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Subject: The Investment FAQ (part 10 of 20)

This article was archived around: 20 Jun 2006 04:24:13 GMT

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Archive-name: investment-faq/general/part10 Version: $Id: part10,v 1.62 2005/01/05 12:40:47 lott Exp lott $ Compiler: Christopher Lott
The Investment FAQ is a collection of frequently asked questions and answers about investments and personal finance. This is a plain-text version of The Investment FAQ, part 10 of 20. The web site always has the latest version, including in-line links. Please browse http://invest-faq.com/ Terms of Use The following terms and conditions apply to the plain-text version of The Investment FAQ that is posted regularly to various newsgroups. Different terms and conditions apply to documents on The Investment FAQ web site. The Investment FAQ is copyright 2005 by Christopher Lott, and is protected by copyright as a collective work and/or compilation, pursuant to U.S. copyright laws, international conventions, and other copyright laws. The contents of The Investment FAQ are intended for personal use, not for sale or other commercial redistribution. The plain-text version of The Investment FAQ may be copied, stored, made available on web sites, or distributed on electronic media provided the following conditions are met: + The URL of The Investment FAQ home page is displayed prominently. + No fees or compensation are charged for this information, excluding charges for the media used to distribute it. + No advertisements appear on the same web page as this material. + Proper attribution is given to the authors of individual articles. + This copyright notice is included intact. Disclaimers Neither the compiler of nor contributors to The Investment FAQ make any express or implied warranties (including, without limitation, any warranty of merchantability or fitness for a particular purpose or use) regarding the information supplied. The Investment FAQ is provided to the user "as is". Neither the compiler nor contributors warrant that The Investment FAQ will be error free. Neither the compiler nor contributors will be liable to any user or anyone else for any inaccuracy, error or omission, regardless of cause, in The Investment FAQ or for any damages (whether direct or indirect, consequential, punitive or exemplary) resulting therefrom. Rules, regulations, laws, conditions, rates, and such information discussed in this FAQ all change quite rapidly. Information given here was current at the time of writing but is almost guaranteed to be out of date by the time you read it. Mention of a product does not constitute an endorsement. Answers to questions sometimes rely on information given in other answers. Readers outside the USA can reach US-800 telephone numbers, for a charge, using a service such as MCI's Call USA. All prices are listed in US dollars unless otherwise specified. Please send comments and new submissions to the compiler. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Real Estate - Renting versus Buying a Home Last-Revised: 21 Nov 1995 Contributed-By: Jeff Mincy (mincy at rcn.com), Chris Lott ( contact me ) This note will explain one way to compare the monetary costs of renting vs. buying a home. It is extremely prejudiced towards the US system. A few small C programs for computing future value, present value, and loan amortization schedules (used to write this article) are available. See the article "Software - Investment-Related Programs" elsewhere in this FAQ for information about obtaining them. 1. Abstract * If you are guaranteed an appreciation rate that is a few points above inflation, buy. * If the monthly costs of buying are basically the same as renting, buy. * The shorter the term, the more advantageous it is to rent. * Tax consequences in the US are fairly minor in the long term. 2. Introduction The three important factors that affect the analysis the most are the following: 1. Relative cash flows; e.g., rent compared to monthly ownership expenses 2. Length of term 3. Rate of appreciation The approach used here is to determine the present value of the money you will pay over the term for the home. In the case of buying, the appreciation rate and thereby the future value of the home is estimated. For home appreciate rates, find something like the tables published by Case Schiller that show changes in house prices for your region. The real estate section in your local newspaper may print it periodically. This analysis neglects utility costs because they can easily be the same whether you rent or buy. However, adding them to the analysis is simple; treat them the same as the costs for insurance in both cases. Opportunity costs of buying are effectively captured by the present value. For example, pretend that you are able to buy a house without having to have a mortgage. Now the question is, is it better to buy the house with your hoard of cash or is it better to invest the cash and continue to rent? To answer this question you have to have estimates for rental costs and house costs (see below), and you have a projected growth rate for the cash investment and projected growth rate for the house. If you project a 4% growth rate for the house and a 15% growth rate for the cash then holding the cash would be a much better investment. First the analysis for renting a home is presented, then the analysis for buying. Examples of analyses over a long term and a short term are given for both scenarios. 