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Subject: The Investment FAQ (part 6 of 20)

This article was archived around: 21 May 2006 04:23:39 GMT

All FAQs in Directory: investment-faq/general
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Archive-name: investment-faq/general/part6 Version: $Id: part06,v 1.61 2003/03/17 02:44:30 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 6 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 2003 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: Exchanges - Circuit Breakers, Curbs, and Other Trading Restrictions Last-Revised: 2 Aug 2002 Contributed-By: Chedley A. Aouriri, Darin Okuyama, Chris Lott ( contact me ), Charles Eglinton A variety of mechanisms are in place on the U.S. exchanges to restrict program trading (i.e., to cut off the big boy's computer connections) whenever the market moves up or down by more than a large number of points in a trading day. Most are triggered by moves down, although some are triggered by moves up as well. The idea is that these curbs on trading, also known as collars, will limit the daily damage by restricting activities that might lead towards greater volatility and large price moves, and encouraging trading activities that tend to stabilize prices. Although these trading restrictions are commonly known as circuit breakers, that term actually refers to just one specific restriction. These changes were enacted in 1989 because program trading was blamed for the fast crash of 1987. Note that the NYSE defines a Program Trade as a basket of 15 or more stocks from the Standard & Poor's 500 Index, or a basket of stocks from the Standard & Poor's 500 Index valued at $1 million or more. Trading restrictions affect trading on the New York Stock Exchange (NYSE) and the Chicago Mercantile Exchange (CME) where S&P 500 futures contracts are traded. When these restrictions are triggered, you may hear the phrase "curbs in" if you listen to CNBC. Here's a table that summarizes the trading restrictions in place on the NYSE and CME as of this writing. The range is always checked in reference to the previous close. E.g., a move of up 200 and down 180 points would still be an up of 20 with respect to the previous close, so the first restriction listed below would not be triggered. Any curb still in effect at the close of trading is removed after the close; i.e., every trading day starts without curbs. Note that the "sidecar" rules were eliminated on Tuesday, February 16, 1999. Restriction Triggered by NYSE collar (Rule 80A) DJIA moves 2% CME restriction 1 S&P500 futures contract moves 2.5% CME restriction 2 S&P500 futures contract moves 5% CME restriction 3 S&P500 futures contract moves 10% NYSE circuit breaker nr. 1 DJIA moves 10% NYSE circuit breaker nr. 2 DJIA moves 20% NYSE Circuit breaker nr. 3 DJIA moves 30% Now some details about each. NYSE Collar (Rule 80A): Index arbitrage tick test Rule 80A provides that index arbitrage orders can only be executed on plus or minus ticks depending on which way the DJIA is. In the parlance of the NYSE, the orders must be "stabilizing." This rule only effects S&P 500 stocks, and is also known as the "uptick downtick rule" because it restricts sells to upticks and buys to downticks. In other words, when the market is down (last tick was down), sell orders can't be executed at lower prices. In an up market (last tick was up), buy orders can't be executed for higher prices. This collar is removed when the DJIA retraces its gain or loss to within approximately 1% of the previous close. As of 3Q02, the collar is imposed at 180 points and removed when the DJIA retraces its position to within 90 points of the previous day's close. CME Restrictions Trading in the S&P500 futures contract is halted just for a few minutes if the prices moves 2.5%, 5%, or 10% from the previous close. Because restrictions on the NYSE effectively shut down trading in this futures contract, there is little need for additional restrictions on the CME. NYSE Circuit Breakers These restrictions are also known as "Rule 80B." The first version of this rule, adopted in 1988, set triggers at 250 DJIA points and 400 DJIA points. These restrictions are updated quarterly to reflect the heights to which the Dow Jones Industrial Average has climbed. * 10% decline (950 points for 3Q02) The first circuit breaker is triggered if the DJIA declines by approximately 10%. The restrictions that are put into place -- if any -- depend on the time of day when the circuit breaker is triggered. If the trigger occurs before 2pm Eastern time, trading is halted for 1 hour. If the trigger occurs between 2 and 2:30pm Eastern, trading is halted for 30 minutes. If the trigger occurs after 2:30pm Eastern time, no restrictions are put into place. (This restriction was first used during the afternoon of 27 Oct 97.) Note that there is no similar restriction to the downside; nothing is done if the Dow rallies 10%. * 20% decline (1900 DJIA points for 3Q02) The second circuit breaker is triggered if the DJIA declines by approximately 20%. The restrictions that are put into place again depend on the time of day when the circuit breaker is triggered. If the trigger occurs before 1pm Eastern time, trading is halted for 2 hours. If the trigger occurs between 1 and 2pm Eastern, trading is halted for 1 hour. If the trigger occurs after 2pm Eastern time, the NYSE ends trading for the day. Again there is no similar restriction to the downside; nothing is done if the Dow rallies 20%. * 30% decline (2850 DJIA points for 3Q02) The third circuit breaker is triggered if the DJIA declines by approximately 30%. The restriction is very simple: the NYSE closes early that day. And like the other cases, again no restrictions are imposed if the Dow rallies 30%. The circuit breakers cut off the automated program trading initiated by the big brokerage houses. The big boys have their computers directly connected to the trading floor on the stock exchanges, and hence can program their computers to place direct huge buy/sell orders that are executed in a blink. This automated connection allows them to short-cut the individual investors who must go thru the brokers and the specialists on the stock exchange. Statistical evidence suggests