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Path: senator-bedfellow.mit.edu!dreaderd!not-for-mail Message-ID: <investment-faq/general/part13_1082200966@rtfm.mit.edu> Supersedes: <investment-faq/general/part13_1079601013@rtfm.mit.edu> Expires: 31 May 2004 11:22:46 GMT References: <investment-faq/general/part1_1082200966@rtfm.mit.edu> X-Last-Updated: 2003/03/17 From: noreply@invest-faq.com (Christopher Lott) Newsgroups: misc.invest.misc,misc.invest.stocks,misc.invest.technical,misc.invest.options,misc.answers,news.answers Subject: The Investment FAQ (part 13 of 20) Followup-To: misc.invest.misc Summary: Answers to frequently asked questions about investments. Should be read by anyone who wishes to post to misc.invest.* Organization: The Investment FAQ publicity department Keywords: invest, finance, stock, bond, fund, broker, exchange, money, FAQ URL: http://invest-faq.com/ Approved: news-answers-request@MIT.Edu Originator: faqserv@penguin-lust.MIT.EDU Date: 17 Apr 2004 11:28:38 GMT Lines: 1124 NNTP-Posting-Host: penguin-lust.mit.edu X-Trace: 1082201318 senator-bedfellow.mit.edu 576 18.181.0.29 Xref: senator-bedfellow.mit.edu misc.invest.misc:42159 misc.invest.stocks:840678 misc.invest.technical:101767 misc.invest.options:54802 misc.answers:17226 news.answers:270008 Archive-name: investment-faq/general/part13 Version: $Id: part13,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 13 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: Stocks - The Dow Jones Industrial Average Last-Revised: 10 Mar 2003 Contributed-By: Norbert Schlenker, Chris Lott ( contact me ) The Dow Jones averages are computed by summing the prices of the stocks in the average and then dividing by a constant called the "divisor". The divisor for the Dow Jones Industrial Average (DJIA) is adjusted periodically to reflect splits in the stocks making up the average. The divisor was originally 30 but has been reduced over the years to a value far less than one. The current value of the divisor is about 0.20; the precise value is published in the Wall Street Journal and Barron's (also see the links at the bottom of this article). According to Dow Jones, the industrial average started out with 12 stocks in 1896. For all of you trivia buffs out there, those original stocks and their fates are as follows: American Cotton Oil (traces remain in CPC International), American Sugar (eventually became Amstar Holdings), American Tobacco (killed by antitrust action in 1911), Chicago Gas (absorbed by Peoples Gas), Distilling and Cattle Feeding (evolved into Quantum Chemical), General Electric (the only survivor), Laclede Gas (now Laclede Group but not in the index), National Lead (now NL Industries but not in the index), North American (group of utilities broken up in 1940s), Tennesee Coal and Iron (gobbled up by U.S. Steel), U.S. Leather preferred (vanished around 1952), and U.S. Rubber (became Uniroyal, in turn bought by Michelin). The number of stocks was increased to 20 in 1916. The 30-stock average made its debut in 1928, and the number has remained constant ever since. Here are some of the recent changes. * On 17 March 1997, Hewlett-Packard, Johnson & Johnson, Travelers Group, and Wal-Mart joined the average, replacing Bethlehem Steel, Texaco, Westinghouse Electric and Woolworth. * In 1998, Travelers Group merged with CitiBank, and the new entity, CitiGroup, replaced the Travelers Group. * On 1 November 1999, Home Depot, Intel, Microsoft, and SBC Communications joined the average, replacing Union Carbide, Goodyear Tire & Rubber, Sears, and Chevron. * Several stocks in the index have merged and/or changed names since the last round of changes: Exxon became Exxon-Mobil after their merger; Allied-Signal merged with Honeywell and kept the Honeywell name; JP Morgan became JP Morgan Chase after their merger; Minnesota Mining and Manufacturing offically became 3M Corp; and Philip Morris renamed itself Altria. The Dow Jones Industrial Average is computed from the following 30 stocks. The links on the ticker symbols will take you to the a page at Yahoo that offers current quotes and charts, and the links on the names will take you to the respective company's home page. Ticker Company Name MMM 3M Corporation AA Alcoa MO Altria (was Philip Morris) AXP American Express T AT&T BA Boeing CAT Caterpillar C CitiGroup KO Coca Cola DD E.I. DuPont de Nemours EK Eastman Kodak XOM Exxon Mobil GE General Electric GM General Motors HPQ Hewlett-Packard HD Home Depot HON Honeywell INTC Intel IBM International Business Machines IP International Paper JPM JP Morgan Chase JNJ Johnson & Johnson MCD McDonalds MRK Merck MSFT Microsoft PG Procter and Gamble SBC SBC Communications UTX United Technologies WMT Wal-Mart Stores DIS Walt Disney Here are a few resources from Dow Jones and Company: * Dow Jones Indexes develops, maintains, and licenses over 3,000 market indexes for investment products. http://www.djindexes.com/ * The current list of companies in the DJIA and their weightings. http://www.djindexes.com/jsp/industrialAverages.jsp * Frequently Asked Questions about the DJIA. http://www.djindexes.com/jsp/avgFaq.jsp --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Other Indexes Last-Revised: 27 Jan 1998 Contributed-By: Rajiv Arora, Christiane Baader, J. Friedl, David Hull, David W. Olson, Steven Pearson, Steven Scroggin, Chris Lott ( contact me ) US Indexes: AMEX Composite A capitalization-weighted index of all stocks trading on the American Stock Exchange. NASDAQ 100 The 100 largest non-financial stocks on the NASDAQ exchange. NASDAQ Composite Midcap index made up of all the OTC stocks that trade on the Nasdaq Market System. 