Guide to Financial Industry

The Guide to Financial Industry

Prepared by Frederic Goblet 01/13/98 page 1





Table of Content

THE GUIDE TO FINANCIAL INDUSTRY....................................................................................2

INTRODUCTION.........................................................................................................................6

WHAT IS AN INVESTMENT ?....................................................................................................7

The Investment Process......................................................................................................7

THE MARKET AND THE INSTITUTIONS ..................................................................................9

THE INVESTMENT BANKS ............................................................................................................9The Investment Bank ..........................................................................................................9

THE INSTITUTIONAL INVESTORS.................................................................................................10THE CUSTODIAN......................................................................................................................10

What is Custody ?.............................................................................................................10The Custodian...................................................................................................................10

THE SUBCUSTODIAN ................................................................................................................12Role of the Subcustodian ..................................................................................................12

TRUSTEE ................................................................................................................................13THE BROKER ..........................................................................................................................14THE SECURITY EXCHANGES......................................................................................................14

The New York Stock Exchange.........................................................................................15The American Stock Exchange .........................................................................................16Regional Stock Exchanges................................................................................................16NASDAQ ..........................................................................................................................16The Chicago Board Options Exchange..............................................................................17Country Specific Exchanges (National Exchanges)............................................................17

THE MARKET INDEXES .............................................................................................................18WHAT IS A TRADE, HOW DOES IT WORK ? ...................................................................................19

Securities Settlement ........................................................................................................22Delivery vs. Payment ........................................................................................................23Clearing House Funds vs. Same Day Funds .....................................................................23Free Delivery.....................................................................................................................23Book Entry vs. Physical.....................................................................................................23Trade Date........................................................................................................................24Contractual Settlement Date .............................................................................................24Actual Settlement Date......................................................................................................24Failed Trades....................................................................................................................24DK (Don't Know) ...............................................................................................................25Market Conventions ..........................................................................................................25

THE INVESTMENT MANAGERS ...................................................................................................27THE DEPOSITORIES AND CLEARANCE SYSTEMS ..........................................................................28

Book Entry ........................................................................................................................28Immobilization ...................................................................................................................29



Dematerialization...............................................................................................................29Depository Trust Company (DTC) .....................................................................................29Participant Trust Company (PTC)......................................................................................30Federal Reserve Bank (+ see Regulators).........................................................................30EUROCLEAR....................................................................................................................30Cedel ................................................................................................................................31

PRIMARY MARKET....................................................................................................................31SECONDARY MARKET...............................................................................................................31THE OVER-THE- COUNTER MARKET..........................................................................................31THE REGULATORS ...................................................................................................................32THE CENTRAL BANK OF THE U.S.A. : THE FEDERAL RESERVE SYSTEM.........................................32

How the Fed works ...........................................................................................................33Member Banks..................................................................................................................33The Federal Reserve’s many Roles...................................................................................33

THE G30 , THE GROUP OF THIRTY............................................................................................34S.W.I.F.T. SOCIETY FOR WORLDWIDE INTERBANK FINANCIAL TELECOMMUNICATIONS ...................35

TYPES OF INVESTMENT ........................................................................................................37

INVESTMENT STRATEGIES ...................................................................................................38

RISK-RETURN TRADE-OFF ............................................................................................38DIVERSIFICATION ...........................................................................................................38ASSET ALLOCATION.......................................................................................................39

THE CONCEPT OF RISK (ββ,…) AND RETURN .......................................................................42

What is Risk ?...................................................................................................................42The Types of Risk .............................................................................................................42How to measure risk ? ......................................................................................................43Measuring Systematic Risk ...............................................................................................44The Required Rate of Return.............................................................................................45

THE BALANCE SHEET AND THE INCOME STATEMENT......................................................46

THE BALANCE SHEET................................................................................................................46Assets...............................................................................................................................46Liabilities ...........................................................................................................................46Owner's equity ..................................................................................................................47

THE INCOME STATEMENT ..........................................................................................................47

THE TIME VALUE OF MONEY ................................................................................................49

THE NET PRESENT VALUE ........................................................................................................49REQUIRED RATE OF RETURN ....................................................................................................49EXPECTED RATE OF RETURN ....................................................................................................49PRESENT VALUE FORMULA .......................................................................................................50FUTURE VALUE FORMULA.........................................................................................................50

THE STOCK MARKET .............................................................................................................51

GOING PUBLIC ........................................................................................................................51THE PRICE..............................................................................................................................52

The Price ..........................................................................................................................52The Spread .......................................................................................................................52The Ticker.........................................................................................................................53Reading the Newspaper ....................................................................................................53

THE SUPPLY AND DEMAND........................................................................................................54HOW TO VALUE A STOCK ?........................................................................................................58EARNINGS PER SHARES (EPS).................................................................................................58



PRICE/EARNINGS RATIO...........................................................................................................58THE STOCK PRICE ...................................................................................................................58DIVIDENDS ..............................................................................................................................59

The Dividend Yield ............................................................................................................59STOCK SPLIT ..........................................................................................................................60VALUABLE STOCK MARKET TERMS ............................................................................................60

Common Stock .................................................................................................................60Preferred stock..................................................................................................................60The Right to Vote ..............................................................................................................61Book Value .......................................................................................................................61Debt /Equity Ratio .............................................................................................................62Tender Offer .....................................................................................................................62Insider Trading ..................................................................................................................62Warrant.............................................................................................................................62Program Trading ...............................................................................................................62Rule of 72 .........................................................................................................................63Capitalization.....................................................................................................................63Arbitrage ...........................................................................................................................63Blue Chips ........................................................................................................................64Bull Market Vs Bear Market...............................................................................................64

SHORT SELLING ......................................................................................................................64BUYING WARRANTS .................................................................................................................65BUYING ON MARGIN .................................................................................................................65

THE FIXED INCOME SECURITIES THE MONEY MARKET VS THE CAPITAL MARKET ......67

MONEY MARKETS ..................................................................................................................68

Money Market Vs Capital Market.......................................................................................68TREASURY BILL OR T-BILL........................................................................................................69COMMERCIAL PAPER................................................................................................................69BANKER’S ACCEPTANCE...........................................................................................................70CERTIFICATES OF DEPOSIT .......................................................................................................71THE EURODOLLAR MARKET ......................................................................................................72

THE BOND MARKET ...............................................................................................................73

Creditor Vs Owner ...........................................................................................................73Registration.......................................................................................................................73Figuring a Bond’s Worth....................................................................................................74VALUE..............................................................................................................................74Analyzing Bond Yield.........................................................................................................75

BUYING AND TRADING BONDS ...................................................................................................77How Trading Works ?........................................................................................................77

VALUABLE BOND MARKET TERMS..............................................................................................77CALL.................................................................................................................................77DEFAULT .........................................................................................................................77COLLATERAL...................................................................................................................78High-Yield (Junk ) Bonds...................................................................................................78

U.S. GOVERNMENT SECURITIES ..........................................................................................79

TREASURY SECURITIES.............................................................................................................79Treasury Bills ....................................................................................................................79Treasury Notes .................................................................................................................79Treasury Bonds.................................................................................................................79Trading .............................................................................................................................80

AGENCY SECURITIES ...............................................................................................................80



Ginnie Maes (GNMA)........................................................................................................80Fannie Maes (FNMA)........................................................................................................81Freddie Macs (FHLMC).....................................................................................................81Sallie Maes .......................................................................................................................81Tennessee Valley Authority...............................................................................................81

MUTUAL FUNDS......................................................................................................................82

Paying out the profits ........................................................................................................83MUTUAL FUND CHECKLIST.........................................................................................................84

Objective...........................................................................................................................84Performance .....................................................................................................................84Loads and fees .................................................................................................................84The Net Asset Value .........................................................................................................85

PENSION FUNDS.....................................................................................................................86

DEFINED BENEFIT PLANS..........................................................................................................86DEFINED CONTRIBUTION PLANS ................................................................................................86

MARKETS FOR DERIVATIVE SECURITIES............................................................................88

THE LANGUAGE OF OPTIONS .....................................................................................................88FUTURES................................................................................................................................90

SOURCES AND BIBLIOGRAPHY ..........................................................................................109



Introduction

This guide aims at two public targets, the beginners and the professionalswho need some memory refreshment.

