Covering Financial Markets

Covering Financial Markets Online Tutorial Donald W. Reynolds National Center for Business Journalism at Arizona State University Prepared by Chris Roush, director of the Carolina Business News Initiative, University of North Carolina at Chapel Hill [email_address]

What we’re going to learn
In this online tutorial, we’ll cover:
How to cover stocks and what to look for as news.
The importance of bond coverage to business coverage.
Why commodities and futures coverage is increasing.
In addition, there will be a test at the end to review all of the material to gauge how well you learned market information.

Quick overview
Covering the markets requires more than an understanding of buying and selling stocks .
Bonds , or debt, are also traded.
Commodities and futures contracts are also important markets for many publications, especially recently with the energy crisis.

Quick overview
The overall point to remember in covering markets is to write stories with the reader in mind.
The Bloomberg Way, a handbook for Bloomberg News reporters, suggests four questions should be answered early in market stories:
What happened to investments today?
Why did it happen?
How does today’s move compare with the past?
Who said what about all of this?

Quick overview
When looking at how the market moved during the time period you’re writing about, consider the following comparisons:
Biggest advance/decline since when?
How many days in a row up/down?
How much have prices/yields changed in that time?
Highest/lowest level since when?
Narrowest/widest range since when?

Quick overview
Answering these questions gives the reader important perspectives on the day’s trading, and can be used for any type of financial market story.

The stock market
The stock market operates with four main functions. Those are:
To provide companies with capital to grow.
To provide investment opportunities for investors.
To provide signals about where the most productive opportunities are.
To provide a mechanism where people who want to buy stock can buy it from those who want to sell it.

The stock market
There are three primary stock markets in the United States. They are:
New York Stock Exchange ( http://www.nyse.com ) – The biggest market in terms of market capitalization. It lists more than 2,800 companies whose stocks trade on a daily basis. The fact book under “Overview” has nice historical data on stock trading. Check out “Daily Statistics” in the pressroom as well.
NASDAQ ( http://www.nasdaq.com ) – The NASDAQ market has a lot of technology and smaller companies. Its Web site is a good way to find investors of public companies you cover and track their buying and selling of those stocks.
American Stock Exchange ( http://www.amex.com ) – The smallest market. Its Web site provides access to market and historical data, charts and tools.

The stock market
Many stock market stories focus on how a particular index performed during the day or week.
But are they accurate barometers for your story?
The Dow Jones Industrial Average is just 30 stocks, while the NASDAQ composite index is more than 4,100 stocks.
The S&P 500 is actually considered a better barometer for the overall stock market.
There are industry indexes too. Might make better sense to use one of those in a story about a specific company.

The stock market
How do investors decide what stocks to buy?
The same tools that investors use can be useful for business reporters in writing about stocks as well.
Use these tools in your stories, and you will catch the attention of your readers and be recognized as someone who writes with authority .

The stock market
One of these tools is total return . Total return, or total loss, tells the reader how well the stock has performed for an investor.
It can be calculated by dividing the change in the price by the investment cost.
If a stock purchased at $10 rises to $15 a share, then the total return is 50 percent. $5 is the change in the price, divided by the $10 investment cost.

The stock market
Book value is another tool. It is an important barometer for value investors who are looking for cheap stocks.
It’s calculated by dividing net worth or shareholder equity by the number of outstanding shares a company has.
A company with $250 million in shareholder equity may have 10 million shares outstanding. $250 million/10 million=$25/share book value.
Compare book value to current stock price. If stock trades for below book value, it may be considered a cheap stock.

The stock market
Price-to-earnings is another ratio used by investors. Also known as a P/E multiple, it tells an investor how much they are paying for each dollar of company earnings.
It is calculated by dividing the stock price by the current or projected earnings per share.
A $30 stock with a 2006 earnings per share estimate by analysts of $1.50/share has a P/E multiple of 20.
Compare that multiple to how other companies in the same industry are valued by investors. That will tell you whether investors like this stock or think other stocks are more attractive.

