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    Chapter 3 Chapter 3 Document Transcript

    • Chapter 3 Online Information and Investing   Outline Learning Goals I. Online Investing A) The Growth of Online Investing 1. Investment Education Sites 2. Investment Tools a. Planning b. Screening c. Charting d. Stock Quotes and Portfolio Tracking 3. Pros and Cons of Using the Internet as an Investment Tool Concepts in Review II. Types and Sources of Investment Information A) Types of Information B) Sources of Information 1. Economic and Current Event Information a. Financial Journals b. General Newspapers c. Institutional News d. Business Periodicals e. Government Publications f. Special Subscription Services 2. Industry and Company Information a. Fair Disclosure Rules b. Stockholders’ Reports c. Comparative Data Sources d. Subscription Services e. Brokerage Reports f. Investment Letters
    • 34  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition 3. Price Information 4. Other Online Investment Information Sources a. Financial Portals b. Bond Sites c. Mutual Fund Sites d. International Sites e. Investment Discussion Forums 5. Avoiding Online Scams Concepts in Review III. Understanding Market Averages and Indexes A) Stock Market Averages and Indexes 1. The Dow Jones Averages 2. Standard & Poor’s Indexes 3. NYSE, AMEX, and Nasdaq Indexes 4. Value Line Indexes 5. Other Averages and Indexes B) Bond Market Indicators 1. Bond Yields 2. Dow Jones Corporate Bond Index 3. NYSE Bond Diary Concepts in Review IV. Making Securities Transactions A) The Role of Stockbrokers 1. Brokerage Services 2. Types of Brokerage Firms 3. Selecting a Stockbroker 4. Opening an Account a. Single or Joint b. Cash or Margin c. Wrap 5. Odd-Lot or Round-Lot Transactions B) Basic Types of Orders 1. Market Order 2. Limit Order 3. Stop-Loss Order
    • Chapter 3 Online Information and Investing  35 C) Online Transactions 1. Day Trading 2. Technical and Service Problems 3. Tips for Successful Online Trades D) Transaction Costs E) Investor Protection: SIPC and Arbitration Concepts in Review V. Investment Advisors and Investment Clubs A) Using Investment Advisors 1. Regulation of Advisors 2. Online Investment Advice 3. The Cost and Use of Investment Advice B) Investment Clubs Concepts in Review Summary Putting Your Investment Know-How to the Test Discussion Questions Problems Case Problems 3.1 The Perezes’ Good Fortune 3.2 Peter and Deborah’s Choices of Brokers and Advisors Excel with Spreadsheets Trading Online with OTIS   Key Concepts 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 traditional and online investment information for making investment decisions. 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/companies. 5. The most commonly cited market averages and indexes, their interpretation, and their use in assessing market conditions. Both stock and bond index are covered. 6. The role of the stockbroker in making security transactions, the types of brokerage services available, and the various types of brokerage accounts.
    • 36  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition 7. A comparison of full-service, premium, and discount brokerage services. 8. The basic types of orders—market, limit, and stop-loss, their use in making security transactions, and transaction costs. 9. The products and services offered, regulation, types, and cost of investment advisors. 10. The investment club as a device for pooling knowledge and money to create and manage a jointly owned portfolio.   Overview 1. The Internet and online investing offer the individual investor advantages once enjoyed by only the professional investor. The number of households using online information for investment purposes is quickly expanding. The challenge now is to use the tools offered by the Internet wisely. 2. Investment information is broadly classified into descriptive and analytical information. It is important that students understand the difference between these two kinds of information and the investor’s need for both types. Online investment tools help investors plan, screen, chart individual securities, and track portfolio performance. 3. The chapter next mentions the benefits and costs of obtaining investment information. The instructor should drive home the point that although an informed investor 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 beginning with The Wall Street Journal. Various other financial publications provide 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. Presenting current examples of Internet sites also works well. 6. The popular market averages and indices are presented next. Movements in market 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 information 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, market, limit, stop-loss orders, and short selling. Therefore, the instructor should devote adequate time to cover these topics and use examples for clarification.