It is mainly a compilation of existing publications mentioned at the end thana new guide containing new information.

This publication is not commercial and is published thanks to the manypeople who helped on the compilation of the information contained.

I want this guide to be helpful, to be informative, self-explaining that will linkthe theory to the real world.

Frederic Goblet



What is an Investment?

To invest is to acquire an asset with the expectation of growing value in thefuture. It is linked to the concept of ownership.

The Investment Process

The investment process can be split in three steps: THE PRE-TRADE, THE

TRADE AND THE POST-TRADE.

The pre-trade concerns the decision on what to buy in what quantity.

The trade process is the actual agreement between the seller and thebuyer regarding the price and the quantity. At this moment, the assetchanges ownership.

The post-trade concerns everything after the trade itself: the managementof the trade.

Pre -Trade Trade Post - Trade

Market DataNewsPortfolio ManagementAnalytics

Order RoutingTrade ManagementTrade ExecutionCash ManagementCurrency ManagementSecurities Lending

Transaction ConfirmationCustodyPerformance & AnalyticsPortfolio Accounting





The Market and The Institutions

"MARKET" in a very general way, refers to the availability of,and inter-relationships between, potential buyers and sellers ofgoods or services. The term "market" can be used in a varietyof ways to refer to different physical locations or environmentsin the investment system for the purchase and sale ofsecurities, commodities or currencies.

THE INVESTMENT BANKS

The Investment Bank

The INVESTMENT BANK is a financial specialist who acts as an intermediaryin the selling of securities.

Three basic functions are provided by the investment banker:

1. He assumes the risk of selling a new security issue at a satisfactory(profitable) price. This is called underwriting. Typically, the investmentbanking house, along with the underwriting syndicate, actually buys the newissue from the corporation that is raising funds. The syndicate (group ofinvestment banking firms) then sells the issue to the investing public at ahigher (hopefully) price than it paid for it.

2. He or she provides for the distribution of the securities to the investing public.

3. He or she advises firms our governments on different matters like merge andacquisitions, economic health, …



THE INSTITUTIONAL INVESTORS

An INSTITUTIONAL INVESTOR is an organization that invests its own assets orthose it holds in trust for others. Typical institutional investors areinvestment companies (including mutual funds), pension systems,insurance companies, universities and banks.

THE CUSTODIAN

What is Custody ?

CUSTODY means “safekeeping of assets”. This refers to “keep” the assets ina “safe” place. They are two main reasons why banks are originallyresponsible for custody:

First, you need a vault in order to immobilize the assets if physical, andsecondly because it implies the exchange between cash and securities.

Custody function involves to:

n capture the trade

n protect the investment, to gain ownership : settlement date

n record the position

n Keep track of the rights (income, corporate action, taxes,…)

The Custodian

A CUSTODIAN is an agent, usually a bank, which receives delivers, andsafekeeps cash and securities for its clients. The custodian is alsoresponsible for the maintenance of the securities while they are undercustody.



RECEIPTS AND DELIVERIES

Receipts and deliveries of securities and cash are done only uponinstruction or authorization of the client or the client's authorizedinvestment manager. These transactions usually involve a trade, that is, apurchase or sale of securities or cash. When a security is purchased, thesecurity is received in and cash is delivered out. When the security is sold,the security is delivered out and cash is received in. Cash itself can bepurchased and sold as an investment in the context of foreign exchange.

SAFEKEEPING

Securities under custody must be protected in a secure environmentregardless of whether they are held physically or electronically. Securitiesheld physically are generally kept in a vault at the custodian bank or in aSUBCUSTODIAN bank hired by the primary custodian. Securities held inBook Entry are recorded on the books of the DEPOSITORY as being in theaccount of the custodian. Once securities have been purchased andreceived into safekeeping, the custodian is responsible for themaintenance of these assets as it pertains to registration, incomecollection, and corporate actions.

INCOME

One major custodial responsibility is the timely crediting of incomepayments due to the client from investments held in the client's portfolio.

Custodians need to be aware of any income event affecting securitiesunder their care. This is often accomplished by contracting for the servicesof various Information agents, who provide, among other things,information regarding the terms of a securities issue, income schedule, ordividend announcements.

CORPORATE ACTIONS

A corporate action on a security can have a significant impact on the valueof that security, and therefore on the value of the client's portfolio.Monitoring and accurately processing corporate actions on securities heldunder custody is one of the important responsibilities of a custodian. Thecustodian must be aware of any pending action, which could affect anysecurity being held on behalf of any client; monitoring for corporate actionsthus becomes a significant element of custodial functions. Most custodianshave contracted with a variety of news services or information agents in



order to receive daily information regarding corporate events. Furtherinformation might be obtained from depositories, subcustodians, or evenissuers.

ACCOUNTING SERVICES

The custodian may also provide accounting services to the client, althoughthis service is not necessarily part of every custodial contract. Thisaccounting can include pricing of securities in the portfolio on a daily,weekly, or monthly basis, keeping track of expense accruals and payments,capital purchases or contributions and disbursements, and calculating theNET ASSET VALUE of the portfolio (also known as fund pricing.)

THE SUBCUSTODIAN

Rule: The securities stay in the local market. They remain in the countrywhere they are issued.

A SUBCUSTODIAN can be a bank located in any country, hired by a primarycustodian that performs custodial functions in the local market in which ithas expertise. The success of the custodian in servicing its clientsdepends greatly on the subcustodian's ability to function for the custodianin that particular market; therefore, a consistently high level of servicequality must be provided.

Role of the Subcustodian

The role of the subcustodian generally includes:

1. Settling and vaulting securities,

2. Collecting income,

3. Sending information to the custodian regarding cash and securitymovements, cash balances, month-end securities positions, notificationof corporate actions and upcoming income events, and reportingchanges in the market environment and tax regulations.



TRUSTEE

A TRUSTEE is a person or entity who is legally responsible for anotherperson or entity's investment, property or other assets. There are twotypes of Trustees in the financial industry, Trustees for Master TrustAccounts and those for Corporate Trust Accounts.

Trustees for Master Trust Accounts

A MASTER TRUST is a pool of trusts or a pool of assets involved in one trustagreement. A trustee for a master trust manages and oversees all assetsfor a trust client according to a trust agreement or plan document. Mostoften a trustee is hired to service PENSION PLANS.

Many of the responsibilities of a trustee and a Custodian are similar,however, a trustee has more responsibilities and greater legal burden onbehalf of the plan or trust. A trustee has a FIDUCIARY RESPONSIBILITY to actwith discretion and diligence in the best interest of the client. Thesefiduciary responsibilities in general apply to a trustee who has the power toact on behalf of the client, to manage a plan, or who provides investmentadvice regarding the plan assets or administers a plan.