3. Renting a Home. Step 1: Gather data You will need: * monthly rent * renter's insurance (usually inexpensive) * term (period of time over which you will rent) * estimated inflation rate to compute present value (historically 4.5%) * estimated annual rate of increase in the rent (can use inflation rate) Step 2: Compute present value of payments You will compute the present value of the cash stream that you will pay over the term, which is the cost of renting over that term. This analysis assumes that there are no tax consequences (benefits) associated with paying rent. 3.1 A long-term example of renting Rent = 990 / month Insurance = 10 / month Term = 30 years Rent increases = 4.5% annually Inflation = 4.5% annually For this cash stream, present value = 348,137.17. 3.2 A short-term example of renting Same numbers, but just 2 years. Present value = 23,502.38 4. Buying a Home Step 1: Gather data. You need a lot to do a fairly thorough analysis: * purchase price * down payment and closing costs * other regular expenses, such as condominium fees * amount of mortgage * mortgage rate * mortgage term * mortgage payments (this is tricky for a variable-rate mortgage) * property taxes * homeowner's insurance (Note: this analysis neglects extraordinary risks such as earthquakes or floods that may cause the homeowner to incur a large loss due to a high deductible in your policy. All of you people in California know what I'm talking about.) * your marginal tax bracket (at what rate is the last dollar taxed) * the current standard deduction which the IRS allows Other values have to be estimated, and they affect the analysis critically: * continuing maintenance costs (I estimate 1/2 of PP over 30 years.) * estimated inflation rate to compute present value (historically 4.5%) * rate of increase of property taxes, maintenance costs, etc. (infl. rate) * appreciation rate of the home (THE most important number of all) Step 2: Compute the monthly expense This includes the mortgage payment, fees, property tax, insurance, and maintenance. The mortgage payment is fixed, but you have to figure inflation into the rest. Then compute the present value of the cash stream. Step 3: Compute your tax savings This is different in every case, but roughly you multiply your tax bracket times the amount by which your interest plus other deductible expenses (e.g., property tax, state income tax) exceeds your standard deduction. No fair using the whole amount because everyone, even a renter, gets the standard deduction for free. Must be summed over the term because the standard deduction will increase annually, as will your expenses. Note that late in the mortgage your interest payments will be be well below the standard deduction. I compute savings of about 5% for the 33% tax bracket. Step 4: Compute the present value First you compute the future value of the home based on the purchase price, the estimated appreciation rate, and the term. Once you have the future value, compute the present value of that sum based on the inflation rate you estimated earlier and the term you used to compute the future value. If appreciation is greater than inflation, you win. Else you break even or even lose. Actually, the math of this step can be simplified as follows: /periods + appr_rate/100\ ^ (periods * yrs) prs-value = cur-value * | ----------------------- | \periods + infl_rate/100/ Step 5: Compute final cost All numbers must be in present value. Final-cost = Down-payment + S2 (expenses) - S3 (tax sav) - S4 (prop value) 4.1 Long-term example Nr. 1 of buying: 6% apprecation Step 1 - the data * Purchase price = 145,000 * Down payment etc = 10,000 * Mortgage amount = 140,000 * Mortgage rate = 8.00% * Mortgage term = 30 years * Mortgage payment = 1027.27 / mo * Property taxes = about 1% of valuation; I'll use 1200/yr = 100/mo (Which increases same as inflation, we'll say. This number is ridiculously low for some areas, but hey, it's just an example!) * Homeowner's ins. = 50 / mo * Condo. fees etc. = 0 * Tax bracket = 33% * Standard ded. = 5600 (Needs to be updated) Estimates: * Maintenance = 1/2 PP is 72,500, or 201/mo; I'll use 200/mo * Inflation rate = 4.5% annually * Prop. taxes incr = 4.5% annually * Home appreciates = 6% annually (the NUMBER ONE critical factor) Step 2 - the monthly expense The monthly expense, both fixed and changing components: Fixed component is the mortgage at 1027.27 monthly. Present value = 203,503.48. Changing component is the rest at 350.00 monthly. Present value = 121,848.01. Total from Step 2: 325,351.49 Step 3 - the tax savings I use my loan program to compute this. Based on the data given above, I compute the savings: Present value = 14,686.22. Not much when compared to the other numbers. Step 4 - the future and present value of the home See data above. Future value = 873,273.41 and present value = 226,959.96 (which is larger than 145k since appreciation is larger than inflation). Before you compute present value, you should subtract reasonable closing costs for the sale; for example, a real estate broker's fee. Step 5 - the final analysis for 6% appreciation Final = 10,000 + 325,351.49 - 14,686.22 - 226,959.96 = 93,705.31 So over the 30 years, assuming that you sell the house in the 30th year for the estimated future value, the present value of your total cost is 93k. (You're 93k in the hole after 30 years, which means you only paid 260.23/month.) 