The stock market
Net profit margin shows how profitable a company is.
It’s calculated by dividing net income by total sales.
So, a company with net income of $25 million on $500 million in sales has a net profit margin of 5 percent.
Again, compare this number to similar companies in the same industry.

The stock market
An initial public offering is when a private company offers its stock to be purchased by the public and begins trading shares on a stock market for the first time.
Companies must register to sell shares with the Securities and Exchange Commission before an IPO is approved. This document is a Form S-1.
The initial document will not have the stock price at which the shares will be sold, but it will have more information than the company has ever had to disclose in the past.

The stock market
When writing about an IPO from the Form S-1, look for these pieces of information and include them in your story:
Price or price range of the stock
Amount/proceeds to the company
What the company will do with the money
Who the underwriters are
The company’s financial performance before the IPO
Risk factors
Corporate strategy
Price range compared to the book value

The stock market
There are two different stock prices to pay attention to during an IPO.
The offering price is the price at which the shares will be sold to IPO investors. The lead underwriter sets this price.
The opening price is the price at which the IPO starts trading on the open market. This could be different than the offering price.

The stock market
A sell-side analyst works for an investment bank and is not typically independent. They make money by convincing investors to trade in the stocks they follow.
This is in contrast to a buy-side analyst, who works for institutional investors or portfolio managers at mutual funds.
In other words, a sell-side analyst is trying to convince the buy-side to trade in the stock. A buy-side analyst may not be an independent source either if they own the stock. They have a vested interest in its performance.

The stock market
But are analysts good sources for journalists?
Many in the past had conflicts due to investment banking and other relationships with the companies they covered.
Sell-side analysts are now disclosing those conflicts in reports they write.
As long as the business reporter discloses those conflicts in a story, then an analyst can be quoted.

The stock market
The buy-side analysts work for mutual funds or other money managers.
Mutual funds are investments where the risk is theoretically lowered because the investor is buying a group of stocks instead of one. There are more than 8,300 mutual funds.
Mutual fund managers are among the largest investors in the stock market. They had more than $9 trillion in investments in 2008.
Investors in mutual funds have voting rights just like shareholders of company stocks

The stock market
In return for managing an investor’s money, mutual funds take a fee, or an expense ratio, to cover their expenses.
Mutual funds operate with different investment strategies. There are market index funds, sector/industry funds, growth funds, value funds, geographical funds, return funds and hybrid funds.
Also, there are money market funds and bond funds.

The stock market
A growing trend in the stock market is hedge funds.
Hedge funds are not regulated by the SEC, whereas mutual funds are. The SEC is considering regulating hedge fund managers as investment advisers.
Unlike mutual funds, the hedge fund manager has an investment stake in the fund he’s managing.

The stock market
There are other differences between mutual funds and hedge funds.
Hedge funds can short stocks. Mutual funds can’t.
Hedge funds can not advertise. Mutual funds can.
Investors in hedge funds are more affluent. Most hedge funds require investors to have $1 million in net worth and $200,000 in net income, though some have lower requirements.

The stock market
They are called “hedge” funds because they “hedge” against a downturn in the market by betting some investments will go up and some will go down.
The pure hedge fund will take half its money and go long in investments. It will take the other half and go short.
The concept is that not all investments will rise all the time. If a hedge fund manager can pick the right stocks going up and going down at the same time, then the portfolio value rises faster.
Between 1990 and 2002, hedge funds rose an average of 12 percent annually vs. 9.1 percent for the S&P 500.

The stock market
Here’s how it works:
ABC Hedge Fund has $10 million to invest. Of that, $8 million comes from investors, and $2 million from the fund manager.
The fund goes to the bank and borrows $10 million. It now has $20 million to invest.
Let’s say that $20 million is invested in a stock at $50/share. The fund buys 400,000 shares.
If the stock goes up to $60, the hedge fund now has $24 million. It pays back the bank its $10 million plus interest and has ~$14 million to repay investors. It gives investors $10 million, for a 25 percent return. Fund manager keeps $4 million, for a 100 percent return.