In most cases, the trustee is liable for a loss which occurs as a result of itsactions, unless the mistake was created by a third party or unless thecontract includes a provision to indemnify the trustee from any loss orexpense.

Because agreements between the client and the trustee may vary, theresponsibilities of the trustee can be different from one client to another.Some of the basic responsibilities of a trustee are recordkeeping, incomecollection, corporate action processing, and pricing, although there can beadditional responsibilities according to the terms of the agreement.

Trustees are also responsible for collecting Income and monitoringcorporate actions on securities held in client portfolios. When a corporateaction is announced, the trustee must notify the Investment Manager whowill decide the suitable course of action on behalf of the client. This finaldecision is passed back to the trustee who will act accordingly.



CORPORATE TRUSTEE

A company issuing bonds in an amount greater than $5 million must hire abank or trust company to administer its securities. The CORPORATE

TRUSTEE acts as intermediary between the company issuing the bonds andthe investors buying the bonds.

THE BROKER

An INVESTMENT BROKER can be anyone who earns commissions or fees forexecuting investment transactions that transfer ownership from one party toanother.

All brokerage firms and all brokers acting as individuals must be a memberof the exchange through which they trade, and must pay an annualmembership fee to the exchange. Exchanges have strict codes of conduct,and can bar individuals or firms from membership due to fraudulent orunethical activity. Brokers can hold MEMBERSHIP in more than oneexchange. Some brokers specialize in a particular security type orcommodity, and would therefore be a member of that specializedexchange.

Some of their functions include: transition management, directedbrokerage, soft dollars agreements, commission recapture programs,electronic trading, …

THE SECURITY EXCHANGES

A STOCK EXCHANGE is a private association that provides a physicallocation and clerical support for its members. Trading occurs AUCTION-STYLE with investors exchanging bids and offers on the exchange’s listedsecurities.

Organized security exchanges are tangible entities whose activities aregoverned by a set of bylaws. Security exchanges physically occupy spaceand financial instruments are traded on such premises.



Exchanges do not buy or sell securities, nor do they set prices. TRADING isconducted on the exchange “FLOOR” where each SPECIALIST presides overthe auctioning of shares for one or more of the listed companies. Sellerswilling to take the lowest prices and buyers willing to pay the highest pricesare given priority trade instructions.

When a company first goes public (INITIAL PUBLIC OFFERING), themanagement decides how its shares will be traded among investors, eitheron a stock exchange, an auction market, or OVER-THE-COUNTER, anegotiated market.

Major stock exchanges must comply with a strict set of reportingrequirements established by the SECURITIES AND EXCHANGE COMMISSION

(SEC). These exchanges are said to be registered.

Organized security exchanges provide several benefits to bothcorporations and investors. They (l) provide a continuous market, (2)establish and publicize fair security prices, and (3) help businesses raisenew financial capital.

A corporation must take steps to have its securities listed on an exchangein order to directly receive the benefits noted above. Listing criteria differfrom exchange to exchange.

Three of the most well known United States exchanges are the NEW YORK

STOCK EXCHANGE (NYSE), THE AMERICAN STOCK EXCHANGE (AMEX), AND

THE NATIONAL ASSOCIATION OF SECURITIES DEALERS AUTOMATED QUOTATION

SYSTEM (NASDAQ). Other national exchanges specialize in commodityand security options and futures trading. These include the CHICAGO

BOARD OF TRADE, CHICAGO BOARD OF OPTIONS EXCHANGE, MID-AMERICA

COMMODITY EXCHANGE, NEW YORK COFFEE, SUGAR AND COCOA EXCHANGE,NEW YORK COTTON EXCHANGE, NEW YORK FUTURES EXCHANGE, PACIFIC

STOCK EXCHANGE AND THE PHILADELPHIA EXCHANGE.

The New York Stock Exchange

The NEW YORK STOCK EXCHANGE (NYSE), sometimes referred to as the"Exchange" or the "Big Board", was established in 1792 and is the oldestand largest securities exchange in the United States. Usually only largefirms can meet the stringent eligibility requirements of the NYSE. Theserequire that a firm have a minimum of one million publicly held shares, a



market value of publicly held shares of at least $10 million, total marketvalue of $16 million, annual net income of over $2.5 million before federalincome taxes, and 2,000 holders of 100 shares or more.

The American Stock Exchange

The AMERICAN STOCK EXCHANGE (AMEX) was originated in 1921.TheAMEX could be considered a proving ground for the NYSE, as it tradessecurities from mainly small and medium size companies. A large numberof companies that were once listed on the AMEX have moved to the NYSE.Another difference between these two exchanges is that the AMEX has anoptions market where the NYSE does not.

Regional Stock Exchanges

Regional stock exchanges are organized securities exchanges locatedoutside of New York City and registered with the SEC. They do notexclusively list only regional or local securities, but list many issues thatare also on the New York exchanges. NYSE and AMEX listings often alsolist on a regional exchange to receive broader market exposure. This duallisting practice of a security on one or more exchanges increasescompetition for the issue and boosts trading availability due to differenttime zones. Regional exchanges in the United States include the BOSTON,CINCINNATI, MIDWEST, PACIFIC, PHILADELPHIA STOCK EXCHANGES.

NASDAQ

NATIONAL ASSOCIATION OF SECURITIES DEALERS AUTOMATED QUOTATION

SYSTEM (NASDAQ) is a computerized communication system that servesthe dual function of providing security information to its members, andacting as an exchange for stocks. Ranking third in trading volume behindthe New York Stock Exchange and the Tokyo Exchange, it featuresefficiency in trading, as it can locate the most up-to-date quotes regardlessof where the market is in the U.S.



The Chicago Board Options Exchange

The CHICAGO BOARD OPTIONS EXCHANGE (CBOE) revolutionized optionstrading by creating standardized, listed options in 1973. Before 1973,options were individually tailored and traded "over-the-counter" by a fewput/call dealers. CBOE established a secondary market where optionscould be traded. The growth in the use of options propelled CBOE tobecome the world's largest options exchange, and the second largestsecurities exchange in the U.S. Today, CBOE captures the largest share ofthe U.S. options market by trading 700,000 option contracts dailyaccounting for over 47 percent of trading in equity options, over 95 percentof index options trading and over 65 percent of all options trading.

Today, options are traded on five U.S. exchanges: the Chicago BoardOptions Exchange, the American Stock Exchange, the New York StockExchange, the Pacific Stock Exchange and the Philadelphia StockExchange. Although there are five U.S. exchanges that trade standardizedoptions, options have become a global contagion trading on over 50exchanges worldwide.

Country Specific Exchanges (National Exchanges)

Various countries throughout the world have national exchanges thatprovide trading arenas for that specific country. Some of these countriesinclude:

AUSTRALIA: Australia Stock Exchange (ASX) is the nation-wideexchange.

AUSTRIA: Vienna Stock Exchange is the national exchange;Telefonhandel is the OTC exchange.

BELGIUM: Brussels is the main exchange, with branches inAntwerp and Liege.

CANADA: Toronto and Montreal exchanges are linked together,with branches in Vancouver and Alberta.

DENMARK: Copenhagen Stock Exchange.



FRANCE: Paris is the center of all equity trading in France.

GERMANY: Frankfurt is the main exchange.

ITALY: Milan is the main exchange, and there are severalregional exchanges.

JAPAN: Tokyo and Osaka are the main exchanges.

MEXICO: Mexico City is the national exchange.

NETHERLANDS: Amsterdam Stock Exchange is the national exchange.