4.2 Long-term example Nr. 2 of buying: 7% apprecation All numbers are the same as in the previous example, however the home appreciates 7%/year. Step 4 now comes out FV=1,176,892.13 and PV=305,869.15 Final = 10,000 + 325,351.49 - 14,686.22 - 305,869.15 = 14796.12 So in this example, 7% was an approximate break-even point in the absolute sense; i.e., you lived for 30 years at near zero cost in today's dollars. 4.3 Long-term example Nr. 3 of buying: 8% apprecation All numbers are the same as in the previous example, however the home appreciates 8%/year. Step 4 now comes out FV=1,585,680.80 and PV=412,111.55 Final = 10,000 + 325,351.49 - 14,686.22 - 412,111.55 = -91,446.28 The negative number means you lived in the home for 30 years and left it in the 30th year with a profit; i.e., you were paid to live there. 4.4 Long-term example Nr. 4 of buying: 2% appreciation All numbers are the same as in the previous example, however the home appreciates 2%/year. Step 4 now comes out FV=264,075.30 and PV=68,632.02 Final = 10,000 + 325,351.49 - 14,686.22 - 68,632.02 = 252,033.25 In this case of poor appreciation, home ownership cost 252k in today's money, or about 700/month. If you could have rented for that, you'd be even. 4.5 Short-term example Nr. 1 of buying: 6% apprecation All numbers are the same as long-term example Nr. 1, but you sell the home after 2 years. Future home value in 2 years is 163,438.17 Cost = down+cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt) = 10,000 + 31,849.52 - 4,156.81 - pv(163,438.17 - 137,563.91) = 10,000 + 31,849.52 - 4,156.81 - 23,651.27 = 14,041.44 4.6 Short-term example Nr. 2 of buying: 2% apprecation All numbers are the same as long-term example Nr. 4, but you sell the home after 2 years. Future home value in 2 years is 150,912.54 Cost = down+cc + all-pymts - tax-savgs - pv(fut-home-value - remaining debt) = 10,000 + 31,849.52 - 4,156.81 - pv(150912.54 - 137,563.91) = 10,000 + 31,849.52 - 4,156.81 - 12,201.78 = 25,490.93 5. A Question Q: Is it true that you can usually rent for less than buying? Answer 1: It depends. It isn't a binary state. It is a fairly complex set of relationships. In large metropolitan areas, where real estate is generally much more expensive than elsewhere, then it is usually better to rent, unless you get a good appreciation rate or if you are going to own for a long period of time. It depends on what you can rent and what you can buy. In other areas, where real estate is relatively cheap, I would say it is probably better to own. On the other hand, if you are currently at a market peak and the country is about to go into a recession it is better to rent and let property values and rent fall. If you are currently at the bottom of the market and the economy is getting better then it is better to own. Answer 2: When you rent from somebody, you are paying that person to assume the risk of homeownership. Landlords are renting out property with the long term goal of making money. They aren't renting out property because they want to do their renters any special favors. This suggests to me that it is generally better to own. 6. Conclusion Once again, the three important factors that affect the analysis the most are cash flows, term, and appreciation. If the relative cash flows are basically the same, then the other two factors affect the analysis the most. The longer you hold the house, the less appreciation you need to beat renting. This relationship always holds, however, the scale changes. For shorter holding periods you also face a risk of market downturn. If there is a substantial risk of a market downturn you shouldn't buy a house unless you are willing to hold the house for a long period. If you have a nice cheap rent controlled apartment, then you should probably not buy. There are other variables that affect the analysis, for example, the inflation rate. If the inflation rate increases, the rental scenario tends to get much worse, while the ownership scenario tends to look better. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - Accredited Investor Last-revised: 1 May 2000 Contributed-By: Chris Lott ( contact me ) The SEC has established criteria for preventing people who perhaps should know better from investing in unregistered securities and other things that are less well known than stocks and bonds. For example, if you've ever been interested in buying into a privately held company, you have probably heard all about this. In a nutshell, for an individual to be considered a qualified investor (also termed an accredited investor), that person must either have a net worth of about a million bucks, or have an annual income in excess of 200k. Companies who wish to raise capital from individuals without issuing registered securities are forced to limit their search to people who fall on the happy side of these thresholds. To read the language straight from the securities lawyers, follow this link: http://www.law.uc.edu/CCL/33ActRls/rule215.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - Full Disclosure Last-revised: 30 Jan 2001 Contributed-By: Chris Lott ( contact me ) The full disclosure rules, also known as regulation FD, were enacted by the SEC to ensure the flow of information to all investors, just just well-connected insiders. Basically the rule says that publically held companies must disclose all material information that might affect investment decisions to all investors at the same time. The intent was to level the playing field for all investors. Regulation FD became effective on 23 October 2000. What was life like before this rule? Basically there was selective disclosure. Before regulation FD, companies communicated well with securities analysts who followed the company (the so-called back channel), but not necessarily as well with individual investors. Analysts were said to interpret the information from companies for the public's benefit. So for example, if a company noticed that sales were weak and that earnings might be poor, the company might call a group of analysts and warn them of this fact. The analysts in turn could tell their big (big) clients this news, and then eventually publish the information for the general public (i.e., small clients). Put simply, if you were big, you could get out before a huge price drop, or get in before a big move up. If you were small, you had no chance. Now, information is made available without any intermediaries like analysts to interpret (or spin) it before it reaches the public. There have been some very noticeable consequences of forcing companies to grant all investors equal access to a company's material disclosures at the same time. For example, company conference calls that were once reserved for analysts only are now accessible to the general public. Another example is that surprises (e.g., earnings shortfalls) are true surprises to everyone, which leads to more frequent occurrences of large changes in a stock's price. Finally, now that analysts no longer have an easy source of information about the companies that they follow, they are forced to do research on their companies - much harder work than before. Some have predicted wide-spread layoffs of analysts because of the change. Timely information (i.e., disclosures) are filed with the SEC in 8-K documents. Note that disclosures can be voluntary (i.e., planned) or involuntary (i.e., goofs). In either case, the new rule says that the company has to disclose the information to everyone as quickly as possible. So an 8-K might get filed unexpectedly because a company exec accidentally disclosed material information during a private meeting. Here are some sites with more information. * FDExpress, a service of Edgar. Subscription required to access company filings. http://www.fdexpress.com * CCBN, a company that provides investor relations services. http://www.ccbn.com/regfd.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - Money-Supply Measures M1, M2, and M3 Last-Revised: 4 Jan 2002 Contributed-By: Ralph Merritt The US Federal Reserve Board measures the money supply using the following measures. M1 Money that can be spent immediately. Includes cash, checking accounts, and NOW accounts. M2 M1 + assets invested for the short term. These assets include money- market accounts and money-market mutual funds. M3 M2 + big deposits. Big deposits include institutional money-market funds and agreements among banks. The pamphlet "Modern Money Mechanics," which explains M1, M2, and M3 in gory detail, was once available free from the Federal Reserve Bank of Chicago. That pamphlet is no longer in print, and the Chicago Fed apparently has no plans to re-issue it. However, electronic copies of it are out there, and here's one: http://landru.i-link-2.net/monques/mmm2.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - Federal Reserve and Interest Rates Last-Revised: 25 Apr 1997 Contributed-By: Jeffrey J. Stitt, Himanshu Bhatt, Nikolaos Bernitsas, Joe Lau This article discusses the interest rates which are managed or influenced by the US Federal Reserve Bank, a collective term for the collection of Federal Reserve Banks across the country. The Discount Rate is the interest rate charged by the Federal Reserve when banks borrow "overnight" from the Fed. The discount rate is under the direct control of the Fed. The discount rate is always lower than the Federal Funds Rate (see below). Generally only large banks borrow directly from the Fed, and thus get the benefit of being able to borrow at the lower discount rate. As of April 1997, the discount rate was 5.00%. The Federal Funds Rate is the interest rate charged