    • Chapter 3 Online Information and Investing  37 8. The role of the SIPC in protecting investors and procedures for settling disputes between 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 described. The chapter closes with a discussion of investment clubs.   Answers to Concepts in Review 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 making process. Investment education sites range from the tutorials and online classes that educate the novice investors to the financial calculators and worksheets used by experienced investors. About 25 million households manage over $1 trillion in assets online. 2. The four types of online investment tools are as follows: (a) Planning. Online calculators and worksheets help you find answers to your financial planning and investing questions. (b) Screening. Screening tools help you sort through huge databases of stocks and mutual funds to find those that have specific characteristics. (c) Charting. This technique allows you to plot the performance of a stock or a group of stocks over a specified time period. (d) Stock Quotes and Portfolio Tracking. This tool allows the investor to track his or her investment, to be alerted whenever an analyst changes the rating, or to indicate how well the portfolio is diversified among major asset classes. 3. As for the advantages of online investing, it is now possible for even 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. Furthermore, you don’t have the safety net of dealing with a human who may be suggesting that you exercise additional caution. The ease of the point-and-click investing can be the financial downfall of inexperienced investors. Transaction costs to add up and margin trading results in interest payments on the loan that will reduce possible gains. 4. Descriptive information is factual information on past behavior of the economy, the market, or a given investment vehicle. Analytical information, on the other hand, tends to analyze existing data and make projections, and is quite often a source of recommendations for potential investments. The investor must evaluate whether the costs of acquiring the information are justified by the potential increase in return. There are either direct or indirect costs associated with information gathering. Direct costs include subscription fees and advisor’s fees. Indirect costs include the time involved to gather information.
    • 38  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition 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, national reports, and regional and corporate news. Regular features, like “Your Money Matters,” address topics of interest to individual investors. Barron’s, on the other hand, is a weekly publication also published by Dow Jones. However, the articles in Barron’s are generally more in-depth and directed to financial issues than those in The Wall Street Journal. Barron’s also has special interest columns like “Up and Down Wall Street.” In addition, there are current price quotations and summary statistics on a wider variety of investment vehicles. Other sources of financial news include Investor’s Business Daily, 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 papers that have national reputations in the political and economic arena such as The New York Times and The Los Angeles Times. USA Today is a national daily newspaper containing a “Money” section devoted to business and personal financial news. Time and Newsweek are also major periodicals in the general news category. Business news articles and statistics on general business and economic activities in the United States and abroad can be found in The Wall Street Journal and in such magazines as Newsweek, Time, U.S. News & World Report, Business Week, Fortune, The Economist, Federal Reserve Bulletin, and the Survey of Current Business. A variety of articles discussing the activities of securities markets and corporations can be found in The Wall Street Journal, Barron’s, Investor’s Business Daily, Forbes, Kiplinger’s Personal Finance, Money, and Smart Money (a new WSJ publication). The last three are oriented toward individual investors and managing personal finances. Local metropolitan newspapers also provide information on securities of local interest. There has been a blurring of the distinctions between print sources and online sources, because many of the print sources now make their information available online. Two advantages of the online sources is the limited amount of advertising and ability to be continually updated. Off course, online sources generally require readers to be at a terminal and carrying a computer with you is not as convenient as simply grabbing the printed material. 6. (a) The stockholder’s report, also called the “annual report,” is an annual publication of publicly held corporations. These reports are usually free and contain a wealth of descriptive and analytical information, including financial statements, about the firm. Stockholder reports are just one of the pieces of information that can be downloaded from company web sites. (b) Comparative data sources enable investors to analyze the financial condition of companies and are typically grouped by industry and size of firm. These include Dun & Bradstreet’s Key Business Ratios, Robert Morris and Associates’ Annual Statement Studies, the Quarterly Financial Report for U.S. Manufacturing, Mining, and Trade Corporations, and the Almanac of Business and Industrial Financial Ratios. (c) Standard and Poor’s Stock Reports is a major service of the Standard and Poor’s Corporation. It contains up-to-date reports on numerous firms, including a summary of the firm’s financial history, its current financial situation, and for NYSE companies, an opinion on the firm’s future prospects. (d) Mergent provides detailed financial information on companies and industries. (e) Value Line Investment Survey offers ratings for all widely held stocks with full-page reports including financial data, descriptions, analysis, and advice.