The stock market
But there is a risk to investing, and hedge funds are a risky investment.
What if the stock goes down to $40? Hedge fund has $16 million. It still has to repay bank $10 million.
What’s left is $6 million for investors, or only 75 cents for every $1 they invested, and nothing for the fund manager.

The stock market
Short selling is betting that the price of a stock will fall.
An investor who borrows shares of stock from a broker and sells them on the open market is said to have a short position in the stock.
If the stock price rises, then the investor will have to buy back the stock at a higher price, losing money.
If the stock price falls, then the investor buys back the stock at a lower price and pockets the difference as profit.

The stock market
Let’s say an investor shorts 1 million shares of a $10 stock. Investor sells the shares and puts $10 million in his wallet.
If the stock drops to $8, the shares are now worth $8 million. Investor takes out $8 million from his wallet and buys back the shares he’s borrowed. His profit is $2 million.
But if the stock rises to $12, then the investor has to pay $12 million to buy back the shares and has lost $2 million.

The stock market
Some companies will pay investors to buy and hold their stock for a long time. These payments are called dividends.
Dividends are often offered on stocks of companies that generate a lot of excess cash.
Dividends are paid quarterly, though many companies offer the option of having the dividend payment reinvested in additional shares.
If a company offers 25 cents in a quarterly dividend on each share for 1,000 shares, then the investor receives $250 each quarter.

Stock market review
Answer the following questions before going on to the next section.
What is not a primary function of the stock market?
A.) To provide companies with capital.
B.) To provide investment opportunities for investors.
C.) To provide a way for executives to sell stock before it goes down.
D.) To allow people to buy stock from those who want to sell it.
The answer is C. Although executives can sell stock, it’s not why the stock goes down.

Stock market review
If an investor purchased a stock for $8 per share and later sold it for $10 per share, what could be their total return?
A.) 10 percent.
B.) 20 percent.
C.) 22 percent.
D.) 25 percent.

The answer is D. The difference is $2, divided by the initial investment price of $8, which equals 25 percent.

Stock market review
True or False: The offering price of an IPO is always the same as the opening price.

The answer is False. The offering price is the price of the stock when sold to the initial investors by the underwriters. The opening price is the price of the stock when it begins trading on the market. They are not always the same.

The bond market
A bond is an IOU between an issuer and an investor.
The issuer sells bonds to raise capital and pays interest over the life of the bond, as well as the principal investment amount at the end of the bond’s term.
When the price of a bond goes up in trading, the yield of the bond goes down. When the yield of the bond goes up, the price goes down.
Unlike stocks, which give the investor a piece of ownership in the company, a bond is not ownership.

The bond market
There are different bond issuers.
Companies sell bonds to investors to raise money to build plants, pay off other debt or make an acquisition.
Unlike their single stock price, large companies have multiple bond issues trading at different values on the market.
Governments sell bonds to pay to build roads, hospitals, new sewer plants, expand universities, etc.
The federal government’s Treasury bonds are considered the safest investment in the world.

The bond market
Corporate bonds are issued by businesses. They can be for any time length, but usually are for 1 year, 5 years, 10 years, 15 years and 30 years.
Municipal bonds are issued by local city, county and state governments. They’re tax-exempt for investors. There have been few failures, but Orange County, Calif., is the biggest. In that case, its municipal investment pool lost $1.5 billion in 1994, leaving the county bankrupt.
Treasury bills are issued by the federal government. A T-bill is 6 to 12 months.
A Treasury note is 1 year to 10 years, and a Treasury bond is 10 years to 30 years.

The bond market
Here is how bonds work:
A company issues a 10-year bond with a face amount of $1,000 and an annual yield of 7 percent.
That means that every year for the next 10 years, the company pays the bondholder $70 in interest.
At the end of the 10 years, the company pays the investor back the $1,000.