NORWAY: Oslo Stock Exchange (OSE) is the nationalexchange, with branches in Bergen and Trondheim.

SPAIN: Madrid is the main exchange, with branches inBilbao, Barcelona and Valencia.

SWEDEN: Stockholm is the national exchange.

SWITZERLAND: Zurich is the main exchange, with branches inGeneva and Basle.

UNITED KINGDOM: London Stock Exchange (LSE) is the main exchangefor equity trading in the U.K. and the Republic ofIreland. Branches are in Manchester,Birmingham,Glasgow, Leeds and Belfast in the U.K., and Dublin inIreland.

THE MARKET INDEXES

A BENCHMARK is a standard; a set of information used for comparisons.Indexes are often used as benchmarks.

A MARKET INDEX is a weighted average of the specific security prices,industrial production components, or market factors that make up the index.



The DOW JONES INDUSTRIAL AVERAGE is composed of 30 stocks. The Dowaccurately measures what it claims to measure : the performance of 30 keycompanies which are worth about 25% of the total value of all stocks listedon the NYSE. To the extent that those companies represent key sectors ofthe economy, their performance indicates how the economy is doing.However, other sectors of the economy perform differently.

The NYSE COMPOSITE INDEX includes all stocks traded on the New YorkStock Exchange . The NYSE also reports the activity in four sectors -industrial, utility, transportation and financial - in separate indexes.

The STANDARD & POOR’S 500 INDEX incorporates a broad base of 500 ofsome of the largest U.S. public corporations: 400 industrial, 40 utility, 40financial and 20 transportation companies.

The NASDAQ COMPOSITE INDEX was created to track the progress of morethan 4000 stocks listed on the National Association of Securities DealersQuotation System.

The AMEX MARKET VALUE INDEX monitors the performance of over 800companies listed on the American Stock Exchange.

The RUSSELL 2000 represents the smallest two-thirds of the 3,000 largestU.S. companies, including a great many of the initial public offerings of thelast few years.

The WILSHIRE 5000, the broadest index, includes all stocks traded OTC andon exchanges, including the S&P 500.

WHAT IS A TRADE, HOW DOES IT WORK ?

Stocks are generally traded in 100-share increments called ROUND LOTS.Any number of share fewer than 100 is an ODD LOT.

When you buy or sell a security, the brokerage firm enters your order intoits computer system for transmittal to its traders at the designatedexchange or the firm’ OTC trading desk. For an exchange-listed security,the order is sent to the BROKERAGE FIRM’S FLOOR BROKER on the exchange



or directly to a SPECIALIST in that particular stock, who maintains a post onthe exchange floor, to be matched with an offsetting order.

THE SPECIALISTS

Brokers called "SPECIALISTS" play a critical role because they serve as thecontact point between brokers with buy and sell orders in the NYSE's two-way auction market.

Each stock listed on the NYSE is allocated to a specialist, a broker whotrades only in specific stocks at a designated location. All buying andselling of a stock occurs at that location, called a trading post. Buyers andsellers - represented by the floor brokers - meet openly at the trading postto find the best price for a security. The people who gather around thespecialist's post are referred to as the trading crowd. Bids to buy and offersto sell are made by open outcry to provide interested parties with anopportunity to participate, enhancing the competitive determination ofprices. When the highest bid meets the lowest offer, a trade is executed.

To a large degree the specialist is responsible for maintaining the market'sfairness, competitiveness and efficiency. Specifically, the specialistperforms four vital functions.

One of the specialist's jobs is to execute orders for floor brokers in theirassigned stocks. A floor broker may get an order from a customer who onlywants to buy a stock at a price lower than the current market price - or sellit at a price higher than the current market price. In such cases, the brokermay ask the specialist to hold the order and execute it if and when the priceof the stock reaches the level specified by the customer. In this role thespecialist acts as an agent for the broker.

In a sense, specialists act as auctioneers for their assigned stocks. At thestart of each trading day, the specialists establish a fair market price foreach of their stocks. The specialists base that price on the supply anddemand for the stock. Then, during the day, the specialists quote thecurrent bids and offers in their stocks to other brokers. Investors may directbrokers to place stock orders contingent on a variety of conditions. Themost common are : MARKET ORDER and LIMIT ORDER.

MARKET ORDERS are executed immediately. A LIMIT ORDER is an open orderto buy or sell at a specified price or better.



When your trade is executed, the brokerage firm sends you a confirm, awritten confirmation that reports the trade date (date the order takes effect,you are the legal owner), the quantity, the description, and the price.

When securities are purchased, payment must be made on or before theSETTLEMENT DATE. Settlement for stock generally occurs on the thirdbusiness day following the trade date.

Commissions and Markups. Transaction costs for buying and selling stockare based on the share price and number of shares traded during a singlemarket session. Stock commissions are typically a fraction of 1 percent to 3percent. The higher the stock price and the greater the number of sharestraded, the lower the commission.



Places orders to buy andsell

Initiates transactionPass the order to a Floor

Broker on the StockExchange

The Customer

The Floor Broker

The Brokerage Firm

The StockExchange

When the order reachesthe floor of the exchange,the floor broker takes it to

a specialist in thatparticular stock

Buy = priority for thehighest bid

Sell = priority for thelowest offer

The Specialist

The Order will beconfronted with othersand the specialist will

match them

Securities Settlement

SECURITIES SETTLEMENT is the final point in the trading process at whichsecurities are delivered and money is exchanged.



Delivery vs. Payment

DELIVERY VS. PAYMENT involves any settlement where securities aredelivered and cash is received concurrently. DVP describes the seller'sperspective.

Clearing House Funds vs. Same Day Funds

Depending upon how payment is made to settle a trade in the UnitedStates, use of clearing house funds or same day funds will determine theavailability of cash associated with a trade. CLEARING HOUSE FUNDS areavailable to spend one day after actual settlement date. Almost all DTCtrades settle in clearing house funds, the exception being commercialpaper which settles in same day funds. SAME DAY FUNDS are available tospend on the same day as actual settlement date. Same day funds aresometimes referred to as Fed funds.

Free Delivery

FREE DELIVERY or Delivery Free of Payment involves security transferswhere there is no corresponding cash movement. Securities transferredfrom a previous custodian or trustee to a newly hired custodian or trusteeare examples of free delivery settlements.

Book Entry vs. Physical

BOOK ENTRY is an electronic system that records transfers of securitiesand/or cash between a buyer and a seller. Most DEPOSITORIES operate in abook entry environment. For securities that settle through book entry,physical certificates may or may not exist. If physical certificates do exist,however, a major advantage to book entry is that these certificates do nothave to physically move in order to settle the trade. Another majoradvantage to book entry is that registration in the name of the new owner isusually effective immediately upon settlement. In the United States, bookentry settlement locations include DTC, the Fed, and PTC.



In contrast, PHYSICAL SETTLEMENT requires that paper certificates changehands. Disadvantages to physical settlement include the increased riskthat certificates could become lost, the time delay associated with re-registration because new certificates must be issued, and the time requiredto make physical delivery itself. Physical certificates are generally held in avault by the appropriate bank or broker.

Trade Date

TRADE DATE refers to the date upon which a buyer and seller agree to theterms of a security purchase or sale, including the price, the amount ofshares, and the date, location, and method of exchanging the cash and thesecurities. By agreeing to the trade, both buyer and seller have enteredinto a mutually binding contract regarding the exchange of securities andcash.