15% of the US market. NYSE Composite A capitalization-weighted index of all stocks trading on the NYSE. Russell 1000 The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represents approximately 10% of the total market capitalization of the Russell 3000 Index. As of the latest reconstitution, the average market capitalization was approximately $421 million; the median market capitalization was approximately $352 million. The largest company in the index had an approximate market capitalization of $1.0 billion. Visit their web site for more information: http://www.russell.com/us/indexes/default.asp Russell 2000 Designed to be a comprehensive representation of the U.S. small-cap equities market. The index consists of the smallest 2000 companies out of the top 3000 in domestic equity capitalization. The stocks range from $40M to $456M in value of outstanding shares. This index is capitalization weighted; i.e., it gives greater weight to stocks with greater market value (i.e., shares * price). Visit their web site for more information: http://www.russell.com/us/indexes/default.asp Russell 3000 The 3000 largest U.S. companies. Visit their web site for more information: http://www.russell.com/us/indexes/default.asp Standard & Poor's 500 Made up of 400 industrial stocks, 20 transportation stocks, 40 utility, and 40 financial. Market value (#of common shares * price per share) weighted. Dividend returns not included in index. Represents about 70% of US stock market. Cap range 73 to 75,000 million. Standard & Poor's 400 (aka S&P Midcap) Tracks 400 industrial stocks. Cap range: 85 million to 6.8 billion. Standard & Poor's 100 (and OEX) The S&P 100 is an index of 100 stocks. The "OEX" is the option on this index, one of the most heavily traded options around. Value Line Composite See Martin Zweig's Winning on Wall Street for a good description. It is a price-weighted index as opposed to a capitalization index. Zweig (and others) think this gives better tracking of investment results, since it is not over-weighted in IBM, for example, and most individuals are likewise not weighted by market cap in their portfolios (unless they buy index funds). Wilshire 5000 The Wilshire 5000 consists of all US-headquartered companies for which prices are readily available. This historically has excluded pink sheet companies, but as the technology for data delivery has improved, so has the list of names in the index, now over 7000. Needless to say, some of these are quite small. The index is capitalization weighted. Since several companies included in the S&P 500 are headquartered outside of the U.S., it is not true that the Wilshire 5000 contains the S&P 500. For more information about the Wilshire indexes, visit their web site: http://www.wilshire.com Non-US Indexes: CAC-40 (France) The CAC-Quarante, this is 40 stocks on the Paris Stock Exchange formed into an index. The futures contract on this index is probably the most heavily traded futures contract in the world. DAX (Germany) The German share index DAX tracks the 30 most heavily traded stocks (based on the past three years of data) on the Frankfurt exchange. FTSE-100 (Great Britain) Commonly known as 'footsie'. Consists of a weighted arithmetical index of 100 leading UK equities by market capitalization. Calculated on a minute-by-minute basis. The footsie basically represents the bulk of the UK market activity. Nikkei (Japan) "Nikkei" is an abbreviation of "nihon keizai" -- "nihon" is Japanese for "Japan", while "keizai" is "business, finance, economy" etc. Nikkei is also the name of Japan's version of the WSJ. The nikkei is sometimes called the "Japanese Dow," in that it is the most popular and commonly quoted Japanese market index. JPN JPN is a modified price-weighted index that measures the aggregate performance of 210 common stocks actively traded on the Tokyo Stock Exchange that are representative of a broad cross section of Japanese industries. Japanese prices are translated without a currency conversion, so the index is not directly affected by dollar/yen changes. JPN is closely related, but not identical, to the Nikkei Index. Options are traded on US exchanges. Europe, Australia, and Far-East (EAFE) Compiled by Morgan Stanley. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Market Volatility Index (VIX) Last-Revised: 26 Jan 2003 Contributed-By: Jack Krupansky (jack "at" finaxyz.com), Chris Lott ( contact me ) The Market Volatility Index (VIX) is a measure of implied volatility in trading of S&P 100 futures (specifically the OEX futures contract) on The Chicago Board Options Exchange. The index is calculated based on the prices of 8 calls and puts on the OEX that expire in approximately 30 days. Values for VIX tend to be between 5 and 100. So what is 'implied volatility'? To understand this, first consider the factors that go into the pricing of options. One of them is 'volatility'. It's simply the extent to which the price of something has changed over a year, measured as a percentage. An option on a more volatile stock or future will be more expensive. But options are just like any other asset and as really priced based on the law of supply and demand. If there is an excess of supply compared to demand, the price will drop. Conversely, if there is an excess of demand, the price rises. Since all the other parameters of the option price are predictable or measurable, the piece that relates to demand can be isolated. It's called the 'implied volatility'. Any excess or deficit of demand would suggest that people have a difference in expectation of the future price of the underlying asset. In other words, the future or 'expected volatility' will tend to be different from the 'historic volatility'. The CBOE has a rather complex formula for averaging various options for the S&P 100 futures to get a hypothetical, normalized, 'ideal' option. The volatility component can be isolated from the the price of this ideal option. That's VIX. Although both 'put' and 'call' options are included in the calculation, it is the 'put' options that lead to most of the excess demand that VIX measures. The VIX is said to to measure market sentiment (or, more interestingly, to indicate the level of anxiety or complacency of the market). It does this by measuring how much people are willing to pay to buy options on the OEX, typically 'put' options which are a bet that the market will decline. When everything is wonderful in the world, nobody wants to buy put insurance, so VIX has a low value. But when it looks like the sky is falling, everybody wants insurance in spades and VIX heads for the moon. Practically, even in the most idyllic of times, VIX may not get below 12 or 13. And even in the worst of panics, in 1998, VIX did not break much above 60. Many view the VIX as a contrarian indicator. High VIX values such as 40 (reached when the stock market is way down) can represent irrational fear and can indicate that the market may be getting ready to turn back up. Low VIX values such as 14 (reached when the market is way up) can represent complacency or 'irrational exuberance' and can indicate the the market is at risk of topping out and due for a fair amount of profit taking. There's no guarantee on any of this and VIX is not necessarily by itself a leading indicator of market action, but is certainly an interesting indicator to help you get a sense of where the market is. Here are some additional resources for the VIX: * The current VIX number from Yahoo Finance http://finance.yahoo.com/q?s=^VIX&d=1d * A brief explanation from the CBOE Options Corner of 30 Aug 2001 * James B. Bittman's book (at Amazon.com) on Trading Index Options For more insights from Jack Krupansky, please visit his web site: http://www.finaxyz.com --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Investor Rights Movement Last-Revised: 24 Jun 1997 Contributed-By: Bob Grumbine (rgrumbin at nyx.net), Chris Lott ( contact me ) The investor rights movement (sometimes called shareholder rights or shareholder activism) involves people who try to use their shares to make publically traded companies more accountable to their shareholders. (Please don't confuse this issue with the topic of the rights of an individual investor with respect to the broker or brokerage firm in case of disputes, etc.) One of the most common goals that current investor rights activists aim for is changing the election process of company boards of directors so that each and every director is elected at once, as opposed to the stagger system that is commonly used. This article will give you a sense of the flavor, color, and some of the directions of what's currently going on in the area of stockholder rights. The key points: (1) you must have your shares registered in your own name to have any real chance of participating; (2) having gotten your shares registered, you need to read in detail every proposal in the proxy statements sent by the companies (or by others in some cases), to determine how to vote your own shares; and (3) if you have the time and energy to attend some annual meetings personally, you yourself can become a stockholder rights activist, voting not only your own shares but any others for which you obtain proxies and, subject to certain rules and procedures, even having your proposal(s) printed in the annual proxy statements for other shareholders to read and vote upon. Ok, now the details. The absolute best sources of information about investor rights activists are the proxy statements which each and every one of the companies in which you own stock are required to send to you each and every year as part of their process of getting their in-house chosen directors elected. Some names stand out clearly as being the kind of people you are looking for. Ever since I was knee-high to a ticker tape, I have admired the work of the Gilbert brothers and Wilma Soss, three of the longest-term most dedicated activists for investor rights ever to grace the annual meetings of major corporations. It has been more than 35 years since I was knee-high to a ticker tape, so Lewis D. Gilbert and Wilma Soss have both passed on. However, John J. Gilbert remains alive, well, and active in promoting the stockholder right of cumulative voting for directors, so that even in the most monolithic corporations held largely by trustees indifferent to the legitimate interests of the real owners of the shares, there can be elected at least some voice for the rights and interests of actual owners. A more recent activist on the single crucial issue of reinstating the election of directors annually , instead of the stagger system, has been Mrs. Evelyn Y. Davis, Watergate Office Building, 2600 Virginia Avenue N.W., Suite 215, Washington, D.C. 20037. As in fact it has been used in far too many instances, the stagger system facilitates incompetent or malicious managers keeping effective control of boards of directors for at least two years and sometimes longer beyond the time it becomes obvious to stockholders that the existing board is acting outrageously against the interests of the owners of the company. As she points out in one of her proxy proposals, "the great majority of New York Stock Exchange listed corporations elect all their directors each year" which "insures that all directors will be more accountable to all shareholders each year and to a certain extent prevents the self-perpetuation of the Board." Rationally behaving directors have no legitimate worry about getting elected every year. It is only those who are doing wrong against the owners, or who intend to do so, who have any need for the "stability" hogwash that so many staggered board companies spew forth as justification for their anti-stockholder provisions. Along with the general purpose activists, there are frequently holders of stock in particular companies, sometimes even former officers or directors, who conclude that the current actions or inactions of the existing set of officers and directors are just plain wrong and need to be redirected or changed, usually in some quite specific ways. To find out about any of these you really must have your shares in all of the companies that you own registered in your own name , so that you yourself appear on the stockholder lists. To be sure, some of the better quality brokers do make an effort to pass along mailings which they are requested to send to you by the companies you own but in which they hold the actual shares. Even those better quality people are usually very delayed and you're going to miss most or all of the individual company activists who see brokerage house shares as being owned by people who just plain don't care about the real companies and who aren't likely to read or understand any of the issues involved. Rightly or wrongly, that does seem to be their view, and if you are someone who actually does care about the companies you own, getting your shares registered in your own name is the only way you're really going to have a chance of being kept informed about what's going on. Along with some who really are, or who have purported to be, concerned about investor rights, you will also find many things included in the proxy statements which look to me to be part of an "investor wrongs" movement. I refer to things such as religious bigot groups insisting that no American company do business with the nationals of any nation which does not welcome their peculiar bigotries with open arms. I've run across (and seen in action at annual meetings) so many of those malicious anti-business twits, that I do feel the need to caution you that not every proponent of issues for the annual stockholder's meeting has even considered (1) the best interests of the company, (2) the best interests of any stockholders other than their own peculiar set of bigots, or (3) the fundamentally rational requirements for business organizations to do business anywhere, let alone on a multinational scale of activities. Just a cautionary note that I think desirable, having referred you to the proxy statements as a source of contacts. For more information on shareholder