that about 2/3 of the Mar-Apr 1994 down slide was caused by the program traders trying to lock in their profits before all hell broke loose. The volume of their trades and their very action may have accelerated the slide. The new game in town is how to outfox the circuit breakers and buy or sell quickly before the 50-point move triggers the halting of the automated trading and shuts off the computer. Here are sources with more information: * HL Camp & Company offers a concise summary of program trading collars including current numbers on their web site. http://www.programtrading.com/curbs.htm * The Chicago Mercantile Exchange publishes their equity index price limits. http://www.cme.com/products/index/products_index_pricelimitguide.cfm * The NYSE publishes press releases every quarter with the numbers for that quarter's circuit breakers. http://www.nyse.com/press/prcircuit.html * The NYSE's glossary includes definitions of the term "Circuit Breakers". http://www.nyse.com/help/glossary.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Exchanges - Contact Information Last-Revised: 13 Aug 1993 Contributed-By: Chris Lott ( contact me ) Here's how to contact the stock exchanges in North America. * American Stock Exchange (AMEX), +1 212 306-1000, http://www.amex.com * ASE, +1 403 974-7400 * Montreal Stock Exchange (MSE), +1 514 871-2424 * NASDAQ/OTC, +1 202 728-8333/8039, http://www.nasdaq.com * New York Stock Exchange (NYSE), +1 212 656-3000, http://www.nyse.com * The Philadelphia Stock Exchange (PHLX), http://www.phlx.com/ * Toronto Stock Exchange (TSE), +1 416 947-4700 * Vancouver Stock Exchange (VSE), +1 604 689-3334/643-6500 If you wish to know the telephone number for a specific company that is listed on a stock exchange, call the exchange and request to be connected with their "listings" or "research" department. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Exchanges - Instinet Last-Revised: 11 May 1994 Contributed-By: Jeffrey Benton (jeffwben at aol.com) Instinet is a professional stock trading system which is owned by Reuters. Institutions use the system to trade large blocks of shares with each other without using the exchanges. Commissions are slightly negotiable but generally $1 per hundred shares. Instinet also runs a crossing network of the NYSE last sale at 6pm. A "cross" is a trade in which a buyer and seller interact directly with no assistance of a market maker or specialist. These buyer-seller pairs are commonly matched up by a computer system such as Instinet. Visit their web site: http://www.instinet.com/ --------------------Check http://invest-faq.com/ for updates------------------ Subject: Exchanges - Market Makers and Specialists Last-Revised: 28 Jan 1994 Contributed-By: Jeffrey Benton (jeffwben at aol.com) Both Market Makers (MMs) and Specialists (specs) make market in stocks. MMs are part of the National Association of Securities Dealers market (NASD), sometimes called Over The Counter (OTC), and specs work on the New York Stock Exchange (NYSE). These people serve a similar function but MMs and specs have a number of differences. See the articles in the FAQ about the NASDAQ and the NYSE for a detailed discussion of these differences. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Exchanges - The NASDAQ Last-Revised: 6 June 2000 Contributed-By: Bill Rini (bill at moneypages.com), Jeffrey Benton (jeffwben at aol.com), Chris Lott ( contact me ) NASDAQ is an abbreviation for the National Association of Securities Dealers Automated Quotation system. It is also commonly, and confusingly, called the OTC market. The NASDAQ market is an interdealer market represented by over 600 securities dealers trading more than 15,000 different issues. These dealers are called market makers (MMs). Unlike the New York Stock Exchange (NYSE), the NASDAQ market does not operate as an auction market (see the FAQ article on the NYSE). Instead, market makers are expected to compete against each other to post the best quotes (best bid/ask prices). A NASDAQ level II quote shows all the bid offers, ask offers, size of each offer (size of the market), and the market makers making the offers in real time. These quotes are available from the Nasdaq Quotation Dissemination Service (NQDS). The size of the market is simply the number of shares the market maker is prepared to fill at that price. Since about 1985 the average person has had access to level II quotes by way of the Small Order Execution System (SOES) of the NASDAQ. Non-professional users can get level II quotes for $50 per month. In May 2000, the Nasdaq announced a pilot program that would reduce this fee to just $10 per month. SOES was implemented by NASDAQ in 1985. Following the 1987 market crash, all market makers were required to use SOES. This system is intended to help the small investor (hence the name) have his or her transactions executed without allowing market makers to take advantage of said small investor. You may see mention of "SOES Bandits" which is slang for people who day-trade stocks on the NASDAQ using the SOES. A SOES bandit tries to scalp profits on the spreads. Visit www.attain.com for more on that topic. A firm can become a market maker (MM) on NASDAQ by applying. The requirements are relatively small, including certain capital requirements, electronic interfaces, and a willingness to make a two-sided market. You must be there every day. If you don't post continuous bids and offers every day you can be penalized and not allowed to make a market for a month. The best way to become a MM is to go to work for a firm that is a MM. MMs are regulated by the NASD which is overseen by the SEC. The brokerage firm can handle customer orders either as a broker or as a dealer/principal. When the brokerage acts as a broker, it simply arranges the trade between buyer and seller, and charges a commission for its services. When the brokerage acts as a dealer/principal, it's either buying or selling from its own account (to or from the customer), or acting as a market maker. The customer is charged either a mark-up or a mark-down, depending on whether they are buying or selling. The brokerage can never charge both a mark-up (or mark-down) and a commission. Whether acting as a broker or as a