Contractual Settlement Date

CONTRACTUAL SETTLEMENT DATE is the date upon which a trade is expectedto settle, according to the terms of the trade agreement.

Actual Settlement Date

ACTUAL SETTLEMENT DATE refers to the date upon which the trade actuallysettles. Actual settlement can occur on or after contractual settlementdate. Although the contractual settlement date is agreed to on trade date,a trade may not settle until sometime later, due to an error or problem withdelivery of the security.

Failed Trades

A FAILED TRADE occurs when a trade does not settle on contractualsettlement date due to either inaccurate delivery or non-delivery of thesecurity by the seller. Trades which are open after contractual settlementdate are said to be "failing", as they have "failed to settle" on time. Failedtrades can cause subsequent problems with income collection andcorporate actions, as the new owner is unable to register the security until



settlement has occurred. A failed buy can also cause problems if thepurchaser wishes to sell the security but is unable to make delivery on thesell since the purchase has not yet settled.

DK (Don't Know)

In some cases, the receiving party does not accept an attempted deliveryof securities for settlement. This may occur when there is a mismatch inthe information connected with the delivery, such as the name of thesecurity, the amount of shares or par, the price, the contractual settlementdate, the broker, etc. It may also occur if the receiving party has noinstructions regarding the trade whatsoever. The receiving party refuses toaccept delivery, saying that they "DON'T KNOW" this trade as delivered.The expression "DK" is short for "don't know", thus, the receiver is said to"DK" the trade. Errors which could cause a mismatch in information mayhave occurred in either the buyer's or seller's instructions to theirrespective agents. Both parties usually reconfirm their information andchanges are made as necessary in order to effect good delivery.

Market Conventions

Depending upon the type of security traded and the market in which thetrade occurs, the period between Trade Date and Contractual SettlementDate will vary. The scheduled contractual settlement date is usuallydenoted as TRADE DATE + (number of days), or TD + (number of days),or T + (number of days). The following describes examples of settlementvariations within different markets as of this writing.

United States

In the United States, LONG TERM DEBT and EQUITY SECURITIES arescheduled for Trade Date + 5 settlement.

Settlement dates for COMMERCIAL SHORT TERM DEBT (MONEYMARKET INSTRUMENTS) can be negotiated at the time of the trade, butdue to the nature of these investments, most are traded to settle either onTrade Date or Trade Date + 1.



SHORT TERM TREASURY securities on the secondary market aregenerally traded for settlement on T + 1. Some trades can be negotiatedfor same day settlement, however the interest rate agreed to may be lowerthan if the trade is made for next day settlement. Treasury securitiesbought at Monday Treasury auctions (primary market purchases) usuallysettle on T + 3.

Canada

The Canadian Depository for Securities (CDS) settles trades executed onthe Toronto and Montreal Exchanges through their Securities SettlementService (SSS). Although owned by the depository, SSS is used to settleboth depository and non-depository trades. SSS operates both a bookentry system and a physical settlement system. Depository eligiblesecurities settle by book entry through the Book Based System (BBS).Depository ineligible securities with valid CUSIP numbers are settledphysically through the Certificate Based System (CBS). Ineligible securitieswithout valid CUSIP numbers cannot be settled through SSS, and mustsettle physically, at the office of the buyer's broker or custodian.

Denmark

All settlements in Denmark occur on T + 3.

Italy

Formal settlement practices in Italy apply only to trades executed on one ofthe official stock exchanges. Whether a trade is contracted to settle on theforward or cash market determines how quickly it will settle. Tradesexecuted on the FORWARD MARKET have a settlement period of up to T+ 45. Trades made during the last two weeks of a month and the first twoweeks of the following month settle during the last half of that secondmonth. Trades executed on the CASH MARKET settle T + 3. Thetransaction costs for cash market trades are slightly higher, as the costsreflect the settlement of those trades within a shorter period of time.

Korea

In Korea, equities and convertible bonds settle on T + 2. Trading andsettlement activity take place on Saturdays, since Saturday is a workingday in Korea.



Sri Lanka

All settlements in Sri Lanka occur on T + 7.

United Kingdom

In the United Kingdom, trades are processed for settlement every fourteendays. The fourteen day schedule is maintained unless the scheduledsettlement date falls on a holiday, then the whole cycle is moved forward tobe begun again on the next open business day. Thus, settlements mayoccur on Mondays for a while, then be pushed forward to Tuesdays, etc.An attempt is made to settle failed trades within the next few days. Tradesare always settled through physical delivery.

THE INVESTMENT MANAGERS

An INVESTMENT MANAGER, (also known as an Investment Advisor), is anindividual or agency designated to make investment decisions for a ClientCompany or entity that has beneficial ownership of assets. Clients may bepension funds, mutual funds, or other types of investment funds.

Often, the investment manager is an outside agent or agency hired by theclient company. Companies may also use internal investment managers.

Investment managers operate in accordance with the client's investmentstrategy. In many instances, investment managers specialize in managinga specific investment type, such as equities or fixed income securities.

Responsibilities include making trade decisions, executing trades withbrokers, and providing trade details to the custodian or trustee bank.Investment managers are also responsible for making decisions onvoluntary corporate actions and managing cash, both as an investmentasset and to ensure that sufficient cash is available to cover pendingpurchases. An investment manager has power to purchase and sell anyplan asset, and has FIDUCIARY responsibility to act with discretion anddiligence in the best interest of the client.



THE DEPOSITORIES AND CLEARANCE SYSTEMS

Today, many debt securities are in electronic book-entry form. Ownershipis transferred via computer rather than via actual transfer of papercertificates, reducing the possibility of loss, theft, or mutilation of thecertificates. In the future, more and more securities certificates will be inthis electronic form.

A DEPOSITORY is an institution that provides central VAULTING of certificates,and where security ownership is transferred and recorded. A security mustbe accepted by a given depository as "depository eligible" before thedepository will begin to service it; once this has occurred however, anattempt is usually made to keep all physical certificates underlying thatsecurity centrally vaulted in the depository, regardless of ownership.

Today there are numerous depositories around the world and in addition tothe standard service of maintaining ownership records, each performsservices unique to their requirements and technology. Many depositoriescollect income, maintain a linkage between cash and security movements,provide recordkeeping of securities held, and provide reporting to allparticipants in the depository to facilitate income and corporate actioninformation flow. Depositories act as TRANSFER AGENT and PAYING AGENT,as well.

The term "clearance system" is often used interchangeably with the term"depository", as both generally provide some form of recordkeeping servicethat facilitates the accuracy of trade information.

Book Entry

The transfer of ownership records at a central location without physical re-registration taking place is known as BOOK ENTRY. Almost all depositoriesuse book entry systems. Reports are generated reflecting currentownership and transfer activity for each security held.

Book entry systems can be used whether or not certificates physically existto represent the underlying securities.



Immobilization

When securities are represented by physical certificates, the depositoryprovides a central vaulting location where the certificates are heldregardless of changes in ownership. This is known as IMMOBILIZATION

since the certificates do not move upon trading. Advantages ofimmobilization include decreased risk of error, decreased risk of loss, anddecreased cost, since certificates do not have to be handled physically toeffect the delivery and re-registration process. Usually, certificates held ina depository are registered in the name of that depository.

Dematerialization

In some cases, security certificates may not exist physically. A depositorysimply records changes in ownership of the security. This certificate-freeenvironment is called DEMATERIALIZATION, also referred to as "scripless".