The bond market
The yield that a company or a government pays on its bonds is typically determined by its rating. The higher the rating, the safer the investment, and the lower the yield.
Most ratings begin at AAA, then go to AA, A, and so on down to C and D.
Anything below BBB is considered a junk bond, or a highly speculative investment

The bond market
Companies, municipalities and state governments want to keep their bond ratings as high – as close to AAA – as possible.
The higher the bond rating, the lower the yield that the issuer offers to investors.
In other words, the better the rating, the lower the cost of capital.

The bond market
Downgrades and upgrades of a company’s bond ratings can be major news stories.
Consider if the state of North Carolina lost its AAA rating. What would that mean?
It meant that when the state borrowed money again for construction projects, it had to spend more money paying interest to investors than before.

The bond market
Some companies will issue what is called a convertible bond. These are bonds that can be converted into stock in the company at a later date.
These bonds are attractive to some investors because they offer greater potential for appreciation in value than bonds and give higher income than common stock.
Convertible bonds become valuable if the company’s stock price goes up. If the stock price falls, then they are typically not converted.

The bond market
Foreign countries also issue bonds. Some of these are called Brady bonds.
Brady Bonds are some of the most liquid emerging market securities. They are named after former U.S. Treasury Secretary Nicholas Brady, who sponsored the effort to restructure emerging market debt instruments.
Most issuers are Latin American countries. The price of these bonds often reflects investor sentiment about these economies.

The bond market
If you’re writing about the stock price of a company in a story, it can be valuable information to tell readers what the bonds are doing as well.
Many times, bond prices don’t react the same way stock prices do. Why is that?
In bankruptcy court proceedings, bondholders are repaid before stock investors, so bonds have more value at this point.

The bond market
Also, make sure you understand the difference between secured bonds and unsecured bonds.
A secured bond is secured by the issuer's pledge of a specific asset, which is a form of collateral on the loan. In the event of a default, the bond issuer passes title of the asset, or the money that has been set aside, onto the bondholders. Secured bonds can also be secured with a revenue stream that comes from the project that the bond issue was used to finance.
These are often issued when a municipality builds a stadium or arena for a sports team.

Bond market review
Answer the following questions about the bond market to test your knowledge.
True or False: A bond with a BBB rating offers a higher yield to investors than a bond with a C rating.
The answer is False. The C-rated bond offers a higher yield because it’s a lower rating and there’s a bigger risk that the issuer might default on the bonds.

Bond market review
Which of these is not a type of bond typically issued?
A.) Corporate bond.
B.) Building bond.
C.) Municipal bond.
D.) Treasury bill.
The answer is B. Although companies and governments may issue bonds to build something, there is no such thing as a “building bond.”

Bond market review
What is the main difference between stocks and bonds?
A.) Only stocks are traded.
B.) Only bonds can go down in price.
C.) Only bonds are bought by mutual funds.
D.) Only stocks convey ownership.
The answer is D. When you own a bond, you do not own a piece of the issuer. However, stock does convey ownership.

Commodities market
A commodity is any bulk good traded on an exchange or in the cash market.
Some examples are grain, gold, oil, beef, silver and natural gas.
Like stocks and bonds, they are regulated. The Commodity Futures Trading Commission ( http://www.cftc.gov ) was created in 1974 to guard investors from manipulation and abusive trading.

Commodities market
Some commodities are called soft commodities. These include coffee, cocoa, sugar and fruit. This term generally refers to commodities that are grown, rather than mined.
Soft commodities play a major part in the futures market. They are used by both farmers wishing to lock in the future prices of their crops, and by speculative investors seeking a profit.

Commodities market
In addition to trading commodities, many of the commodities markets also trade another type of financial instrument called a future.
A future is a financial contract for the sale of a financial instrument of physical commodity for future delivery.
Futures contracts try to bet what the value of a stock index or commodity will be at some date in the future.
Futures are often used by mutual funds and large institutions to hedge their positions when the market is rocky.