dealer/principal, the brokerage is required to disclose its role in the transaction. However dealers/principals are not necessarily required to disclose the amount of the mark-up or mark-down, although most do this automatically on the confirmation as a matter of policy. Despite its role in the transaction, the firm must be able to display that it made every effort to obtain the best posted price. Whenever there is a question about the execution price of a trade, it is usually best to ask the firm to produce a Time and Sales report, which will allow the customer to compare all execution prices with their own. In the OTC public almost always meets dealer which means it is nearly impossible to buy on the bid or sell on the ask. The dealers can buy on the bid even though the public is bidding. Despite the requirement of making a market, in the case of MM's there is no one firm who has to take the responsibility if trading is not fair or orderly. During the crash of 1987 the NYSE performed much better than NASDAQ. This was in spite of the fact that some stocks have 30+ MMs. Many OTC firms simply stopped making markets or answering phones until the dust settled. Academic research has shown that an auction market such as the NYSE results in better trades (in tighter ranges, less volatility, less difference in price between trades). When you compare the multiple market makers on the NASDAQ with the few specialists on the NYSE (see the NYSE article), this is a counterintuitive result. But it is true. In 1996 the NASDAQ was investigated for various practices. It settled a suit brought against it by the SEC and agreed to change key aspects of how it does business. Forbes ran a highly critical article entitled "Fun and Games" on the NASDAQ. This was once available on the web, but has vanished. Related topics include price improvement, bid and ask, order routing, and the 1996 settlement between the SEC and the NASDAQ. Please see the articles elsewhere in this FAQ about those topics. In 1998, a merger between the NASD and the AMEX resulted in the Nasdaq-Amex Market Group. For more information, visit their home page: http://www.nasdaq.com --------------------Check http://invest-faq.com/ for updates------------------ Subject: Exchanges - The New York Stock Exchange Last-Revised: 4 June 1999 Contributed-By: Jeffrey Benton (jeffwben at aol.com), Chris Lott ( contact me ) The New York Stock Exchange (NYSE) is the largest agency auction market in the United States. Visit their home page: http://www.nyse.com The NYSE uses an agency auction market system which is designed to allow the public to meet the public as much as possible. The majority of volume (approx 88%) occurs with no intervention from the dealer. Specialists (specs) make markets in stocks and work on the NYSE. The responsibility of a spec is to make a fair and orderly market in the issues assigned to them. They must yield to public orders which means they may not trade for their own account when there are public bids and offers. The spec has an affirmative obligation to eliminate imbalances of supply and demand when they occur. The exchange has strict guidelines for trading depth and continuity that must be observed. Specs are subject to fines and censures if they fail to perform this function. NYSE specs have large capital requirements and are overseen by Market Surveillance at the NYSE. Specs are required to make a continuous market. Most academic literature shows NYSE stocks trade better (in tighter ranges, less volatility, less difference in price between trades) when compared with the OTC market (NASDAQ). On the NYSE 93% of trades occur at no change or 1/8 of a point difference. It is counterintuitive that one spec could make a better market than many market makers (see the article about the NASDAQ). However, the spec operates under an entirely different system. The NYSE system requires exposure of public orders to the auction, the opportunity for price improvement, and to trade ahead of the dealer. The system on the NYSE is very different than NASDAQ and has been shown to create a better market for the stocks listed there. This is why 90% of US stocks that are eligible for NYSE listing have listed. A specialist will maintain a narrow spread. Since the NYSE does not post bid/ask information, you need to check out the 1-minute tick to figure out the spread. In other words, you'll need access to a professional's data feed before you can really see the size of the spread. But the structure of the market strongly encourages narrow spreads, so investors shouldn't be overly concerned about this. There are 1366 NYSE members (i.e., seats). Approximately 450 are specialists working for 38 specialists firms. As of 11/93 there were 2283 common and 597 preferred stocks listed on the NYSE. Each individual spec handles approximately 6 issues. The very big stocks will have a spec devoted solely to them. Every listed stock has one firm assigned to it on the floor. Most stocks are also listed on regional exchanges in LA, SF, Chi., Phil., and Bos. All NYSE trading (approx 80% of total volume) will occur at that post on the floor of the specialist assigned to it. To become a NYSE spec the normal route is to go to work for a specialist firm as a clerk and eventually to become a broker. The New York Stock Exchange imposes fairly stringent restrictions on the companies that wish to list their shares on the exchange. Some of the guides used by the NYSE for an original listing of a domestic company are national interest in the company and a minimum of 1.1 million shares publicly held among not fewer than 2,000 round-lot stockholders. The publicly held common shares should have a minimum aggregate market value of $18 million. The company should have net income in the latest year of over $2.5 million before federal income tax and $2 million in each of the preceding two years. The NYSE also requires that domestic listed companies meet certain criteria with respect to outside directors, audit committee composition, voting rights and related party transactions. A company also pays significant initial and annual fees to be listed on the NYSE. Initial fees are $36,800 plus a charge per million shares issued. Annual fees are also based on the number of shares issued, subject to a minimum of $16,170 and a maximum of $500,000. For example, a company that issues 4 million shares of common stock would pay over $81,000 to be listed and over $16,000 annually to remain listed. For all the gory details, visit this NYSE page: http://www.nyse.com/listed/listed.