rights and activism, try these sites: * Corporate Governance: enhancing wealth creation through increased accountability. http://www.corpgov.net/ * Greenway Partners, shareholder activism for the 1990's and beyond. http://www.greenway.com/ * Infoseek's index. http://www.infoseek.com/Shareholder_activism?lk=noframes * LENS is an activist money manager. http://www.lens-inc.com/ --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Initial Public Offerings (IPOs) Last-Revised: 7 Nov 1995 Contributed-By: Art Kamlet (artkamlet at aol.com), Bill Rini (bill at moneypages.com) This article is divided into four parts: 1. Introduction to IPOs 2. The Mechanics of Stock Offerings 3. The Underwriting Process 4. IPO's in the Real World 1. Introduction to IPOs When a company whose stock is not publicly traded wants to offer that stock to the general public, it usually asks an "underwriter" to help it do this work. The underwriter is almost always an investment banking company, and the underwriter may put together a syndicate of several investment banking companies and brokers. The underwriter agrees to pay the issuer a certain price for a minimum number of shares, and then must resell those shares to buyers, often clients of the underwriting firm or its commercial brokerage cousin. Each member of the syndicate will agree to resell a certain number of shares. The underwriters charge a fee for their services. For example, if BigGlom Corporation (BGC) wants to offer its privately- held stock to the public, it may contact BigBankBrokers (BBB) to handle the underwriting. BGC and BBB may agree that 1 million shares of BGC common will be offered to the public at $10 per share. BBB's fee for this service will be $0.60 per share, so that BGC receives $9,400,000. BBB may ask several other firms to join in a syndicate and to help it market these shares to the public. A tentative date will be set, and a preliminary prospectus detailing all sorts of financial and business information will be issued by the issuer, usually with the underwriter's active assistance. Usually, terms and conditions of the offer are subject to change up until the issuer and underwriter agree to the final offer. The issuer then releases the stock to the underwriter and the underwriter releases the stock to the public. It is now up to the underwriter to make sure those shares get sold, or else the underwriter is stuck with the shares. The issuer and the underwriting syndicate jointly determine the price of a new issue. The approximate price listed in the red herring (the preliminary prospectus - often with words in red letters which say this is preliminary and the price is not yet set) may or may not be close to the final issue price. Consider NetManage, NETM which started trading on NASDAQ on Tuesday, 21 Sep 1993. The preliminary prospectus said they expected to release the stock at $9-10 per share. It was released at $16/share and traded two days later at $26+. In this case, there could have been sufficient demand that both the issuer (who would like to set the price as high as possible) and the underwriters (who receive a commission of perhaps 6%, but who also must resell the entire issue) agreed to issue at 16. If it then jumped to 26 on or slightly after opening, both parties underestimated demand. This happens fairly often. IPO Stock at the release price is usually not available to most of the public. You could certainly have asked your broker to buy you shares of that stock at market at opening. But it's not easy to get in on the IPO. You need a good relationship with a broker who belongs to the syndicate and can actually get their hands on some of the IPO. Usually that means you need a large account and good business relationship with that brokerage, and you have a broker who has enough influence to get some of that IPO. By the way, if you get a cold call from someone who has an IPO and wants to make you rich, my advice is to hang up. That's the sort of IPO that gives IPOs a bad name. Even if you that know a stock is to be released within a week, there is no good way to monitor the release without calling the underwriters every day. The underwriters are trying to line up a few large customers to resell the IPO to in advance of the offer, and that could go faster or slower than predicted. Once the IPO goes off, of course, it will start trading and you can get in on the open market. 2. The Mechanics of Stock Offerings The Securities Act of 1933, also known as the Full Disclosure Act, the New Issues Act, the Truth in Securities Act, and the Prospectus Act governs the issue of new issue corporate securities. The Securities Act of 1933 attempts to protect investors by requiring full disclosure of all material information in connection with the offering of new securities. Part of meeting the full disclosure clause of the Act of 1933, requires that corporate issuers must file a registration statement and preliminary prospectus (also know as a red herring) with the SEC. The Registration statement must contain the following information: * A description of the issuer's business. * The names and addresses of the key company officers, with salary and a 5 year business history on each. * The amount of ownership of the key officers. * The company's capitalization and description of how the proceeds from the offering will be used. * Any legal proceedings that the company is involved in. Once the registration statement and preliminary prospectus are filed with the SEC, a 20 day cooling-off period begins. During the cooling-off period the new issue may be discussed with potential buyers, but the broker is prohibited from sending any materials (including Value Line and S&P sheets) other than the preliminary prospectus. Testing receptivity to the new issue is known as gathering "indications of interest." An indication of interest does not obligate or bind the customer to purchase the issue when it becomes available, since all sales are prohibited until the security has cleared registration. A final prospectus is issued when the registration statement becomes effective (when the registration statement has cleared). The final prospectus contains all of the information in the preliminary prospectus (plus any amendments), as well as the final price of the issue, and the underwriting spread. The clearing of a security for distribution does not indicate that the SEC approves of the issue. The SEC ensures only that all necessary information has been filed, but does not attest to the accuracy of the information, nor does it pass judgment on the investment