Commodities market
Depending on your local economy, there may be a commodity traded every day that is vitally important to one of your largest employers or to a local farmer.
As a reporter in 1989-90 at the Sarasota Herald-Tribune, for example, I had to pay attention to frozen concentrated orange juice prices on the New York Cotton Exchange, particularly after freezes.
Tropicana was based in nearby Bradenton, and in addition, many orange farmers in the state sold their crops to them or Minute Maid.

Commodities market
Like stocks, commodities are traded at different markets. They include:

The Chicago Board of Trade ( http://www.cbot.com ) – Commodity exchange for both agricultural and financial contracts. Also the home to trading for U.S. Treasury bond futures contracts and other U.S. Treasury instruments spanning the yield curve.
The Chicago Mercantile Exchange ( http://www.cme.com ) – Focuses primarily on financial futures. A publicly traded company, this exchange offers futures, and options on futures, in four basic product areas: interest rates, stock indexes, foreign exchange and commodities (which include beef, dairy, forest and hog).
The New York Mercantile Exchange ( http://www.nymex.com ) – The largest physical commodity exchange in the world. It is the pre-eminent energy and precious metals market. Agricultural products no longer trade here. Under “Resources,” the site has a listing of industry conferences and conventions.

Commodity contracts are bought and sold. It’s not exactly like stocks, where stock represents ownership.
A corn producer could purchase corn futures on a commodity exchange to lock in the price for a specified amount of corn at a future date. At the same time, a speculator could buy and sell corn futures with the hope of profiting from future changes in corn prices.

Commodities market
Commodity prices fluctuate based on a number of different economic-related conditions. They include:
Consumer demand;
Weather conditions;
Inflation;
Perceived scarcity.
The risk of changing prices is actually the reason that exchange trading of agricultural products began.

Commodities market
Some commodity traders are involved in what is called a commodity swap . This is where exchanged cash flows are dependent on the price of an underlying commodity. This is usually used to hedge against the price of a commodity.
In this swap, the user of a commodity would secure a maximum price and agree to pay a financial institution this fixed price. Then in return, the user would get payments based on the market price for that commodity.
On the other side, a producer wishes to fix his income. So he agrees to pay the market price to a financial institution, in return for receiving fixed payments for the commodity.
The vast majority of commodity swaps involve oil.

Commodities market
There are also mutual fund-type investments used in commodity trading. These are called commodity pools.
A pool collects money from investors to use in futures and commodity trading.
The investor’s risk is limited to the amount of money he has contributed to the pool.

Commodities market
Like stocks, there are also indexes for commodities.
A commodity index tracks a basket of commodities to measure their performance. These indexes will often be traded on exchanges, allowing investors to gain easier access to commodities without having to enter the futures market.
The value of these indexes fluctuates based on the underlying commodities. This value can be traded on the exchange much in the same way as stock-index futures.

Commodities market
The price of agricultural commodities is affected by monthly crop reports from the U.S. Department of Agriculture (Check http://www.nass.usda.gov ).
These crop reports actually played a big role in the Dan Aykroyd and Eddie Murphy film, “Trading Places.”
Crop reports analyze acreage, crop yield, weather and exports. These reports can make commodity prices go up or down.

Commodities market
Commodity prices are a leading indicator of price pressure.
As demand starts to exceed supply, suppliers or manufacturers of commodities are able to raise prices.
There is a correlation between commodity prices and the Consumer Price Index, but it has faded somewhat as commodities have become less important to the economy’s cost structure.
Still, they are watched closely by the stock market and the Federal Reserve.

Commodities market
Rarely does a commodities trader accept delivery of, say, 40,000 pounds of pork bellies that are the underlying commodity of a contract.
When the product is about to be produced and shipped, the trader will likely sell the contract to a company that needs the raw product to manufacture a food product

Commodities market
Futures contracts operate in much the same way as commodities contracts.
However, futures contracts have evolved to include financial instruments that don’t include agricultural or natural resource products.
Futures can now be traded on items such as the S&P 500, natural disasters and other financial-related items such as Treasury bills.