Depository Trust Company (DTC)

DTC, located in New York City, is a member owned depository and not aprofit driven company. With a main purpose of providing timely andaccurate securities settlements, fees are kept to a minimum and any profitsgenerated are distributed to participants in DTC. Established in 1968, DTCis the largest safekeeper of corporate stocks and bonds in the U.S. Not allsecurities are "DTC eligible", or can be traded using DTC as thedepository, however, most U.S. equities and corporate bonds are eligible.A security which is DTC eligible does not have to be traded or held in DTC.An owner has the option of withdrawing the certificates from DTC andholding them physically.

To participate in DTC, an institution applies for DTC membership, andupon approval, is assigned a participant number. Payments on trades inDTC are usually in "same day funds", meaning that cash movement occurson the day of actual settlement.



Participant Trust Company (PTC)

PTC purchased the Mortgaged-Backed Securities Clearing Corporation(MBSCC), a depository for Government National Mortgage Association(GNMA) securities, in 1989. This depository, renamed the Participant TrustCompany (PTC), is chartered by the state of New York and is registeredwith the Securities and Exchange Commission as a clearing agency. PTCis a central depository where mortgaged-backed securities are exchangedand vaulted. PTC is member owned. In PTC, cash payment is in sameday funds.

Federal Reserve Bank (+ see Regulators)

The FEDERAL RESERVE BANK provides a book entry system for settlementsof securities issued by the United States Treasury, including Treasury Bills,Notes and Bonds, along with the related re-purchase agreements andcertain mortgage and loan issues. Only members of the Federal ReserveBank, which are generally commercial banks, may be direct participants inthis depository. Since brokers, therefore, cannot be participants, a brokermust affiliate with a member bank in order to settle transactions. Cash fordelivery or receipt of settled trades is in same day funds.

EUROCLEAR

International depositories were developed in order to deal with the growingnumber of trades that crossed country borders and were not beingadequately handled.

EUROCLEAR is a major international depository, located in Brussels, formedto provide exchange and clearance services for internationally tradedsecurities. Euroclear was initiated in principle in 1965 and formally createdin 1968 with Morgan Guarantee Trust as founder. Euroclear is owned bythe Euroclear Clearance System Public Limited Company, whoseshareholders are over one hundred banks, brokers and investmentinstitutions worldwide. As of this writing, Euroclear handles securitiesissued from over 121 countries worldwide.

Euroclear has an "electronic bridge", a direct link, to the Cedel depositoryto facilitate settlements between the two.



Cedel

CEDEL (CENTRALE DE LIVRAISON DE VALEURS MOBILIERES) is the secondmajor depository, along with Euroclear, for international trading. Located inLuxembourg, Cedel was created in 1971 and is owned by various banks.Cedel works with Euroclear to facilitate transaction flows. An example ofthe cooperation between these two depositories which results in efficiencyfor participants, is that Cedel performs pre-matching of trades withEuroclear daily to ensure timely delivery and receipt. Benefits of Cedel'sworking relationship with Euroclear include fewer physical settlements thatresult in lower fees charged to participants and same day cash proceeds.

PRIMARY MARKET

Securities are first offered for sale in a primary market. For example, thesale of a new bond issue, preferred stock issue, or common stock issuetakes place in the PRIMARY MARKET. These transactions increase the totalstock of financial assets in existence in the economy.

SECONDARY MARKET

Trading in currently existing securities takes place in the SECONDARY

MARKET. The total stock of financial assets is unaffected by suchtransactions.

THE OVER-THE- COUNTER MARKET

OVER-THE-COUNTER MARKETS include all security markets except theorganized exchanges. The money market is a prominent example. Mostcorporate bonds are traded over-the-counter.

Most Stocks and Bonds are not traded on exchanges but in the over-the-counter market. The OTC market is not a place but rather a method ofnegotiated trading which, unlike exchanges, has no central location. It iscomposed of numerous dealers called market makers. Acting as



wholesalers and principals, these dealers “make a market” in the shares ofone or more companies as they trade for their customers and their ownaccounts.

THE REGULATORS

The various securities markets, procedures of issuance, marketing, andsubsequent trading of securities, must adhere to certain rules andstandards in order to proceed in a reasonable and orderly fashion.

In the U.S., the main regulatory agencies include the Securities andExchange Commission (SEC), and the Federal Reserve Board (Fed).

The SECURITIES AND EXCHANGE COMMISSION (SEC) regulates all organizedsecurities exchanges to protect investors from unfair practices and tomaintain orderly markets.

SEC regulations include three major Acts governing the trading ofsecurities on organized exchanges. The SECURITIES ACT OF 1933 pertainsto newly issued securities, the SECURITIES EXCHANGE ACT OF 1934 dealswith trading in securities markets, and the SECURITIES ACT AMENDMENT OF

1975 centers on the national securities markets. In fact, the SECestablished many of the regulations cited in the U.S. Regulations and Actsmodule.

There are also specific regulators for specific markets, such as theCOMMODITIES FUTURES TRADING COMMISSION which regulates activities incommodities futures markets.

THE CENTRAL BANK OF THE U.S.A.: THE FEDERAL RESERVE SYSTEM

THE FEDERAL RESERVE SYSTEM is the guardian of the nation’s money -banker, regulator, controller, and watchdog all rolled into one.

Like other countries, the U.S. has a national bank. However, the FederalReserve (the Fed) is not one bank; it’s twelve separate ones governed by a



seven- member Board of Governors. Congress established it in 1913 tostabilize the country’s chaotic financial system.

How the Fed works

Technically a corporation owned by banks, the Fed works more like agovernment agency than a business. Under the direction of its Chairman, itsets economic policy, supervises banking operations, and has become amajor factor in shaping the economy.

The Fed has several tools by which it influences, indirectly and to a greateror lesser extent, the amount of money in the economy and the general levelof interest rates. These tools are reserve requirements, open marketoperations, open market repurchase agreements and the discount rate.These instruments represent the key ways that the Fed interacts withcommercials banks in the process of creating money.

Member Banks

About half of all the banks in the country are members of the FederalReserve System. All national Banks must belong, and state-charteredbanks are eligible if they meet the financial standards the Fed hasestablished.

The Federal Reserve’s many Roles

The Fed plays many roles as part of its responsibility to keep the economyhealthy. The Fed handles the day-to-day banking business of the U.S.government. It gets deposits of corporate taxes for unemployment,withholding and income, and also of federal excise taxes on liquor,tobacco, gasoline and regulated services like phone systems. It alsoauthorizes payment of government bills like Social Security and Medicareas well as interest payments on Treasury bills, notes and bonds.

Moreover, the Fed manages the currencies replacement, the gold mattersand is also a clearing house for checks.



THE FED AS A REGULATOR

By buying and selling government securities, the Fed tries to balance themoney in circulation. When the economy is stable, the demand for goodsand services is constant, and so are prices. Achieving that stabilitysupports the Fed’s goals of keeping the economy healthy and maintainingthe value of the dollar.

THE FED AS A LENDER

If a bank needs to borrow money, it can turn to a Federal Reserve Bank.The interest the Fed charges banks is called the DISCOUNT RATE. Bankersdo not like to borrow from the Fed since it may suggest they haveproblems. In addition, they can borrow more cheaply from other banks.

THE FED AS AN AUDITOR

The Fed monitors the business affairs and audits the records of all thebanks in its system. Its particular concerns are compliance with bankingrules and the quality of loans.

THE G30, THE GROUP OF THIRTY

The GROUP OF THIRTY (commonly known as G30) is a private, internationalgroup of top economists and bankers who meet for the purposes ofexploring and discussing issues of international finance and globaleconomics. Although the group has no legislative power, it is highlyrespected, and its recommendations are taken into serious considerationwhen relevant national or market policies and practices throughout theworld are being revised or formulated.