merit of the issue. Any representation that the SEC has approved of the issue is a violation of federal law. 3. The Underwriting Process The underwriting process begins with the decision of what type of offering the company needs. The company usually consults with an investment banker to determine how best to structure the offering and how it should be distributed. Securities are usually offered in either the new issue, or the additional issue market. Initial Public Offerings (IPO's) are issues from companies first going public, while additional issues are from companies that are already publicly traded. In addition to the IPO and additional issue offerings, offerings may be further classified as: * Primary Offerings: Proceeds go to the issuing corporation. * Secondary Offerings: Proceeds go to a major stockholder who is selling all or part of his/her equity in the corporation. * Split Offerings: A combination of primary and secondary offerings. * Shelf Offering: Under SEC Rule 415 - allows the issuer to sell securities over a two year period as the funds are needed. The next step in the underwriting process is to form the syndicate (and selling group if needed). Because most new issues are too large for one underwriter to effectively manage, the investment banker, also known as the underwriting manager, invites other investment bankers to participate in a joint distribution of the offering. The group of investment bankers is known as the syndicate. Members of the syndicate usually make a firm commitment to distribute a certain percentage of the entire offering a nd are held financially responsible for any unsold portions. Selling groups of chosen brokerages, are often formed to assist the syndicate members meet their obligations to distribute the new securities. Members of the selling group usually act on a " best efforts" basis and are not financially responsible for any unsold portions. Under the most common type of underwriting, firm commitment, the managing underwriter makes a commitment to the issuing corporation to purchase all shares being offered. If part of the new issue goes unsold, any losses are distributed among the members of the syndicate. Whenever new shares are issued, there is a spread between what the underwriters buy the stock from the issuing corporation for and the price at which the shares are offered to the public (Public Offering Price, POP). The price paid to the issuer is known as the underwriting proceeds. The spread between the POP and the underwriting proceeds is split into the following components: * Manager's Fee: Goes to the managing underwriter for negotiating and managing the offering. * Underwriting Fee: Goes to the managing underwriter and syndicate members for assuming the risk of buying the securities from the issuing corporation. * Selling Concession - Goes to the managing underwriter, the syndicate members, and to selling group members for placing the securities with investors. The underwriting fee us usually distributed to the three groups in the following percentages: * Manager's Fee 10% - 20% of the spread * Underwriting Fee 20% - 30% of the spread * Selling Concession 50% - 60% of the spread In most underwritings, the underwriting manager agrees to maintain a secondary market for the newly issued securities. In the case of "hot issues" there is already a demand in the secondary market and no stabilization of the stock price is needed. However many times the managing underwriter will need to stabilize the price to keep it from falling too far below the POP. SEC Rule 10b-7 outlines what steps are considered stabilization and what constitutes market manipulation. The managing underwriter may enter bids (offers to buy) at prices that bear little or no relationship to actual supply and demand, just so as the bid does not exceed the POP. In addition, the underwriter may not enter a stabilizing bid higher than the highest bid of an independent market maker, nor may the underwriter buy stock ahead of an independent market maker. Managing underwriters may also discourage selling through the use of a syndicate penalty bid. Although the customer is not penalized, both the broker and the brokerage firm are required to rebate the selling concession back to the syndicate. Many broke rages will further penalize the broker by also requiring that the commission from the sell be rebated back to the brokerage firm. 4. IPO's in the Real World Of course knowing the logistics of how IPO's come to market is all fine and dandy, but the real question is, are they a good investment? That does tend to be a tricky issue. On one hand there are the Boston Chickens and Snapples that shoot up 50% or 100%. But then there is the research by people like Tim Loughran and Jay Ritter that shows that the average return on IPO's issued between 1970 and 1990 is a mere 5% annually. How can the two sides of this issue be so far apart? An easy answer is that for every Microsoft, there are many stocks that end up in bankruptcy. But another answer comes from the fact that all the spectacular stories we hear about the IPO market are usually basing the percentage increase from the POP, and the Loughran and Ritter study uses purchase prices based on the day after the offering hit the market. For most investors, buying shares of a "hot" IPO at the POP is next to impossible. Starting with the managing underwriter and all the way down to the investor, shares of such attractive new issues are allocated based on preference. Most brokers reserve whatever limited allocation they receive for only their best customers. In fact, the old joke about IPO's is that if you get the number of shares you ask for, give them back, because it means nobody else wants it. While the deck may seem stacked against the average investor. For an active trader things may not be as bad as they appear. The Loughram and Ritter study assumed that the IPO was never sold. The study does not take into account an investor who bought an issue like 3DO (THDO - NASDAQ), the day after the IPO and sold it in the low to mid 40's, before it came crashing down. Obviously opportunities exist, however it's not the easy money so often associated with the IPO market. Portions of this article are copyright 1995 by Bill Rini. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Mergers Last-Revised: 9 Apr 1997 Contributed-By: George Regnery (regnery at yahoo.com) When one firm takes another over, or merges with another, a number of things can happen to the firm's shares. The answer is, it depends. In some cases, the shares of one company are converted to shares of the other company. For instance, 3Com announced in early 1997 that it was going to purchase US Robotics. Every US Robotics shareholder will receive 1.75 shares of 3Com stock. In other cases, one company simply buys all of the other company's shares. It pays cash for these shares. Another possibility, not very common for large transactions, is for one company to purchase all the assets of another company. Company X buys all of Company Y's assets for cash, which means that Company Y will have only cash (and debt, if they had debt before). Of course, then company Y is merely a shell, and will eventually move into other businesses or liquidate. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Market Capitalization Last-Revised: 11 Mar 1997 Contributed-By: Chris Lott ( contact me ) The market capitalization (or "cap") of a stock is simply the market value of all outstanding shares and is computed by multiplying the market price by the number of outstanding shares. For example, a publically held company with 10 million shares outstanding that trade at US$20 each would have a market capitalization of 200 million US$. The value for a stock's "cap" is used to segment the universe of stocks into various chunks, including large-cap, mid-cap, small-cap, etc. There are no hard-and-fast rules that define precisely what it means for a company to be in one of these categories, but there is some general agreement. The Motley Fool offers these guidelines: * Large-cap: Over $5 billion * Mid-cap: $500 million to $5 billion * Small-cap: $150 million to $500 million * Micro-cap: Below $150 million According to these rules, the example listed above would be a small-cap stock. When reading a mutual fund prospectus, you may see the term "median market cap." This is just the median of the capitalization values for all stocks held by the fund. The median value is the middle value; i.e., half the stocks in the fund have a market capitalization value below the median, and the other half above the median. This value helps you understand whether the fund invests primarily in huge companies, in tiny companies, or somewhere in the middle. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Outstanding Shares and Float Last-Revised: 30 Jan 2001 Contributed-By: Chris Lott ( contact me ) Data that are frequently reported about a stock are the number of shares outstanding and the float. These two bits of information are not the same thing, although they are closely related. In a nutshell, the outstanding shares are those held by the public (but possibly restricted from trading), and the float is the number of shares held by the public and available to be traded. If that was not clear, let's begin at the beginning. When a company incorporates, the articles of incorporation state how many shares are authorized. For example, the company NotLosingMoney.com could incorporate and have 1,000,000 (one million) shares. This is the number of authorized shares. At the moment of incorporation, these shares are held in the company treasury (at least that's what people say); the number of outstanding shares and the float are both zero. Next our example company sells some percentage of the authorized shares to the public, possibly via an inital public offering (IPO). The company chooses to sell 10% of the authorized shares to the public. In addition, as part of going public, the company grants 10% of the authorized shares to employees etc., but these people cannot sell their shares for six months. So after the IPO, the public (i.e., not the company) holds 200,000 shares, and the rest is in the treasury. So we say that the number of shares outstanding is 200,000. However, due to various restrictions placed on the employees, their share holdings cannot be traded. While the restriction on insiders (commonly called a lockup) is in force, just 100,000 shares are available for trading, and the float is just 100,000 shares. You may have heard the term "thin float" in connection with an IPO. This refers to the practice of allowing just a small percentage of the authorized shares to be sold to the public in the IPO. In cases where demand was high (and the supply was artificially low), the result was large jumps in price on the first day of trading. When a company buys back its own shares on the open market and returns these shares to the company treasury, this reduces both the float and the number of outstanding shares. If a company has sufficient cash to purchase shares, in theory these purchases could eventually buy all the shares outstanding, which is essentially the same as taking the company private. Perhaps it is obvious, but when a company splits its shares, the number of authorized shares is affected by the split. For example, if a large company had 100 million shares authorized and implemented a 2 for 1 split, then after the split the company has 200 million shares authorized. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Preferred Shares Last-Revised: 22 Oct 97 Contributed-By: John Schott (jschott at voicenet.com) Preferred stocks combine characteristics of common stocks and bonds. Garden-variety preferred shares are a lot like general obligation bonds/debentures; they are called shares, but carry with them a set dividend, much like the interest on a bond. Preferred shares also do not normally vote, which distinguishes them from the common shares. While today there are a lot of different kinds of hybrid preferred issues, such as a call on the gold production of Freeport McMoran Copper and Gold to the point where they will deliver it, this article will consider characteristics of the most ordinary variety of preferred shares. In general, a preferred has a fixed dividend (as a bond pays interest), a redemption price (as a bond), and perhaps a redemption date (like a bond). Unlike a stock, it normally does not participate in the appreciation (or drop) of the common stock (it trades like a bond). Preferreds can be thought of as the lowest-possible grade bonds. The big point is that the dividend must be paid from after-tax money, making them a very expensive form of capitalization. One difference from bonds is that in liquidation (e.g. following bankruptcy), bond holder claims have priority over preferred shares, which in turn have priority over common shares (in that sense, the preferred shares are "preferred"). These shares are also preferred (hence the name) with respect to payment of dividends, while common shares may have a rising, falling or omitted dividends. Normally a common dividend may not be paid unless the