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Exchanges - Members and Seats on AMEX Last-Revised: 2 Aug 1999 Contributed-By: Jon Feins (proclm at kear.tdsnet.com), J. Bouvrie (fnux at thetasys.com) Most exchanges allow you to buy seats (become a member) without being a registered securities dealer. You would not, however, be allowed to use the seat to transact business on that exchange. You would be allowed to lease out the seat and would thus own the seat as an investment. Here's the disclaimer right up front: I have been negotiating seat leases for investors for the last 5 years. My expertise is mainly on the American Stock Exchange (AMEX) and New York Stock Exchange (NYSE). I spent 5 years on the floor of the NYSE and NYFE before going to the AMEX for 3 years as a floor broker/trader. Anyone can purchase a seat on a major stock exchange as an investment and lease it to either a floor trader, specialist, or floor broker. Most people do not realize that they can do this without any background and without taking a test. You do not even have to be a registered rep. or registered with the SEC. The return is between 12%-20% of the current seat prices depending on the supply and demand at the time the lease is negotiated. The AMEX currently has a very high demand for leases. The last leases I negotiated were at a variable rate of 1 5/8%/month (19.5% per year) of the average seat sales as posted by the exchange in their monthly bulletin. AMEX seats are currently quoted $565,000/bid - $690,000/offer. The last contracted sale was for $660,000 on 15 July 1999. You can call the AMEX's 24 hour market line 877-AMEXSEAT to hear the latest quote. Amex seats can be put in an IRA or a Keogh Plan making the investment even more appealing. In late 1996, the AMEX approved a rule allowing individuals to own more than one seat. Since then seats have been slowly going up. Call the AMEX market line (212-306-2243) for the current price. There are only 661 regular seats and 203 Option Principal Memberships (OPM) on the AMEX. Every Specialist and Floor Broker needs a regular membership to do business. A Trader can use either an OPM or a regular seat. If a trader wants to trade listed AMEX stocks (s)he needs to use a regular seat. When applying for an AMEX membership you need to fill out an application which consists of: 1. Information about the person applying for membership. 2. Authorization form for orally bidding for or offering the membership. 3. Personal financial statement. 4. Completed U-4 for for background check along with a fingerprint form. 5. Acknowledgement of non-eligibility of gratuity fund form. After completing the paperwork a non-refundable application fee of $500 must be submitted to the exchange. About a week after processing your application you will be able to buy/bid for a seat. Other costs involved with the purchase of a seat on the AMEX include a one time transfer fee of $2,500 (If/when you sell the seat the buyer of your seat has to pay this transfer fee). When the seat is leased out a transfer fee of $1,500 is paid by the lessee. Your total costs are: 1. Purchase price of the seat. 2. $500 application fee. 3. One-time $2,500 transfer fee. 4. $24.50 Finger print processing fee. When you sell the seat there are no costs, and the exchange will send you a check for the full selling price which they collect from the buyer of your seat. In the deals that I broker, once an investor has purchased the seat I find a lessee. All my leases require a letter of indemnity from the clearing house of the lessee. A clearing house (Merrill Lynch, Paine Webber, Bear Stearns etc...) is used by the lessee to clear the trades they execute. Whether the lessee is a trader, specialist or a floor broker they must use a clearing house who charges them commissions for each of their trades and is liable for their losses. If a person who is worth $100,000 dollars loses $500,000 dollars the clearing house is liable for the losses of the other $400,000. The letter of indemnity from the clearing house states that they do not view the seat as collateral. In addition to this letter of indemnity, I only lease to people who are employed by a well-capitalized firm which also signs the lease as a guarantor. My leases have attorney reviewed modifications which further protect the interests of the owner of the seat. Just like a person who rents a house needs to be careful of who they lease to, so does the lessor of a seat. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Exchanges - Ticker Tape Terminology Last-Revised: 19 Sep 1999 Contributed-By: Keith Brewster, Norbert Schlenker, Richard Sauers (rsauers at enter.net), Art Kamlet (artkamlet at aol.com) Every stock traded on the world's stock exchanges is identified by a short symbol. For example, the symbol for AT&T is just T. These symbols date from the days when stock trades were reported on a ticker tape. Ticker symbols are still used today as brief, unambiguous identifiers for stocks. Similar abbreviations are used for stock options and many other securities. Ticker symbols get reused on different exchanges, so you'll sometimes see a qualification ahead of the ticker symbol. For example, the symbol "C:A" refers to a company traded on one of the Canadian exchanges (Toronto, to be exact) with the symbol A. The stock quote services on the web usually understand this notation. It's probably no surprise that the North American-centric services pretty much assume that anything unqualified is traded on a U.S. exchange; I've found that they do not accept something like "NYSE:T" even though they perhaps should. A few stock ticker symbols include a suffix, which seems to differentiate among a company's various classes of common stock. Somem of the quote services allow you to enter the ticker and suffix all run together, while others require you to enter a dot between the ticker and the suffix. For an example, try AKO, classes A and B. Now that you understand