Commodities market
Futures prices of financial instruments such as T-bills, Treasury bonds or the Euro can be affected by monetary policy.
The same thing happens with the stock market. Higher interest rates usually hurt the stock market, sending the price of stock futures down.

Test
Answer the following 10 questions about covering the financial markets.
When you have answered a question, click “Continue,” and you will see whether your answer is correct.

Test Question No. 1
What are the three major stock exchanges in the United States?
A.) New York Stock Exchange, Philadelphia Stock Exchange, San Francisco Stock Exchange.
B.) Chicago Board of Trade, New York Stock Exchange, New York Mercantile Exchange.
C.) New York Stock Exchange, NASDAQ, American Stock Exchange.
D.) Dow Jones Industrial Average, Standard & Poor’s 500, NASDAQ Composite.

Test Question No. 2
How do you determine the book value of a company?
A.) Divide its stock price by the number of shares outstanding.
B.) Divide its shareholder equity by the number of shares outstanding.
C.) Divide its earnings per share by the stock price.
D.) Divide its net income by the number of shares outstanding.

Test Question No. 3
After calculating a company’s P/E ratio, what should a business reporter do with the number?
A.) Compare it to the P/E of similar companies.
B.) Compare it to the P/E of companies located nearby.
C.) Compare it to the P/E of companies in the Dow Jones Industrial Average.
D.) Compare it to the P/E multiple of all industrial companies.

Test Question No. 4
What index is the best barometer of the overall market?
A.) The Dow Jones Industrial Average.
B.) The NASDAQ composite.
C.) The Standard & Poor’s 500 Index.
D.) The Russell 1000 Growth Index.

Test Question No. 5
When writing about a company’s initial public offering, what should be included in the story?
A.) The stock price or stock price range.
B.) The underwriters.
C.) The amount of money raised.
D.) The risk factors.
E.) All of the above.

Test Question No. 6
What statement is true about buy-side and sell-side analysts?
A.) A buy-side analyst only examines bonds.
B.) A sell-side analyst works for institutional investors such as mutual funds.
C.) A buy-side analyst has a vested interest in the stocks his firm owns.
D.) A sell-side analyst never has a conflict of interest.

Test Question No. 7
What is NOT a difference between hedge funds and mutual funds?
A.) Hedge funds buy bonds, while mutual funds buy stocks.
B.) Hedge fund managers put their own money into the fund, while mutual fund managers do not.
C.) Hedge fund managers can not advertise, while mutual funds can.
D.) Hedge funds can short stocks, while mutual funds can not.

Test Question No. 8
True of False: Investors who purchase municipal bonds do not have to pay taxes on their profits.
A.) True
B.) False

Test Question No. 9
When a company’s bond rating is lowered, what does that mean?
A.) The company will pay investors a lower yield on its bonds.
B.) The company will pay investors a higher yield on its bonds.
C.) The company will issue bonds in smaller denominations.
D.) The company will issue bonds for shorter time periods.

Test Question No. 10
What is a futures contract?
A.) A contract that will pay an investor a higher amount of money in the future.
B.) A contract that bets on the future value of a commodity or stock index.
C.) A contract that is only used to bet on future stock prices.
D.) A contract that is only used to bet on future commodity prices.

Your instructor
Please contact me with any questions about financial markets or business journalism at [email_address] .
Chris Roush is director of the Carolina Business News Initiative and the author of Show Me the Money: Writing Business and Economics Stories for Mass Communication , a business reporting textbook published by Lawrence Erlbaum Associates, and Profits and Losses: How Business Journalism Shaped Society , a book published by Marion Street Press. Roush worked as a business reporter for The Sarasota Herald-Tribune , The Tampa Tribune and The Atlanta Journal-Constitution . He has also worked for BusinessWeek in its Connecticut bureau and for Bloomberg News in its Atlanta bureau

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Covering Financial Markets

by Reynolds Center for Business Journalism on May 03, 2010

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