    • Chapter 3 Online Information and Investing  39 7. (a) The prospectus is part of the registration statement required by the SEC on a new security issue. It describes in detail the key aspects of the issuer, its management and financial position, and the security to be issued. Brokerage firms provide prospectuses at no cost to their clients. (Note: This information source is available only when a firm is making an issue of new securities.) (b) Back office research reports present analyses and recommendations on the current and future prospects for the security markets, specific industries, and specific securities. These are prepared by brokerage firm research staffs and are available (usually free of charge) to existing as well as potential clients. Several information vendors, such as Multex and Zacks, consolidate research from many companies and put it on the web. (c) Investment letters are the analysts’ conclusions, and recommendations of various experts. Common examples of investment letters are Blue Chip Advisor, The Dines Letter, Dow Theory Letters. the Growth Stock Outlook, Louis Rukeyser’s Wall Street, and Zack’s Advisor. Although some investment letters concentrate on specific types of securities, others are concerned solely with assessing the economy and/or security markets. The cost varies between $75 and $300 per year for a subscription to these (generally) weekly or monthly letters. The Hulbert Financial Digest monitors the performance of investment letters. (d) Price quotations include the current prices and price statistics for various types of securities. Almost all brokerage houses have automated devices for obtaining up-to-the-minute quotations. Many firms still use a ticker, a lighted screen on which stock transactions made on the floor of the exchange are reported immediately as they occur. The stock names are shown in an abbreviated form called ticker symbols. Recently, more firms have acquired sophisticated computer terminals to more efficiently provide up-to-the-minute stock price information. The most common sources of such information, however, are the daily newspaper and The Wall Street Journal, which contains current quotations on numerous short-investment vehicles. Barron’s and Investor’s Daily also provide a wealth of security price quotations, which is especially useful for bond quotations. 8. Electronic and on-line investment information allows individual investors to get timely historical and current information such as stock quotes and economic and financial information. In addition, investors may use their personal computer (PC) to access CD-ROM and diskettes for investment information, financial data, and/or analysis software. Most of the online services charge initial, monthly, and/or usage fees. Charges sometimes vary depending on the time of day the service is accessed. Table 3.4 provides a listing of popular sites and a description of the unique data found there. 9. Stock market averages and indexes are used to measure the general behavior of securities markets. Averages reflect the arithmetic average price behavior of a certain group of stocks at a given point in time, whereas indexes measure the current price behavior of the group relative to a base value set at an earlier point in time. Averages and indexes provide a convenient way of capturing the general mood of the market. When the averages or indexes reflect an upward trend in prices, a bull market is said to exist. Likewise, when these measures exhibit a downward trend, a bear market exists.