In 1989, the G30 issued a set of NINE RECOMMENDATIONS for improvinginternational securities settlements, corporate actions processing, andincome processing. The purpose was to reduce risk and improve efficiencyin national and world markets.

The nine G30 recommendations, as published in 1989, are:

1) By 1990, all comparisons of trades between direct market participants shouldbe accomplished by T+1.



2) Indirect market participants should, by 1992, be members of a tradecomparison system that achieves positive affirmation of trade details.

3) Each country should have a fully developed central securities depositoryorganized to encourage the broadest possible industry participation by 1992.

4) Each country should determine whether a trade netting system would helpreduce risk and improve efficiency. If a netting system is appropriate, itshould be in place by 1992.

5) Delivery vs. Payment (DVP) should be used for settling all securitiestransactions. A DVP system should be in place by 1992.

6) Payments associated with the settlement of securities transactions should beconsistent across all instruments and markets by adopting the same dayfunds convention.

7) All markets should adopt a "rolling settlement" system. Final settlementshould occur on T+3 by 1992. As an interim target, final settlement shouldoccur by T+5 by 1990, except where it hinders the achievement of T+3 by1992.

8) Securities lending and borrowing should be encouraged as a way to expeditethe settlement of securities transactions. Regulatory barriers to securitieslending should be removed by 1990.

9) Each country should adopt the ISO standard for securities messages and theISIN numbering system by 1992.

S.W.I.F.T. SOCIETY FOR WORLDWIDE INTERBANK FINANCIAL

TELECOMMUNICATIONS

S.W.I.F.T. is an acronym for SOCIETY FOR WORLDWIDE INTERBANKFINANCIAL TELECOMMUNICATIONS. S.W.I.F.T. is not a paymentsystem, rather it is a system of electronic communication. S.W.I.F.T. is anonprofit organization that facilitates the exchange of payment instructionsor advises of payment between financial institutions around the world.S.W.I.F.T. messages can be sent both internationally and domestically. A



S.W.I.F.T. message can also be used to convey trading and settlementmessages, corporate action notices, and general messages, among others.

S.W.I.F.T. was organized in 1973 to provide a more efficientcommunications method than telegraph wire (also known as TELEX) ormail. Participants to the S.W.I.F.T. network include broker-dealers,securities firms, Investment Management Institutions, recognizedexchanges, central depositories and clearing institutions, registrars andtransfer agents, and custodian banks.

The advantages of S.W.I.F.T. in a global environment are that it providescommon rules, standards and communication methods across a variety ofusers. S.W.I.F.T. is considered one of the most secure and efficientnetworks for the delivery of funds transfer instructions. S.W.I.F.T. protectsagainst unauthorized access, loss or incorrect delivery of messages,transmission errors, loss of confidentiality and fraudulent changes tomessages.



Types of Investment

There are four basic types of investments:

1. LAND (real estate)

2. COMMODITIES

3. SECURITIES (debt/equity)

4. CASH (“fake asset”)



Investment Strategies

Various INVESTMENT STRATEGIES allow all types of investors the opportunityto maximize returns on their investments according to their individualneeds.

Before developing an investment strategy, investors must consider theobjectives and constraints influencing their investment choices.

Objectives are what the investor wishes to accomplish by investing. Forexample, objectives can be to generate a steady and secure income flow,to maintain liquidity, to have a specified amount of money available at aparticular time in the future, to increase the initial capital by a substantialamount, etc… Not all objectives are mutually exclusive, but differentobjectives require different types of investments and strategies.

Constraints provide the framework of limitations within which the statedobjectives will be pursued. Constraints can be liquidity requirements, taxconsiderations, legal and regulatory requirements, or circumstances of theinvestor.

RISK-RETURN TRADE-OFF

The RISK-RETURN TRADE-OFF is a subjective principle of investmentstrategy. Before a strategy can be developed, the amount of risk aninvestor is willing to take must be considered.

Generally, the highest risk investments will offer the highest potentialreturns, as well as the highest potential for losses.

DIVERSIFICATION

DIVERSIFICATION reduces an investor's exposure to risk by spreading avariety of investment choices among different asset categories.Diversification works on the theory of "not putting all of your eggs in onebasket"; by choosing investments in different markets or industries, or



mixing equity and debt, the investor is protected from a negative impact inone category. For diversification to be effective, the chosen investmentsshould not fluctuate in a similar fashion, such that external marketconditions would cause the investments to rise or fall in value at the sametime. Diversification implies that if one asset or investment categoryperforms poorly, the entire portfolio will not be affected.

ASSET ALLOCATION

Everyone invests for the same basic reason: to make their assets work ashard as they can to meet a set of financial objectives. But those objectivesare different for each of us, and they define how we invest.

The relationship between your needs, resources, goals and tolerance forrisk will pinpoint the asset allocation strategy--the method by which youdivide your assets among stocks, bonds and cash--that's best for you. Thedifferent strategies are based on several factors, and differ in how theybalance risk and reward. In general, higher growth means a greateremphasis on stocks--and a higher level of risk.

Identifying your investment objectives will help you decide whichinvestment strategy is right for you.

ASSET ALLOCATION is related to diversification, and refers to the question ofwhat percentage of a portfolio should be invested in any asset category inorder to maximize returns within the risk parameters desired. Determiningan optimal asset mix of any combination of investments, including shortterm debt, stocks, bonds, real estate, options, futures, venture capital andderivatives, enhances the investor's ability to achieve desired returns.

• You need a CAPITAL PRESERVATION strategy.

This strategy is based on the following asset allocation:

Stocks: 10%

Bonds: 55%

Cash: 35%



This division of assets is designed to maintain capital. Most of your moneywill be in bonds and cash, with a small portion seeking equity growth tooffset the effects of inflation. Overall returns may be lower than normal inorder to minimize the risk of principal loss.

• You need a CURRENT INCOME strategy.


Stocks: 30%

Bonds: 60%

Cash: 10%

While moderate risk is assumed from fluctuating interest rates, this strategyprovides the greatest level of income.

• You need an INCOME AND GROWTH strategy.


Stocks: 40%

Bonds: 50%

Cash: 10%

This strategy seeks a balance between bonds for income and stocks forgrowth of principal and dividends. Dividends and interest income comprisea large part of the invested assets' total return. Some risk is assumed inorder to achieve growth.

• You need a LONG-TERM GROWTH strategy.


Stocks: 70%



Bonds: 25%

Cash: 5%

In order to accumulate wealth over a 3-5 year period, this strategy placesgreater emphasis on stocks. An investor would need to be willing to acceptsome price volatility to achieve growth. Equities are dominant, particularlyleading companies in strategically favored industries. There is limitedturnover, and dividend reinvestment and dollar cost averaging are stressedto achieve the growth objective.

• You need an AGGRESSIVE GROWTH strategy.


Stocks: 80%

Bonds: 10%

Cash: 10%

The primary investment objective of this strategy is to achieve above-average capital growth over a 3 - 5 year period. Income is of no concern.The investor is willing to make few changes in this larger-than-normalcommitment to stocks in strategically favored industries.



The Concept of Risk (ββ,…) and Return

What is Risk ?

RISK can be defined as the possible variation in cash flow about anexpected cash flow.

Conventionally, we measure the EXPECTED CASH FLOW as follows:

EX = X1 P1 + X2 P2 + . . . + Xn Pn

where Xi is the cash flow in the ith state of the economy and Pi is theprobability of the ith state of the economy.