by banks when banks borrow "overnight" from each other. The funds rate fluctuates according to supply and demand and is not under the direct control of the Fed, but is strongly influenced by the Fed's actions. As of April 1997, the target funds rate is 5.38%; the actual rate varies above and below that figure. The Fed adjusts the funds rate via "open market operations". What actually happens is that the Fed sells US treasury securities to banks. As a result, the bank reserves at the Fed drop. Given that banks have to maintain at the Fed a certain level of required reserves based on their demand deposits (checking accounts), they end up borrowing more from each other to cover their short position at the Fed. The resulting pressure on intrabank lending funds drives the funds rate up. The Fed has no idea of how many billions of US treasuries it needs to sell in order for the funds rate to reach the Fed's target. It goes by trial and error. That's why it takes a few days for the funds rate to adjust to the new target following an announcement. Adjustments in the discount rate usually lag behind changes in the funds rate. Once the spread between the two rates gets too large (meaning fat profits for the big banks which routinely borrow from the Fed at the discount rate and lend to smaller banks at the funds rate) the Fed moves to adjust the discount rate accordingly. It usually happens when the spread reaches about 1%. Another interest rate of significant interest is the Prime Rate, the interest that a bank charges its "best" customers. There is no single prime rate, but the commercial banks generally offer the same prime rate. The Fed does not adjust a bank's prime rate directly, but indirectly. The change in discount rates will affect the prime rate. As of April, 1997 the prime rate is 8.5%. For an in-depth look at the Federal Reserve, get the book by William Greider titled Secrets of the temple: How the Federal Reserve runs the country . --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - Margin Requirements Last-Revised: 26 May 2002 Contributed-By: Chris Lott ( contact me ), John Marucco This article discusses the rules and regulations that apply to margin accounts at brokerage houses. The basic rules are set by the Federal Reserve Board (FRB), the New York Stock Exchange (NYSE), and the National Asssociation of Securities Dealers (NASD). Every broker must apply the minimum rules to customers, but a broker is free to apply more stringent requirements. Also see the article elsewhere in the FAQ for an explanation of a margin account versus a cash account . Buying on margin means that your broker loans you money to make a purchase. But how much can you borrow? As it turns out, the amount of debt that you can establish and maintain with your broker is closely regulated. Here is a summary of those regulations. The Federal Reserve Board's Regulation T states how much money you may borrow to establish a new position . Briefly, you may borrow 50% of the cost of the new position. For example, $100,000 of cash can be used to buy $200,000 worth of stock. The NYSE's Rule 431 and the NASD's Rule 2520 both state how much money you can continue to borrow to hold an open position . In brief, you must maintain 25% equity for long positions and 30% equity for short positions. Continuing the example in which $100,000 was used to buy $200,000 of stock, the account holder would have to keep holdings of $50,000 in the account to maintain the open long position. The best holding in this case is of course cash; a $200,000 margined position can be kept open with $50,000 of cash. If the account holder wants to use fully paid securities to meet the maintenance requirement, then securities (i.e., stock) with a loan value of $50,000 are required. See the rule above - you can only borrow up to 50% - so to achieve a loan value of $50,000, the account holder must have at least $100,000 of fully paid securities in the account. If the value of the customer's holdings drops to less than 25% of the value of open positions (maybe some stocks fell in price dramatically), than the brokerage house is required to impose a margin call on the account holder. This means that the person must either sell open positions, or deposit cash and/or securities, until the account equity returns to 25%. If the account holder doesn't meet the margin call, then four times the amount of the call will be liquidated within the account. Here are a few examples, showing Long Market, Short Market, Debit Balance, Credit Balance, and Equity numbers for various situations. Remember, Equity is the Long Market Value plus the Credit Balance, less any Short Market Value and Debit Balance. (The Current Market Value of securities is the Long Market value less the Short Market value.) The Credit Balance is cash - money that is left over after everything is paid and all margin requirements are satisfied. This is supposed to give a feel for how a brokerage statement is marked to market each day. So in the first example, a customer buys 100,000 worth of some stock on margin. The 50% margin requirement (Regulation T) can be met with