    • 40  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition 10. (a) The four Dow Jones Averages include the Dow Jones Industrial Average (thirty widely-held stocks issued by large firms), the Dow Jones Transportation Average (twenty transportation stocks), the Dow Jones Utility Average (fifteen public utility stocks), the Dow Jones U.S. Total Market Index (includes all of the above). (b) The six Standard and Poor’s (S&P) Indexes include the S&P 400 Industrial Index (400 industrial firms), the Transportation Index (twenty transportation companies), the Utilities Index (forty public utility stocks), the Financials Index (forty financial stocks), the Composite Index (includes the 500 stocks in the S&P indexes mentioned above), the MidCap Index (400 medium-sized companies), the SmallCap index (made up of 600 small-sized companies); and the 1500 SuperComp index, which includes all stocks in the Composite, MidCap, and SmallCap indexes. Nearly all these indexes can be found in financial newspapers such as The Wall Street Journal, Barron’s, Investor’s Business Daily, and local newspapers in major metropolitan areas. 11. (a) The New York Stock Exchange Index includes all of the over 3,100 stocks listed on the New York Stock Exchange. It is calculated in a manner similar to the S&P Indexes. This index reflects the value of the stocks listed on the NYSE relative to a base of 5000 set at December 31, 2002. (b) The American Stock Exchange Index reflects the price of shares on the American Stock Exchange relative to a base of 550 set on December 29, 1995. (c) The Nasdaq Stock Market Indexes reflect the behavior of the over-the-counter market. The most popular, the Nasdaq Composite Index, is calculated using more than 3,380 domestic common stocks traded on the Nasdaq system. The index is based on a value of 125 set on January 1, 1994. Another popular Nasdaq index is the Nasdaq 100, which includes 100 of the largest domestic and international non-financial companies that are listed on the Nasdaq. (d) The Value Line Composite Average includes the approximately 1,700 stocks in the Value Line Investment Survey and traded on a broad cross section of exchanges as well as in the over-the- counter market. The base of 100 reflects the June 30, 1961, average of the stocks. (e) The Wilshire 5000 Index, represents the total dollar value (in billions of dollars) of over 5,000 actively traded stocks, including those on the NYSE and the AMEX in addition to active OTC stocks. 12. (a) Bond yields capture the behavior of market interest rates and represent a type of summary measure of the return an investor would receive on a bond if it were held to maturity. In addition to the yield on 10-high grade corporate bonds and 10 medium-grade corporate bonds, a ratio of the high-grade yield to the medium-grade yield is calculated and known as the confidence index. (b) The Dow Jones Corporate Bond Index, quoted in The Wall Street Journal and Barron’s, is the mathematical average of the closing prices of 32 industrial, 32 financial, and 32 utility/telecom bonds. (c) Since the New York Stock Exchange is the dominant organized exchange for bond trading, the New York Stock Exchange Bond Diary provides useful insight to the behavior of bond markets in general. Information includes the number of bond issues traded; the number that advanced, declined, or remained unchanged; the number of new highs and new lows; and total sales volume in dollars.
    • Chapter 3 Online Information and Investing  41 13. Stockbrokers help investors buy and sell securities. Besides this major role, full-service stockbrokers provide clients with several other benefits. For example, most brokerage firms offer their clients a wide variety of information. Many of them have research staffs that periodically review published economic, market, industry, or company behavior forecasts and make recommendations to their clients as to which securities they should buy or sell. Every month they mail investors a record of transactions for that month with a total ending balance. Some brokerage firms also make arrangements to transfer funds from the sale of securities directly to an investor’s savings account, where 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 conflicts. You should also make sure that the broker does not charge you too much for the services provided and that you are not paying for services that you do not need. 14. (a) A brokerage account may be either single or joint. Joint accounts are typically between married couples or between parent and child. (b) A custodial account is one in which a parent or a guardian will take responsibility for all transactions undertaken on behalf of a minor. (c) A cash account is one in which a customer can only use cash to make transactions. This is perhaps the most common type of account. (d) A customer who wishes to trade in securities using borrowed money establishes a margin account. By leaving the securities with the brokerage firm as collateral, the customer can borrow a pre-specified amount to trade in securities. Needless to say, the brokerage firm will first verify the customer’s creditworthiness before opening a margin account in that customer’s name. (e) A wrap account is an account in which customers with large portfolios pay the brokerage firm a flat annual fee, typically between 2 and 3 percent of their portfolio’s total asset value, to cover the combined costs of a money manager’s services and the cost of commissions on their trades. These accounts allow the wealthy investor to conveniently shift the burden of stock-selection decisions to a professional—either in-house or independent—money manager. 15. A market order is an order to buy or sell a security at the best price available at the time the order is placed. It is the quickest way to make securities transactions. A limit order is an order to buy stock at or below or to sell stock at or above a specified price. It is best used when securities prices fluctuate widely. A stop-loss order is an order to buy or sell the stock when its market price reaches or drops below a specified level. It is used primarily by investors who wish to protect themselves from a rapid decline in the price of the stock. The stop-loss order gives them the opportunity to sell the stock when the price declines to the stop price, thereby reducing their potential losses. It becomes a market order and may in fact be executed at a lower price than the price at which the order was initiated.