a bit about the ticker symbol, there's some more explanation required to understand what appears on the "ticker tape" such as those shown on CNN or CNBC. Ticker tape says: Translation (but see below): NIKE68 1/2 100 shares sold at 68 1/2 10sNIKE68 1/2 1000 shares sold at " 10.000sNIKE68 1/2 10000 shares sold at " The extra zeroes for the big trades are to make them stand out. All trades on CNN and CNBC are delayed by 15 minutes. CNBC once advertised a "ticker guide pamphlet, free for the asking", back when they merged with FNN. It also has explanations for the futures they show. You can also see an explanation on the web at this URL: http://www.cnbc.com/onlycnbc/101/ticker.asp However, the first translation is not necessarily correct. CNBC has a dynamic maximum size for transactions that are displayed this way. Depending on how busy things are at any particular time, the maximum varies from 100 to 5000 shares. You can figure out the current maximum by watching carefully for about five minutes. If the smallest number of shares you see in the second format is "10s" for any traded security, then the first form can mean anything from 100 to 900 shares. If the smallest you see is "50s" (which is pretty common), the first form means anything between 100 and 4900 shares. Note that at busy times, a broker's ticker drops the volume figure and then everything but the last dollar digit (e.g. on a busy day, a trade of 25,000 IBM at 68 3/4 shows only as "IBM 8 3/4" on a broker's ticker). That never happens on CNBC, so I don't know how they can keep up with all trades without "forgetting" a few. NASDAQ uses a "fifth letter" identifier in its ticker symbols. Four letter symbols, and five letter symbols in instances of multiple issues listed by the same company, are listed in newspapers and carried on the ticker screen by CNBC and CNN. These symbols are required to retrieve quotes from quote servers. Here's the complete list of the NASDAQ fifth-letter identifiers with brief descriptions: Symbol Meaning A Class A B Class B C exempt from NASDAQ listing qualifications for limited period D new issue E delinquent in required SEC filings F foreign G First convertible bond H Second convertible bond (same company) I Third convertible bond (same company) J Voting K Nonvoting L misc situations, including second class units, third class warrants, or sixth class preferred stock M Fourth class preferred (same company) N Third class preferred (same company) O Second class preferred (same company) P First class preferred (same company) Q in bankruptcy proceedings R Rights S Shares of beneficial interest T with warrants or rights U Units V When issued and when distributed W Warrants X mutual fund Y American Depositary Receipts Z misc situations, including second class of warrants, fifth class preferred stock or any unit, receipt or certificate representing a limited partnership interest. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Financial Planning - Basics Last-Revised: 22 Oct 1997 Contributed-By: James E. Mallett (jmallett at stetson.edu) One complaint I often hear is that an individual would like to invest but they do not have any money. Financial planning may help many people to overcome this lack of ability to save for investment. With proper planning perhaps you will be able to establish goals and save money to meet these goals. While you can start this personal financial planning yourself, you may soon discover that it will pay you to find a Certified Financial Planner to help in the process. This article gives a short primer on how to start personal financial planning for yourself. To begin the financial planning process, you need specific financial goals. By specific goals, I mean to establish a date to meet the goal and a savings plan that meets your goals. At first these goals may seem unobtainable but continuing the planning process will enable you to evaluate these goals and modify as necessary. Next you need to track your expenses and income until you can develop a yearly statement (cash/flow statement). To see where you are currently, list the value of all your assets and what you owe. Subtract your debts from your assets and you have your current net worth (balance sheet). You should update these statements yearly. Once you have established your income and expenses you can develop a budget. Your aim in establishing a budget is to attempt to increase your income and/or reduce your expenditures so that you have savings to meet your initial goals. If on the first try you are short of funds, do not despair. Try looking at your taxes to see if they can be reduced. Consult a tax attorney if necessary. Analyze your debt to see if it can be consolidated into a lower interest rate loan. Perhaps a home equity loan might fit the bill. Next review your consumption patterns. Are your financial goals worth driving an older automobile; are you shopping for the best prices; and what current expenses that you have are unnecessary? By getting your finances in order, you will gain funds to save and invest toward your goals. If you do not have sufficient funds to meet your goals, modify them. Look for opportunities in the future to reestablish these goals. Seek the aid of financial professionals, educate yourself with personal finance books and magazines. Here are a few resources on financial planning. * James E. Mallett's site about financial planning: http://improveyourfinances.com/ * The International Association for Financial Planning offers a sales pitch and some information on their site: http://www.planningpaysoff.org/ --------------------Check http://invest-faq.com/ for updates------------------ Subject: Financial Planning - Choosing a Financial Planner Last-Revised: 20 Apr 1998 Contributed-By: James E. Mallett (jmallett at stetson.edu) Virtually anyone with moderate wealth or a decent income could benefit from the services of a financial planner. By a financial planner, I mean someone with the expertise to produce a comprehensive financial plan for an individual household. This plan should cover the household's financial goals, budget, insurance and risk review, asset allocation, retirement plan, and a review of an estate plan. Such detailed planning is unlikely to be meet by