risk, high-interest bonds.

2. Standard & Poor’s and Moody’s consider junk bonds as non-investment-grade bonds because of their high risk and high default rates.

3. If the company can’t pay off the bond, the investor is left with nothing more than paper—in other words, junk.

C. BUYING STOCK ON MARGIN.

1. BUYING STOCK ON MARGIN is purchasing stocks by borrowing some of the purchase cost from the brokerage firm.

2. MARGIN is the amount of money an investor must invest in the stock; the Federal Reserve sets MARGIN RATES (discussed in detail in Ch. 21.)

3. Margin debt reached its highest level ever in early 2000.

4. The downside is that investors must repay the credit extended, plus interest.

5. If the value of investor’s account goes down, the broker will issue a MARGIN CALL requiring the investor to come up with more money to cover any losses.

6. If the investor is unable to make the margin call, the broker can legally sell the stock.

D. INVESTING IN COMMODITIES.

1. Investors willing to speculate in COMMODITIES hope to profit from the rise and fall of prices of items such as coffee, wheat, pork bellies, petroleum, and other “commodities” that are scheduled for delivery at a given date in time.

a. Trading in commodities demands much expertise.

b. About 75 to 80% of the investors who speculate in commodities lose money in the long run.

2. Trading in commodities, however, can also be a vehicle for protecting businesspeople, farmers, and others from wide fluctuations in commodity prices.

3. A COMMODITY EXCHANGE is a securities exchange that specializes in the buying and selling of precious metals and minerals (e.g., silver,

foreign currencies, gasoline) and agricultural goods (e.g., wheat, cattle, sugar.)

a. The Chicago Board of Trade (CBOT) is the largest commodity exchange in terms of floor size.

b. Commodity exchanges operate like stock exchanges where members of the exchange meet on the exchange’s floor to transact deals.

c. However all transactions for a specific commodity take place in a specific trading area, or “PIT.”

d. Today more traders are working from computers to sell and buy contracts on global computer networks.

4. The largest trading futures exchange in the world is now the Frankfurt, Germany-based Eurex exchange.

5. FUTURE MARKETS involve the purchase and sale of goods for delivery some time in the future.

X. UNDERSTANDING INFORMATION FROM SECURITIES MARKETS.

LEARNING GOAL 10

Explain securities quotations listed in the financial section of a newspaper, and describe stock market indicators like the Dow Jones Average affect the market.

A. A wealth of investment information is available in The Wall Street Journal, daily newspapers, magazines, and on websites.

B. UNDERSTANDING BOND QUOTATIONS.

1. Government-issued bonds are covered in The Wall Street Journal in a table called TREASURY ISSUES.

2. These issues are traded on the over-the-counter market.

3. The PRICE is quoted as a PERCENTAGE OF $1,000.

C. UNDERSTANDING STOCK QUOTATIONS.

1. The Wall Street Journal lists stock quotations from the OTC markets of New York Stock Exchange, the American Stock Exchange, and the NASDAQ.

2. Figure 20.8 shows the information on the New York and American Stock Exchanges.

3. STOCK QUOTATIONS tell you many things:

a. Stocks are quoted in decimal amounts.

b. The New York Stock Exchange officially shifted from trading stocks in fractions to trading in decimals in 2000.

c. The NASDAQ converted to decimals in the spring of 2001.

d. Preferred stocks are listed separately in The Wall Street Journal.

e. If a publication does not list preferred stock separately, preferred stocks are identified by the letters PF following the abbreviate company name.

4. STOCK QUOTES SHOW:

a. The percentage of change in the stock’s price for the year to date (YTD).

b. The highest and lowest price the stock has sold for over the past 52 weeks.

c. The company name and the company’s stock symbol.

d. The last dividend per share paid.

e. The stock’s dividend yield (annual dividend as a percentage of the price per share.)

f. The P/E ratio (price to earnings ratio.)

g. Number of shares traded that day in 100s.

h. The stock’s closing price for the day.

i. The net change in the stock’s price from the previous day.

D. UNDERSTANDING MUTUAL FUND QUOTATIONS.

1. Buying into mutual funds is a way to diversify investments at minimum cost.

2. Figure 20.9 shows The Wall Street Journal’s listing of mutual funds.

a. There are many types of funds available to meet investor objectives.

b. Many companies offer a variety of fund types within the fund family.

3. The quotation shows:

a. The funds’ name.

b. The fund’s NET ASSET VALUE (NAV), the market value of the mutual fund’s portfolio divided by the number of shares outstanding–this is the price per share.

c. The net change in the NAV from the previous day’s trading.

d. The fund’s YTD return.

e. The longer-term return (i.e., 1-year, 3-year, 5-year).

4. With mutual funds it is also simple to change your investment objectives by switching your money to another fund.

E. STOCK MARKET INDICATORS.

1. The DOW JONES INDUSTRIAL AVERAGE (THE DOW) is the average cost of 30 selected industrial stocks, used to give an indication of the direction (up or down) of the stock market over time.

a. Charles Dow began measuring stock averages in 1884 using the prices of 12 important stocks.

b. New stocks are substituted on the Dow when deemed appropriate.

c. The Dow was broadened to include 30 stocks.

d. In 1991 Disney was added to the Dow to reflect the increased importance of the service sector.

2. Critics argue that the SAMPLE IS TOO SMALL to get a good statistical representation.

3. Many investors prefer to follow stock indexes like the STANDARD & POOR’S 500 that track a broader mix.

4. Investors also closely follow the NASDAQ average.

F. THE MARKET’S ROLLER-COASTER RIDE.

1. The first crash occurred on “Black Tuesday,” October 28, 1929, when the stock market lost almost 13% of its value.

2. The stock market dropped 508 points on October 19, 1987, losing 22% of its value, the largest one-day drop in history.

3. On October 27, 1997 the Dow fell 554 points due to fears of economic problems in Asian markets.

4. From 2000 to 2002 both the S&P and NASDAQ declined three years in a row.

5. Many analysts believe the 1987 crash was due to PROGRAM TRADING, the process of giving instructions to computers to automatically sell if the price of a stock dips to a certain point to avoid potential losses.

6. As a result, U.S. exchanges created mechanisms to restrict program trading whenever the market moves up or down by a large number of points.

a. Program trading curbs are put in effect when the Dow moves up or down more than a certain number of points.

b. Computer use is turned off, so trading must be done “by hand” rather than automatically.

c. Circuit breakers, complete halts in trading, are triggered when the Dow falls 10, 20, or 30 percent in a day.

d. Circuit breakers were triggered for the first and only time on October 27, 1997, when the Dow fell 550 points.

e. Many believe that the 1997 market drop could have been much worse had it not been for the new rules.

G. INVESTING CHALLENGES IN THE 21st-CENTURY MARKET.

1. 21st Century markets will probably experience heightened volatility.

a. The September 11, 2001 terrorist attacks showed that even the U.S. is not immune to outside forces.

b. We live in a global market of closely linked economies.

c. In 1997 the Asian crisis created a DOMINO EFFECT on many other countries.

2. Investor confidence eroded in the early 2000s.

a. Investor trust was shattered by disclosures of financial fraud in companies such as WorldCom, Enron, and Tyco.

b. Investment analysts also came under fire for giving companies exaggerated evaluations.

c. The New York and NASDAQ exchanges are INTENSELY COMPETITIVE in the search for investors’ dollars.

3. Traditional brokers such as Merrill Lynch are changing the way they do business in response to competition from online brokers like E*Trade.

4. The basic lessons are to diversify your investments and understand the risks of investing.

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