    • 42  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition 16. Typically, brokers charge fixed commissions in return for facilitating the purchase or sale of securities. Negotiated commissions are also available to investors who maintain large accounts with the broker. The commissions usually vary depending on the services the broker provides to the investor. The major difference between a full-service and discount broker is the full-service broker provides investment advice. Because investing through a discount or deep-discount broker can save from 30 to 80 percent of the commission, the investor must weigh the benefit of advice against the higher commission. Online brokers are typically deep discount brokers through whom investors can execute trades electronically online. These brokers charge very low commissions, but offer little or no individualized research, information or investment advice. Full service brokers provide personalized, timely research and information. Basic discounters provide low costs and fast trades. Premium discount brokers are in between these extremes. 17. Day trading is the opposite of a buy-and-hold strategy since true day traders do not even own stocks overnight. The method is highly risky since it often involves margin and short transactions that may result in total loss. In addition, day traders have high expenses for brokerage commissions, training, and computer equipment. First, know how to place and confirm your order before you begin trading. Second, verify the stock symbol of the security you wish to buy. Third, use limit orders. Fourth, don’t ignore the online reminders that ask you to check and recheck. Fifth, don’t get carried away. Sixth, open accounts with two brokers. Lastly, double-check orders for accuracy. Many investors set aside an amount of their capital that is designated for purely speculative purposes and not required for day-to-day survival. In this way, they are not jeopardizing themselves or their loved ones if they suffer heavy losses. 18. Most firms have use a fixed-commission schedule for individual investors with accounts less than $50,000. Traditional brokers generally charge on the basis of the number of shares and price per share (e.g., market value of the purchase). They sometimes charge an annual management fee and lower commissions. Online brokers, by comparison charge a flat rate for transactions of up to 1,000 shares. Online investors will pay a surcharge if they seek personalized broker assistance. 19. The Securities Investor Protection Corporation (SPIC), a nonprofit membership corporation, was authorized to protect customer accounts against the consequences of financial failure of the brokerage firm. Mediation is an informal, voluntary approach in which you and the broker agree to a third party who facilitates negotiations between the two of you to resolve disputes. If mediation is not pursued or it fails, you may choose arbitration, a formal process whereby you and your broker present the two sides of the argument before a panel of third party individuals. 20. Investment advisors are individuals or firms who advise clients about portfolio management. This may be done on a discretionary basis, in which case the advisor has complete control over the client’s portfolio. In other cases, the advisor provides investment information and advice, and the client makes his or her own investment decisions. Professional investment advisors are required to register and file regular reports with the SEC under the Investment Advisers Act of 1940; a 1960 amendment gave the SEC broader powers to monitor their activities. However, those who provide investment advice in addition to their primary job responsibility—such as financial planners, stockbrokers, bankers, and accountants—are not regulated by the Act. Many states have similar legislation. It is important to remember that these laws only protect against fraud and unethical practices. They do not provide the investor any indication of the quality of investment advice. Professional investment advice usually costs between one-quarter of 1 percent and 3 percent annually of the amount of money being managed. For larger portfolios, the fee is in the range of one-quarter percent to three-quarters percent; for small portfolios an annual fee ranging from 2 to 3 percent of the dollar amount of funds managed.