brokers and agents interested in commissions on financial products they sell. A financial planner has a broad knowledge of areas such as tax planning, investments, and estate law but is unlikely to be the financial professional you require in these individual areas. Rather the financial planner can help coordinate your financial planning with your accountant, insurance agent, investment professional, and estate lawyer. The broad expertise that a professional financial planner possesses will help insure that your financial goals are met and that all areas of your financial life are reviewed. Hiring a planner will help you avoid expensive financial mistakes that could seriously damage your financial health. It would not be difficult for most financial planners to find serious gaps in most household finances, gaps that are easily worth the cost of the planner's services. Even individuals with expert knowledge in one finance field such as investments can overlook areas such as insurance or estate planning. Few people have the time, desire, or expertise to do a complete financial plan for themselves. Saying that most would benefit from using a financial planner is not to imply that there are not wide differences in abilities and costs among planners. Few areas will pay richer rewards for the public than gaining basic knowledge in personal finance. If one is not careful, fees and commissions could negate much, if not all, of the benefit of using a financial planner. This article lists a few issues to consider when choosing a financial planner. The first step in looking for a financial planner is to limit your search to someone who is certified in financial planning. Two certifying associations that I would recommend are the Certified Financial Planner and the Personal Financial Specialist (given to qualifying Certified Public Accountants). The second step is to seek out recommendations from people that you respect for names of financial planners and interview these planners. Your aim is to find someone who meets your needs and who will look after your interests. A problem that exists in selecting financial professionals is that what is in your best interest may fall a distant second to what is in their interest of making a profit. The third question you need to ask is how does the financial planner receive compensation and what will this compensation cost you annually. In calculating the costs, one must consider fees, commissions, transaction costs, and (if any) what are the annual fees of the financial products that they recommend (such as mutual fund management fees). It is quite possible that after adding sales loads and management fees, the after-expense return that you receive from equities will not justify the risk. Recent high market returns have served to mask the fleecing of many American investors. Financial planners fall into two broad types: fee-only financial planners and commission and/or fee-based financial planners. While some give the nod automatically to fee-only financial planners, it will depend on your particular circumstances as to which one will be best for you. If you only need a comprehensive financial plan and you are willing to invest your funds yourself, than a fee-only financial planner who charges by the hour may be your best choice. If you want the financial planner to manage your money, than many fee-only financial planners have moved to an asset-based fee, normally 0.5% to 1.5%, of your assets. Two factors should be kept in mind. One is that this fee is charged annually. Second, most financial planners put your funds to work in a mutual fund and that means you continue to pay the mutual fund another management fee annually. Since evidence and theory suggest that none of these efforts will result in outperforming an index mutual fund, one might wonder why not go directly there and save about 2% in management fees. Plus, on average, you will have a mutual fund that will outperform most professionals. With commission-based financial planners, individuals run the risk that the commissions charged on the financial products that they recommend will add greatly to the cost of the financial planning. The risk of conflict of interest arises when the planner receives greater compensation based on what financial products that they recommend. It may be possible, however, for some individuals that the free or reduced-cost financial plan would not be offset by the higher commissions. For example, the one-time load on the mutual fund might be cheaper than paying the annual 1.5% fee to a fee-based financial planner. You must compare all of these costs when deciding which financial planner is the best for you. Given this information on financial planners, it is clear that knowledge on the consumer's part is very important. While many households will spend a great deal of time shopping for an automobile, the decision of whom to trust with their wealth too is often made without much thought. As a result Americans spend many billions more on financial services than what is really needed. For more insights from James E. Mallett about financial planning, please visit his site: http://www.stetson.edu/~jmallett/finplan.htm For a list of 10 questions you should ask before hiring a financial planner, visit this government site: http://www.pueblo.gsa.gov/cic_text/money/financial-planner/10questions.html --------------------Check http://invest-faq.com/ for updates------------------ Subject: Financial Planning - Compensation and Conflicts of Interest Last-Revised: 19 Apr 2000 Contributed-By: Ed Zollars (ezollar at mindspring.com) This article discusses the primary ways that financial planners are paid for their services, and illustrates the biases and conflicts of interest that invariably are present in each compensation scheme. Hourly rate When a financial planner is paid an hourly rate, he or she may have a bias towards selling the client more advice than is needed, and/or selling additional hourly services to the client. However, the actual financial product sold to the client, or even if any is sold at all, is a matter of indifference. A practical problem is that this advice, if done properly (thorough investigation by adviser into the entire background of the