either stock or cash. To satisfy the margin requirement with cash , the customer must deposit 50,000 in cash. The account will then appears as follows; the "Equity" reflects the cash deposit: Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- 100,000 0 0 50,000 50,000 To satisfy the margin requirement with stock , the customer must deposit marginable stock with a loan value of 50,000 (two times the amount of the call). The account will then appears as follows; the 200,000 of long market consists of 100,000 stock deposited to meet reg. T and 100,000 of the stock purchased on margin: Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- 200,000 0 0 100,000 100,000 Here's a new example. What if the account looks like this: Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- 20,000 0 0 17,000 3,000 The maintenance requirement calls for an equity position that is 25% of 20,000 which is 5,000, but equity is only 3,000. Because the equity is less than 25% of the market value, a maintenance (aka margin) call is triggered. The call is for the difference between the requirement and actual equity, which is 5,000 - 3,000 or 2000. To meet the call, either 2,000 of cash or 4,000 of stock must be deposited. Here is what would happen if the account holder deposits 2,000 in cash; note that the cash deposit pays down the loan. Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- 20,000 0 0 15,000 5,000 Here is what would happen if the account holder deposits 4,000 of stock: Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- 24,000 0 0 17,000 7,000 Ok, now what happens if the account holder does not meet the call? As mentioned above, four times the amount of the call will be sold. So stock in the amount of 8,000 will be sold and the account will look like this: Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- 12,000 0 0 9,000 3,000 In the case of short sales, Regulation T imposes an initial margin requirement of 150%. This sounds extreme, but the first 100% of the requirement can be satisified by the proceeds of the short sale, leaving just 50% for the customer to maintain in margin (so it looks much like the situation for going long). To maintain a short position, rule 2520 requires margin of $5 per share or 30 percent of the current market value (whichever is greater). Let's say a person shorts $10,000 worth of stock. They must have securities with a loan value of at least $5,000 to comply with regulation T. In this example, to keep things simple, the customer deposits cash. So the Credit Balance consists of the 10,000 in proceeds from the short sale plus the 5,000 Regulation T deposit. Remember that market value is long market value minus short market value, and because we gave our customer no securities in this example, the "long market" value is zero, making the market value negative. Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- 0 10,000 15,000 0 5,000 While we're discussing shorting, what about being short against the box? (Also see the FAQ article about short-against-the-box positions .) When an individual is long a stock position and then shorts the same stock, a separate margin requirement is applicable. When shorting a position that is long in an account the requirement is 5% of the market value of the underlying stock. Let's say the original stock holding of $100,000 was purchased on margin (with a corresponding 50% requirement). And the same holding is sold short against the box, yielding $100,000 of proceeds that is shown in the Credit Balance column, plus a cash deposit of $5,000. The account would look like this: Long Market Short Market Credit Balance Debit Balance Equity ----------------------------------------------------------------------- Initial position 100,000 50,000 50,000 Sell short 0 100,000 105,000 100,000 5,000 Net 100,000 100,000 105,000 150,000 55,000 Customer accounts are suppsed to be checked for compliance with Regulation T and Rule 2520 at the end of each trading day. A brokerage house may impose a margin call on an account holder at any time during the day, though. Finally, special conditions apply to day-traders. Check with your broker. Here are some additional resources: * The NASD's Investor Education section has information about margin: http://www.nasd.com/Investor/Trading/Margin/ * The full text of Regulation T http://www.access.gpo.gov/nara/cfr/waisidx_99/12cfr220_99.