    • Chapter 3 Online Information and Investing  43 21. Investment clubs offer the individual investor access to information and/or advice from a broad range of differently experienced people who have similar attitudes, investments strategies and goals. Also, through the investment club the individual investor can participate in a larger, and probably more diversified, investment portfolio, therefore increasing the probability of earning a favorable return on his or her investments. For the uninitiated investor a club can provide an excellent mechanism for learning key aspects of portfolio construction and investment management. Investment clubs regularly outperform the market and the professional money managers because they buy stocks for the long term instead of trying to time the market.   Suggested Answers to Investing in Action Questions Investment Junkies (p. 114) How might online trading and market conditions contribute to an investor’s gambling problem? Answer: The speed and simplicity of Internet stock trading, with periodic successes, leads to more online trading. Greater online trading, in turn, created additional demand. Additional demand, pushed prices beyond equilibrium levels. Additional problems are created by the large amount being risked with each trade. For instance, a round lot trading at $100, is $10,000 being gambled each time. The excitement, fed by television programs and stations dedicated to the marketplace, created a gambling euphoria.   Suggested Answers to Ethics in Investing Questions Did Martha Stewart Cross the Line? (p. 107) Do all investors have the right to sell stock every time a broker tells them to? Answer: No, since the term insider, which was originally reserved to company’s officers, directors, employees as well as their relatives, has now been subsequently expanded to include anyone who obtains nonpublic information about a company. So if your broker gives you a tip to sell the stock today because the company is going to announce bad earnings tomorrow—beware!   Suggested Answers to Discussion Questions Questions 1 to 4 and 6 will have answers that will vary depending on the choices made by the student. 5. You should ask a broker about how much experience they have and whether they have been involved in any disciplinary actions by the SEC. You should ask if they have a minimum account size for new clients. You should also ask how they construct portfolios or choose investments for their clients. Their response should include consideration of each client’s individual needs and circumstances. 7. (a) Market orders are used when an investor wants to buy or sell a security quickly and is willing to trade at the current market price.
    • 44  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition (b) Limit orders are used when an investor want to buy or sell a security and want to trade at a specified price. (c) Stop-loss orders are used when investors want to protect themselves from significant losses. They typically enter these orders at a price below their purchase price after buying a security to limit the amount of their potential loss. 8. Answers will vary with each student’s research. 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 research 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 prefer 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 1. (a) Cost of research: 10 hours at $10 per hour $100 Research data 75 Total $175 (b) Increase in expected return: New return of 10% – Current return of 8% = 2% increase $10,000 investment × 0.02 increase = $200 (c) Yes; the expected increase in return is greater than the cost of doing the research. 2. Mini-Dow Average (MCA) = Closing Price Closing Price of Stock 1 + . . . + of Stock 5 MCA Divisor $65 + $37 + $110 + $73 + $96 381 (a) MDA—Today = = = 498.04 0.765 0.765 $74 + $34 + $96 + $72 + $87 363 MDA—1 Year Ago = = = 459.49 0.790 0.790 (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.
    • Chapter 3 Online Information and Investing  45 3. SP-6 Index = Current Closing Market Current Closing Market Value of Stock 1 + . . . + 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 = $4010 Jan. 1, 2005 $240 + $630 + $450 + $150 + $320 + $80 1870 = 2.144 × 100 = 214.4 SP-6 Index = $430 + $1150 + $980 + $360 + $650 + $290 = 3860 June 30, 2005 $240 + $630 + $450 + $150 + $320 + $80 1870 = 2.064 × 100 = 206.4 (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.
    • 46  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition Closing Price of Stock A + . . . + Closing Price of Stock F 4. Market Average = Divisor (a) $50 + $10 + $7 + $26 + $45 + $32 $170 Market Average1978 = = = 170 1.00 $40 + $36 + $23 + $61 + $70 + $30 $260 Market Average2002 = = = 361.11 0.72 0.72 $46 + $37 + $20 + $59 + $82 + $32 $276 Market Average2005 = = = 394.29 0.70 0.70 (b) Current Closing Market Current Closing Market Value of Stock A + . . . + Value of Stock F Market Index = Base Period Current Base Period Current Market Value of Stock A + . . . + Market Value of Stock F $50 + $10 + $7 + $26 + $45 + $32 $170 Market Index1978 = = =1 $50 + $10 + $7 + $26 + $45 + $32 $170 = 1 × 10 = 10 $40 + $36 + $23 + $61 + $70 + $30 $260 Market Index2002 = = = 1.529 $50 + $10 + $7 + $26 + $45 + $32 $170 = 1.529 × 10 = 15.29 $46 + $37 + $20 + $59 + $82 + $32 $276 Market Index2005 = = = 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. 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 executed at that price. 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 order. 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).