client) is going to be very expensive because it needs to be customized to the client. Thus, we see very little of this type of advice except for specialized areas (like taxation, business law, etc.). Flat rate If a financial planner is paid a flat rate, he or she may have a bias towards giving the client canned advice in order to gain efficiencies. That can lead to not tailoring the advice to the specific situation because that adds (uncompensated) time to the engagement. Additionally, there's a bias towards selling additional services not included in the initial package. Again, generally indifference as to whether a sale is closed on an actual investment, or which investment actually gets chosen. The advantage to the client is that he or she knows the cost going in. Percent of assets under management paid annually If a financial planner receives each year a percentage of assets under management, he or she may have a bias towards keeping as much under management as possible, thus leading to some bias against using funds for other purposes (including paying down debt). This structure may also encourage the advising of riskier ventures, since they present the adviser with the potential for higher compensation. Obviously, the client does have to put some assets under management (so there is a bias to do something), but the particular investments are a matter of indifference. Commissions on sales When a planner receives a commission on any product sold to the client, this can lead to a bias towards closing the sale on a product that will pay the adviser a commission and discouraging the acquisition of products that won't pay this adviser a commission. Since advice is offered as a method to encourage the client to get moving towards a buy, these advisers tend to be rather thorough in raising issues that relate to their products (finding needs). Will tend to have a bias to be less thorough in raising issues for which the solution doesn't involve their product (so in estate planning there will be lots of talk about ILITs or CRUTs, but little talk about FLPs, AB trusts, etc.). A practical advantage is that because the client can simply walk away, this can be the least expensive way to get a good quick general education on the subject at hand. Also, many investments sold by commissioned salespeople spread the fee over a number of years, so it becomes a payment on the installment plan that may allow some people to receive advice they need. Note that any competent professional will actively control for any bias introduced by the compensation mechanism. Therefore, none of the issues raised here represent an insurmountable flaw of a particular method of compensation. Too often this sort of analysis can degnerate into a mudslinging contest that suggests there is only one right way to handle every situation, which is simply not the case. In the end, a client of a financial planner should ask/recognize the ways by which the planner gets paid, and use that information to note any bias that might be present in the advice given. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Financial Planning - Estate Planning Checkup Last-Revised: 20 June 1999 Contributed-By: Nolo Press This article is copyright &copy; Nolo Press 1999 and was reprinted with specific permission. For more great, free information about legal matters, visit their website: http://www.nolo.com Lots of Americans haven't made even a simple will, to say nothing of a more comprehensive plan to avoid probate or save on estate taxes. And even those who have thought about what should happen to their property when they eventually shuffle off to Nirvana haven't updated their plan in many years. We're not going to nag, but we are going to chime in with a few suggestions as to what your estate plan should look like. Oh yes, in case you're new to this area, estate planning is simply a fancy term for the process of arranging for what will happen to your property (estate) if a particularly large and lethal brick falls on your head. Depending on your age, health, wealth and innate level of cautiousness, you may not need to do much at all in the way of estate planning. And even if you do decide you need a will or a trust, you probably won't need a lawyer. Especially if you aren't dripping with Picassos or fat investment accounts, it is easy and safe to prepare most basic estate planning documents yourself. Just learn what you're doing by using a good self-help book or piece of software. We've arranged our tips by some broad categories of family situation and age. As they say, check all that apply. But keep in mind that age is an imprecise proxy for life expectancy, which is affected by all sorts of other factors--heavy smoking while participating in extreme sports and driving a motorcycle, for example. It's up to you to add or subtract a few years, based on your health and lifestyle. You're 25 and Single What are you doing reading about estate planning? You're supposed to be surfing the Net or dancing until dawn. But you might as well keep reading; this won't take long. At your age, there's not much point in putting a lot of energy into estate planning. Unless your lifestyle is unusually risky or you have a serious illness, you're very unlikely to die for a long, long time. If you're an uncommonly rich 25-year-old, though, write a will. (Bricks can fall on anyone.) That way you can leave your possessions to any recipient you choose--your boyfriend, your favorite cause, the nephew who thinks you're totally cool. If you don't write a will, whatever wealth you leave behind will probably go to your parents. Think about it. You're Paired Up, But Not Married If you've got a life partner but no marriage certificate, a will is almost a must-have document. Without a will, state law will dictate where your property goes after your death, and no state gives anything to an unmarried partner. Instead, your closest relatives would inherit everything. Other options to make sure that your partner isn't left out in the cold after your death is to own big-ticket items, such as houses and cars, together in "joint tenancy" with right of survivorship. Then, when one of you dies, the survivor will automatically own 100% of the property. You Have Young