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - Securities and Exchange Commission (U.S.) Last-revised: 22 Dec 1999 Contributed-By: Dennis Yelle Just in case you want to ask questions, complain about your broker, or whatever, here's the vital information: Securities and Exchange Commission 450 5th Street, N. W. Washington, DC 20549 Office of Public Affairs: +1 202 272-2650 Office of Consumer Affairs: +1 202 272-7440 SEC policy concerning online enforcement: http://www.sec.gov/enforce/comctr.htm A web-enabled complaint submission form: http://www.sec.gov/enforce/con-form.htm E-Mail address for complaints: enforcement@sec.gov --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - SEC Rule 144 Last-Revised: 6 June 2000 Contributed-By: Bill Rini (bill at moneypages.com), Julie O'Neill (joneill at feinberglawgroup.com) The Federal Securities Act of 1933 generally requires that stock and other securities must be registered with the Securities and Exchange Commission (the "S.E.C.") prior to their offer or sale. Registering securities with the S.E.C. can be expensive and time-consuming. This article offers a brief introduction to SEC Rule 144, which allows for the sale of restricted securities in limited quantities without requiring the securities to be registered. First it's probably appropriate to explain the basics of restricted securities. Restricted securities are generally those which are first issued in a private placement exempt from registration and which bear a restrictive legend. The legend commonly states that the securities are not registered and cannot be offered or sold unless they are registered with the S.E.C. or exempt from registration. The restrictive legend serves to ensure that the initial, unregistered sale is not part of a scheme to avoid registration while achieving some broader distribution than the initial sale. Normally, if securities are registered when they are first issued, then they do not bear any restrictive legend and are not deemed restricted securities. Rule 144 generally applies to corporate insiders and buyers of private placement securities that were not sold under SEC registration statement requirements. Corporate insiders are officers, directors, or anyone else owning more than 10% of the outstanding company securities. Stock either acquired through compensation arrangements or open market purchases is considered restricted for as long as the insider is affiliated with the company. For example, if a corporate officer purchases shares in his or her employer on the open market, then the officer must comply with Rule 144 when those shares are sold, even though the shares when purchased were not considered restricted. If, however, the buyer of restricted securities has no management or major ownership interests in the company, the restricted status of the securities expires over a period of time. Under Rule 144, restricted securities may be sold to the public without full registration (the restriction lapses upon transfer of ownership) if the following conditions are met. 1. The securities have been owned and fully paid for at least one year (there are special exceptions that we'll skip here). 2. Current financial information must be made available to the buyer. Companies that file 10K and 10Q reports with the SEC satisfy this requirement. 3. The seller must file Form 144, "Notice of Proposed Sale of Securities," with the SEC no later than the first day of the sale. The filing is effective for 90 days. If the seller wishes to extend the selling period or sell additional securities, a new form 144 is required. 4. The sale of the securities may not be advertised and no additional commissions can be paid. 5. If the securities were owned for between one and two years, the volume of securities sold is limited to the greater of 1% of all outstanding shares, or the average weekly trading volume for the proceeding four weeks. If the shares have been owned for two years or more, no volume restrictions apply to non-insiders. Insiders are always subject to volume restrictions. The most recent rule change of Feb 1997 reduced the holding periods by one year. For all the details, visit the SEC's page on this rule: http://www.sec.gov/rules/final/33-7390.txt Julie O'Neill offers some insights about the SEC's Rule 144: http://www.feinberglawgroup.com/rule144.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - SEC Registered Advisory Service Last-revised: 9 Jan 1996 Contributed-By: Paul Maffia (paulmaf at eskimo.com) Some advisers will advertise with the information that they are an S.E.C. Registered Advisory Service. This does not mean a damn thing except that they have obeyed the law and registered as the law requires. All it takes is filling out a long form, $150 and no convictions for financial fraud. If they attempt to imply anything in their ads other than the fact they are registered, they are violating the law. Basically, this means that they can inform you that they are registered in a none-too-prominent way. If the information is conveyed in any other way, such as being very prominent, or using words that convey any meaning other than the simple fact of registration; or implying any special expertise; or implying special approval, etc., they are violating the law and can easily be fined and as well as lose their registration. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - SEC/NASDAQ Settlement Last-Revised: 26 Feb 1997 Contributed-By: John Schott (jschott at voicenet.com), Chris Lott ( contact me ) The SEC's settlement with NASDAQ in late 1996 will almost certainly impact trading and price improvement in a favorable way for small investors. The settlement resulted in rule changes that are intended to improve greater access to the market for individual investors, and to improve the display and execution of orders. The changes will be implemented in several phases, with the first phase beginning on 10 Jan 1997. Initially only 50 stocks will be in the program, but in subsequent steps in 1997, the number of stocks will be expanded to cover all NASDAQ stocks. This action began after many people complained about very high spreads in some shares traded on the NASDAQ market. In effect,the SEC contention was that some market makers possible did not publically post orders inside the spread because it impacted their profit margins. Here are some of the key changes that resulted from the settlement. * All NASDAQ market makers must execute or publicly display customer limit orders that are (a) priced better than their public quote or (b) limit orders that add to the size of their quote. * All investors will have access to prices previously available only to institutions or professional traders. These rules are expected to produce more trading inside the spread, so wide spreads may become less common. But remember, a market maker or broker making a market for a stock has to be compensated for the risk they take. They have to hold inventory or risk selling you stock they don't have and finding some quickly. With a stock that moves about or trades seldom, they have to make money on the spread to cover the "bad moves" that can leave them holding inventory at a bad price. Reduced spreads may in fact force less well capitalized or managed market makers to leave the market for certain stocks, as there may be less chance for profit. It will definitely be interesting to see how the spreads change over the next few months as the NASDAQ settlement is phased in on more and more stocks. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - Series of Examinations/Registrations Last-revised: 30 Sep 1999 Contributed-By: Charlie H. Luh, Chris Lott ( contact me ) The National Association of Securities Dealers (NASD) administers a series of licensing examinations that are used to qualify people for employment in many parts of the finance industry. For example, the Series 7 is commonly (although somewhat incorrectly) known as the stockbroker exam. The following examinations are offered: * Series 3 - Commodity Futures Examination * Series 4 - Registered Options Principal * Series 5 - Interest Rate Options Examination * Series 6 - Investment Company and Variable Contracts Products Rep. Translation: qualifies sales representatives to sell mutual funds and variable annuities. * Series 7 - Full Registration/General Securities Representative Translation: qualifies sales representatives to sell stocks and bonds. Variations include: * Securities Traders (NYSE) * Trading Supervisor (NYSE) * Series 8 - General Securities Sales Supervisor * Branch Office Manager (NYSE) * Series 11 - Assistant Representative/Order Processing * Series 15 - Foreign Currency Options * Series 16 - Supervisory Analyst * Series 22 - Direct Participation Program Representative * Series 24 - General Securities Principal * Series 26 - Investment Company and Variable Contracts Principal * Series 27 - Financial and Operations Principal * Series 28 - Introducing B/D/Financial and Operations Principal * Series 39 - Direct Participation Program Principal * Series 42 - Options Representative * Series 52 - Municipal Securities Representative * Series 53 - Municipal Securities Principal * Series 62 - Corporate Securities Representative * Series 63 - Uniform Securities Agent State Law Examination * Series 65 - Uniform Investment Advisor Law Examination The following NASD resources should help. * The procedures for becoming a member of NASD, including details about registering personnel through the Central Registration Depository (CRD). http://www.nasdr.com/4700.htm * The NASD's CRD call center: +1 (301) 590-6500 * The NASD home page. http://www.nasd.com/ --------------------Check http://invest-faq.com/ for updates------------------ Subject: Regulation - SIPC, or How to Survive a Bankrupt Broker Last-Revised: 26 May 1999 Contributed-By: Art Kamlet (artkamlet at aol.com), Dave Barrett The U.S. Securities Investor Protection Corporation (SIPC) is a federally chartered private corporation whose job is to insure shareholders against the situation of a U.S. stock-broker going bankrupt. The National Association of Security Dealers requires all of their member brokers to have SIPC insurance. Many brokers supplement the limits that SIPC insures ($100,000 cash and $500,000 total, I think-- I could be wrong here) with additional policies so you are covered up to $1 million or more. If you deal with discount houses, all brokerages, their clearing agents, and any holding companies they have which can be holding your assets in street-name had better be insured with the S.I.P.C. You're going to pay a modest SEC tax (less than US$1) on any trade you make anywhere, so make sure you're getting the benefit. If a broker goes bankrupt it's the only thing that prevents a total loss. Investigate thoroughly! The bottom line is that you should not do business with any broker who is not insured by the SIPC. --------------------Check http://invest-faq.com/ for updates------------------ Compilation Copyright (c) 2005 by Christopher Lott.