preferred shares are fully paid. In many cases (sometimes called "cumulative preferred"), not only must the current preferred dividend be paid, but also any missed preferred dividends (from earlier time periods) must be made up before any common dividend may be paid. (My father once got about a $70 arrearage paid just because Jimmy Ling wanted to pay a $0.10 dividend on his common LTV shares.) Basically, preferreds stand between the bonds and the common shares in the pecking order. So if a company goes bankrupt, and the bond holders get paid off, the preferreds have next call on the assets - and unless they get something, the common shareholders don't either. Some preferred shares also carry with them a conversion privilege (and hence may be called "convertible preferred"), normally at a fixed number of shares of common per share of preferred. If the value of the common shares into which a preferred share may be converted is low, the preferred will perform price-wise as if it were a bond; that is often the case soon after issue. If, however, the common shares rise in value enough, the value of the preferred will be determined more by the conversion feature than by its value as a pseudo-bond. Thus, convertible preferred might perform like a bond early in its life (and its value as a pseudo-bond will be a floor under its price) and, if all goes well, as a (multiple of) common stock later in its life when the conversion value governs. And as time has gone on, even more elaborate variations have been introduced. The primary reason is that a firm can tailor its cost of funds between that of the common stock and bonds by tailoring a preferred issue. But it isn't a bond on the books - and it costs more than common stock. In general, you won't find a lot of information on the preferred shares anywhere. Since they are in a never-never land, it is hard to analyze them (they are usually somewhere low on the equity worth scale from the common and bonds). So they can't really carry a P/E and the like. Unfortunately, most come with the equivalent of the bonds indenture - that is the "fine print" and you may have to get and read it to see just what you have. (I once had preferreds that paid dividends in more shares of itself and in shares of another preferred, but how Interco got itself into bankruptcy is another story.) There are other reasons why preferreds are issued and purchased. A lot of convertibles are held by people who want to participate in the rise of a hot company, but want to be insulated from a drop should it not work out. Here's a different strategy. For example, I've got some Williams Brothers Preferreds. They pay about 8.5% and are callable in Fall, 1997. When I bought them (some years ago), they had just been issued and were unrated (likely still are not). But Williams itself is a well-run company with strong cash flow that then needed the money fast to buy out a customer who was in trouble. So I bought these shares more as I'd buy a CD. The yield is high, the firm solid - and likely they will pull my investment out from under me someday. Meanwhile, it forms a bit of my "ready cash" account. And I can always sell it if I want to. Problem is, with so many variants, there isn't always a preferred that you'd want to buy at the current price to carry out some specific strategy. Naturally, not every firm has them, the issues are often thinly traded and may not trade on the exchange of the parent firms common (or even be listed on any exchange). If the preferred shares get called (i.e., converted), you normally collect just as if common shares are bought out - in cash, no deduction. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Price Basis Last-Revised: 28 Oct 1997 Contributed-By: George Regnery (regnery at yahoo.com) This article presents a bit of finance theory, namely the basis for a stock's price. A stock's price is equal to the net present value (NPV) of all expected future dividends. (See the article elsewhere in the FAQ for an explanation of the time value of money and NPV.) A company will plow its earnings back into the company when it believes it can use this money better than its investors, i.e., when the investment opportunities it has are better than its investors have available. Eventually, the company is going to run out of such projects: it simply won't be able to expand forever. When it gets to the point where it cannot use all of its earnings, either the company will pay dividends, it will build up a cash mountain, or it will squander the money. If a company builds a cash mountain, you'll see some investors demand higher dividends, and/or the company management will waste the money. Look at Kerkorian and Chrysler. Sure, there are some companies that have recently built up a cash mountain. Microsoft, for instance. But Gates owns a huge chunk of Microsoft, and he'd have to pay 39.6% tax on any dividend, whereas he'd have to pay only 28% (or perhaps 20%) on capital gains. But eventually, Microsoft is going to pay a dividend on its common shares. From a mathematical perspective, it's quite clear that a stock price is equal to the NPV of all future dividends. For instance, the stock price today is equal to the NPV of the dividends during the first year, plus the discounted value of the stock in a year's time. In other words, P(0) = PV (Div 1) + P(1). But the price in a year is equal to the NPV of dividends paid during the second year plus the PV of the stock at the end of two years. If you keep applying this logic, then the stock price will become equivalent to the NPV of all future dividends. Stocks don't mature like bonds do. Of course it's also true that a stock's price is equal to whatever the market will bear, pure supply and demand. But this doesn't mean a stock's price, or a bond's price for that matter, can't have a price that is determined by a formula. (Unfortunately, no formula is going to tell you what dividend a company will pay in 5 years.) A bond's price is equal to the NPV of all coupon payments plus the PV of the final principal payment. (You discount at an appropriate rate for the risk involved). Any investment's price is going to be equal to the NPV of all future cash flows generated by that investment, and of course you have to discount at the correct discount rate. The only cash flows that investors in stocks get are from the dividends. If the price is not equal to the NPV of all future cash flows, then someone is leaving money on the table. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Price Tables in Newspapers Last-Revised: 21 Apr 1997 Contributed-By: Bruce A. Werner (BruceWerner at yahoo.com), Chris Lott ( contact me ) Stock prices from the previous day's trading are printed in tables in most newspapers Tuesday through Saturday, and the week's activity is commonly summarized on Sunday. These tables use an extremely abbreviated format, including footnotes to indicate various situations. The tables are distributed by the Associated Press. This article lists the most commonly used footnotes about stock prices, the stock itself, and dividends (three parts in the following table), so if your newspaper doesn't explain its tables, this might help. Sources consulted for this information include the Baltimore Sun, the New Jersey Star-Ledger, and others; your local paper will probably be similar, although typesetting tricks like boldface etc. may vary across different papers. The long and the short of it is you want your companies to have lots of u's and never anything that starts with v (you have to wonder about the use of adjacent letters). Footnote Explanation Price d Price is a new 52-week low u Price is a new 52-week high x Ex-dividend (ex-rights) price y Ex-dividend and sales in full z Sales in full Stock g Dividend or earnings in Canadian currency n New issue in the past 52 weeks (i.e., the high/low aren't true 52-week figures) pf Preferred shares pp Holder owes installments of purchase price rt Rights s Split or stock dividend of more than 25% in the past 52 weeks un Units v Trading was halted on the primary market vj Bankrupt, reorganizing, etc. wd When distributed wi When issued wt Warrants ww With warrants xw Without warrants Dividend a Also extra(s) b Annual rate plus stock div. c Liquidating div. e Declared or paid in preceding 12 months. f Annual dividend rate increased. i Declared or paid after stock dividend or split up j Paid this year, div. omitted, deferred or no action taken at last div. meeting. k Declared or paid this year, an accumulative issue with div. in arrears r Declared or paid in preceding 12 months plus stock div. t Paid in stock in preceding 12 months, est. cash value on ex-div. or ex-dist. date Other boldface Stock's price changed 5% or more from previous day underline Stock's trading volume equalled or exceeded 2 percent of the total number of shares outstanding. triangle Stock reached a 52-week high (pointing up) or low (pointing down) --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Price Data Last-Revised: 30 Jan 2002 Contributed-By: Chris Lott ( contact me ) Many people have asked me "how can I get the closing price for stock XY on date Z." A common variant is to get the close of the Dow Jones Industrial Average (or other stock index) for some given date or range. The answer is that you need to find a provider of historical data (also called historical quotes). If all you need is the open, close, and volume for a stock on some date, you're in luck, because this is available at no charge on the web (see below). However, if you want detailed data suitable for detailed analysis, such as the full report of every trade, you probably will have to pay for it. Don't forget that the most reliable way to find a stock's price on a given day is to visit a library with good newspaper archives. Look up the newspaper for the following day (most likely on microfilm) and print the section from the financial pages where the closing price appears. Print that page, and be sure to print the portion of the page showing the date. This may be the best way for people who are trying to establish a cost basis for some shares of stock. Yahoo's historical stock price data goes back to about 1970. You can download the data in spreadsheet format. They even use friendly ticker symbols for the stock indexes (e.g., the ticker for the Dow Jones Industrial Average is DJIA). http://chart.yahoo.com/d --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Replacing Lost Certificates Last-Revised: 19 Feb 1998 Contributed-By: Richard Sauers (rsauers at enter.net), Bob Grumbine (rgrumbin at nyx.net), Chris Lott ( contact me ) If a stock holder loses a stock certificate through fire, theft, or whatever, shares registered in the stock holder's name (as opposed to so-called "street name") can be replaced fairly quickly and easily. To replace a lost certificate, begin by contacting the company's stock transfer agent. If you don't know the transfer agent, contact the company to find out; Value Line or Standard & Poor's Corporation Records (probably available at your friendly local library) are a good source for the contact addresses of the company itself. Tell the transfer agent the approximate date the certificate was issued. The transfer agent will ask you to post a bond, called a surety bond, that indemnifies the transfer agent. The cost of the surety bond required is typically 3% of the value of the certificate. (The transfer agent will be able to recommend a surety company.) Once the bond is posted, the transfer agent should be able to reissue the missing certificate with no further ado. If you hold shares in your name, you might consider preparing yourself for this eventuality by keeping a copy of the stock certificate (it will show the number, transfer agent, etc.) separate from the original. --------------------Check http://invest-faq.com/ for updates------------------ Subject: Stocks - Repurchasing by Companies Last-Revised: 11 Nov 1996 Contributed-By: Bob Bose (bobbose at sover.net) Companies may repurchase their own stock on the open market, usually common shares, for many reasons. In theory, the buyback should not be a short term fix to the stock price but a rational use of cash, implying that a company's best investment alternative is to buy back its stock. Normally these purchases are done with free cash flow, but not always. What happens is that if earnings stay constant, the reduced number of shares will result in higher earnings per share, which all else being equal will result, should result, in a higher stock price. But note that there is a difference between announcing a buyback and actually buying back stock. Just the announcement usually helps the stock price, but what really counts is that they actually buy back stock. Just don't be fooled into believing that all "announced share buybacks" are actually implemented. Some are announced just for the short term bounce that usually comes with the announcement. Those types of companies I would avoid as management is out to deceive their shareholders. --------------------Check http://invest-faq.com/ for updates------------------ Compilation Copyright (c) 2003 by Christopher Lott.