Children Having children complicates life--but then, you already know that. Estate planning is no exception. Here's what to think about. First, write a will. Nothing fancy--just a document that leaves your property to whomever you choose and names a guardian for your children. The guardian will take over if both you and the other parent are unavailable. That's an unlikely situation, but one that's worth addressing just in case. If you fail to name a guardian, a court will appoint someone--possibly one of your parents. The other big reason to write a will is that if you don't, some of your property may go not to your spouse, but directly to your children. When given a choice, most people prefer that the money go to their spouse, who will use it for the kids. The problem with the children inheriting directly is that the surviving parent may need to get court permission to handle the money--a waste of time and money in most families. Second, think about buying life insurance so the other parent will be able to replace your earnings if that damn brick chooses you. Term life insurance is relatively cheap, especially if you're young and don't smoke. You can shop for the best bargain by consulting free services that compare the rates of lots of companies. Look for their ads in personal finance magazines. You're Middle-Aged and Know the Names of at Least Three Mutual Funds If you've made it to a comfortable time in life--you've accumulated some material wealth and enough wisdom to let you know that other things matter, too--you will probably want to take some time to reflect on what you will eventually leave behind. But given that you may well live another 30 or 40 years, there is no need to obsess about it. Chances are your conclusions will be different in ten or 20 years, and your estate plan will change accordingly. To save your family the cost (and hassles) of probate court proceedings after your death, think about creating a revocable living trust. It's hardly more trouble than writing a will, and lets everything go directly to your heirs after your death, without taking a circuitous and expensive detour through probate court. While you're alive, the trust has no effect, and you can revoke it or change its terms at any time. But after your death, the person you chose to be your "successor trustee" takes control of trust property and transfers it according to the directions you left in the trust document. It's quick and simple. There are other, even easier ways to avoid probate: you can turn any bank account into a "payable-on-death" account simply by signing a form (the bank will supply it) and naming someone to inherit whatever funds are in the account at your death. You can do the same thing, in 29 states, with securities. (Ask your broker if your state has adopted a law called the Uniform Transfer-on-Death Securities Registration Act.) If you have enough property to worry about federal estate taxes, think about a tax-avoidance trust as well. Currently, estates worth more than $650,000 are taxed; that amount will increase to $1 million by 2006. Most estates are never subject to tax, but if estate tax does take a bite, it can be a big one. Tax rates now start at 37% and rise to 55% for estates worth more than $3 million. One way to reduce estate tax is to give away property before your death. After all, if you don't own it, it can't be taxed. But in 2002, gifts larger than $11,000 per year per recipient are subject to gift tax, which applies at the same rates as does estate tax. Still, an annual gifting plan can reduce the size of even a big estate, especially if you have a covey of kids and grandkids. Gifts to your spouse (as long as he or she is a U.S. citizen), gifts that directly pay tuition or medical bills, or gifts to a tax-exempt organization are exempt from gift tax. Another way to cut taxes is to create certain kinds of trusts. The most common, the AB trust, is one that couples use. Each spouse leaves property to their children--with the crucial condition that the surviving spouse has the right to use the income that property produces for as long as he or she lives. In some circumstances, the surviving spouse may even be able to spend principal. By 2006, an AB trust will shield up to $2 million from estate tax. Charitable trusts, which involve making a gift to a charity and getting some payments back, can also save on both estate and income tax. There are many other varieties of trusts; learn about them on your own, and then have an experienced estate planning lawyer draw up the documents you decide on. You're Elderly or Ill Now is the time to take concrete steps to establish an estate plan pronto. It's also a good idea to think about what could happen before your death, if you become seriously ill and unable to handle your own affairs. First, the basics: Consider a probate-avoidance living trust and, if you're concerned about estate taxes, a tax-saving trust. (These devices are discussed just above.) Write a will, or update an old one. Then, although no one wants to do it, take a minute to think about the possibility that at some time, you might become incapacitated and unable to handle day-to-day financial matters or make healthcare decisions. If you don't do anything to prepare for this unpleasant possibility, a judge may have to appoint someone to make these decisions for you. No one wants a court's intervention in such personal matters, but someone must have legal authority to act on your behalf. You can choose that person yourself, and give him or her legal authority to act for you, by creating documents called durable powers of attorney. You'll need one for your financial matters and one for healthcare. (Some states allow the two to be combined, but it's usually not a good idea. They're used in completely different situations.) You choose someone you trust to act for you (called your attorney-in-fact) and spell out his or her authority. If you wish, you can even state that the document won't have any effect unless and until you become incapacitated. Once signed and notarized, it's legally valid, and your mind can be at ease. --------------------Check http://invest-faq.com/ for updates------------------ Compilation Copyright (c) 2003 by Christopher Lott.