    • Chapter 3 Online Information and Investing  47 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 realize 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). In this case, the loss would be $6/share, or $300.00 total 8. You should place a stop loss order to buy 100 shares at $45. 9. Since the stock never fell to the limit order buy price, you never purchased it. However, you sold it at $70 per share, so you are now short 100 shares. Because the stock is currently selling for $75, your current position is a loss of $500. 10. It is likely that you sold 500 shares at $30. It doesn’t matter that the stock rebounded. Once the sale was executed you had closed your position in the stock. This problem illustrates that although you can protect against declining stock prices using limit orders, there are risks involved. 11. Probably nothing will happen. Although you placed a limit order to buy the stock, and the limit price was hit, you did not have enough equity in your account to make this transaction. 300 shares at $50 per share would cost $15,000. You could make this purchase with $7,500 in your 50% margin account, but not with $5,000.   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 provides the reader with a summary of statistics for a wide variety of investment vehicles. 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 financial 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.
    • 48  Gitman/Joehnk • Fundamentals of Investing, Ninth Edition (b) Since there are no budget constraints for Angel and he is willing to spend a substantial amount on getting information, he should consider the S&P Financial Reports and Services. The S&P Stock Reports, for example, contain up-to-date reports on numerous firms. Their trade and security service provides background information on specific industries. The S&P Stock and Bond Guides provide additional information about stocks and bonds. In addition, Outlook includes several interesting articles that Angel might find to have great educational value. Mergent also publishes a variety of material that could be useful to Angel. Mergent’s Manuals, for example, contain historical and current financial and operation data about all major firms within certain business groupings. Mergent’s Handbook of Common Stocks and Dividend Record also provide useful information on stocks and dividend payments. The Mergent’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 periodically 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 expertise needed to interpret all the information he can get. Because Value Line provides certain specific recommendations, Angel might be best off using this information until he learns how to analyze securities on his own. (c) 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 accessed. Other popular sites include http://Finance.Yahoo.com, and the website of the Securities Exchange Commission at www.sec.gov. (d) While the basic role of the stockbroker would be to buy and sell securities on Angel’s behalf, stockbrokers also provide additional services. For example, stockbrokers often advise clients and supply them with various types of information including prospectuses on new issues and back-office research reports. Often, stockbrokers analyze their clients’ portfolios. Securities can also be held by the broker “in street name” and Angel need not worry about safekeeping the share certificates. It is extremely important for a client to establish a good rapport with a broker. Once a broker understands the client’s investment needs and objectives, the broker is in a better position to offer meaningful investment advice. (e) 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 services of an investment advisor. The use of an investment advisor removes the burden 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, Angel probably can do without the advisory service.
    • Chapter 3 Online Information and Investing  49 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. (e) There are many sources of information and advice available to Peter and Deborah, from stockbrokers and investment advisors to investment clubs and online investment education sites. Peter may consider sites such as The Motley Fool, Zacks Investment Research, and The Wall Street Journal Online. Deborah, on the other hand, may prefer an investment advisor or a full service stockbroker who could provide her with stock recommendations and portfolio management advise. The latter suggestion would be a more likely outcome because of the size of her investment portfolio, although one can find money managers who will handle smaller accounts. One issue will be the cost of having a portfolio of this size managed by an advisor (which will include transaction costs incurred by the advisor), as opposed to the cost of using a full service broker.   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 professional 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 university 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 experienced investor. Comment on the role that public and university libraries might play in your investment program.