Similarly, the EXPECTED RATE OF RETURN is given by:

ER = R i PiΣΣ

i = 1

n

where Ri is the rate of return in the ith state of the economy and pi is theprobability of ith state of the economy.

The Types of Risk

MARKET RISK An asset may lose market value because of economicand other swings in the overall market or conditionsaffecting the asset itself.

CREDIT RISK The borrower may fail to repay principal

INFLATION RISK The currency in which an asset is based may losepurchasing power



LIQUIDITY RISK An asset may lose market value because it is difficultto sell.

INTEREST-RATE RISK The market value of a fixed-income investment movesopposite to market interest rates.

REINVESTMENT RISK When reinvesting a bond’s principal and interestproceeds, you might not get as high a rate becausemarket interest rates have declined.

CURRENCY RISK An asset denominated in foreign currency may losevalue when the home base strengthens.

How to measure risk ?

Market risk refers to the fluctuation of an investment’s price volatility orpotential loss in market value at the time you need to liquidate. Wall Streethas found a way to actually measure the risk of certain investments interms of price volatility.

ALPHA. With this measure, you can gauge how much better an investmentor portfolio performs, given its risk. Alpha is the return over and above themarket average, as measured by the S&P 500 Index. An Alpha of ‘0’ meansyou are being adequately compensated for risk taken; a higher numberreflects better than expected performance.

BETA. With this measure, you can gauge a security’s price volatilityrelative to the overall market. Theoretically, a portfolio or security with abeta of 1.00 moves in line with S&P 500 index. A Beta higher than 1.00denotes greater price volatility than the overall market.

Statistically, risk may be measured by the standard deviation of the randomcash flow.

The STANDARD DEVIATION is denoted by σσ and is calculated as follows:

σ = R i – ER 2 PiΣΣi = 1

n



where n is the number of states of the economy, Ri is the return in the ithstate and Pi is the probability of the ith state of the economy.

The attractiveness of a security cannot be determined by standarddeviation alone. The risk and return of a security has to be compared withthe alternatives available for investment.

Total Risk or variability of returns can be divided into:

The variability of returns unique to the security :

Commonly referred to as Firm Specific Risk or Unique Risk or DiversifiableRisk or Unsystematic Risk.

The risk related to market movements : Also referred to as MARKET RISK orNon-diversifiable Risk or Systematic Risk.

By diversifying, the investor can eliminate the “unique” security risk. Thesystematic risk, however, cannot be diversified.

Measuring Systematic Risk

SYSTEMATIC RISK affects all securities. To measure systematic risk, wemeasure the tendency of a stock to move relative to the market.

The plot of firm excess returns versus market excess returns is called theCHARACTERISTIC LINE, i.e.,

ER - Rf = β (ERm - Rf)

The measure of a stock’s systematic risk or market risk is commonly calledBETA. BETA is also the slope of the Characteristic line.

The BETA of stock A is calculated as follows:

ββ a =Cov ( R a , R m )

Var Rm



where Ra is the return on stock A and Rm is the return on the marketportfolio and where

Var Rm = Rmi – ERm

2 piΣΣi = 1

n

Cov Ra, Rm = Rai – ERa Rmi – ERm piΣΣ

i = 1

n

The beta of a portfolio is the weighted average of the individual securitiesbetas. The beta of the market is one.

The Required Rate of Return

The required rate of return equals the risk free rate plus a return tocompensate for the additional risk.

The REQUIRED RATE OF RETURN can be expressed as :

R = Rf + RP,

where R is the investor’s required rate of return, Rf is the risk-free rate,and RP is the risk premium.



The Balance Sheet and the Income Statement

THE BALANCE SHEET

The BALANCE SHEET represents a statement of the financial position of thefirm on a given date, its asset holdings, liabilities, and owner suppliedequity. This statement is considered the most important financial statementfor judging the economic well being of the firm. The balance sheet consistsof two basic components: (1) assets and (2) liabilities plus owner's equity.

Assets

On the ASSET side of the balance sheet, we usually find two categories.

a) CURRENT ASSETS are those assets that are expected to be realized incash, sold, or consumed either in 1 year or within the operating cycle ofthe firm, whichever is longer.

b) FIXED OR NONCURRENT ASSETS contain all those resources that are notexpected to be converted into cash within the operating cycle of thefirm. Security investments, plant, equipment, and land are the mostcommon fixed assets.

Liabilities

LIABILITIES represent the outstanding claims held against a firm's assetsand are reported at their stated or face value. There are two basiccategories of liabilities.

a) CURRENT LIABILITIES represent obligations that are reasonably expectedto be liquidated within 1 year.

b) LONG-TERM OR NONCURRENT LIABILITIES include permanent obligations ofthe firm that are not reasonably expected to be liquidated within the



normal operating cycle of the firms but are payable at some later date.Noncurrent liabilities are often referred to as long-term liabilities.

Owner's equity

OWNER'S EQUITY represents the book value of the owner's interest in theassets of the firm. Owner's equity is comprised of capital stock (par valueof common stock plus paid in capital) and retained earnings (undistributedearnings).

THE INCOME STATEMENT

The INCOME STATEMENT represents an attempt to measure the net results ofa firm's operations over a specified time interval. Some of the moreimportant components of the income statement are discussed below:

1. SALES represent the total sales of products or services net of returnsand allowances attributable to the period.

2. COST OF GOODS SOLD is simply the cost of the product sold or serviceprovided. There are two widely used methods for computing cost ofgoods sold. The First In First Out (FIFO) method assigns to cost ofgoods sold the prices the firms paid on the oldest item in inventory.The Last In First Out (LIFO) method assigns cost to items sold basedon the cost of the most recently purchased inventory item. The methodselected can have an important effect on net earnings for a period inwhich prices have risen or fallen significantly.

3. GROSS PROFIT represents the amount by which sales exceed cost ofgoods sold.

4. SELLING EXPENSE includes all those expenses incurred in the process ofmaking the period's sales.

5. GENERAL AND ADMINISTRATIVE EXPENSES include all those operatingexpenses not directly attributed to the cost of merchandise sold orselling expenses. These expenses usually include administrative



salaries, utilities, non-income-related taxes, insurance, anddepreciation.

Depreciation is not a cash expense; it represents an attempt to allocatethe cost of the firm's plant and equipment against the periods in whichthose assets are being used. The purpose of depreciation is to allowfirms to help defray the cost of asset allocation by deducting the cost fortax purposes.

6. NET OPERATING INCOME reflects the net results of a firm's operationsbefore considering financing costs and income taxes.

7. NET INCOME AFTER TAXES represents net earning for the period afterincome taxes.

8. RETAINED EARNINGS for the period represent any earnings that remainafter all dividends have been paid to stockholders. This amount is oftenadded to the existing retained earnings figure on the balance sheet.



The Time Value of Money

THE NET PRESENT VALUE

NPV = Present value of expected future cash flows - Cost

NPV measures the value created by a financial decision.

Positive NPV increases wealth.

A zero NPV decision earns the “fair” rate of return.

A positive NPV decision earns more than the fair rate of return.

REQUIRED RATE OF RETURN

The REQUIRED RATE OF RETURN is the return that exactly reflects the risk ofthe expected future cash flows.

A person requires the return from an investment before she/he is willing tomake the investment.

EXPECTED RATE OF RETURN

It is the return that an investor expects to earn from the investment.

If it is equal to the required rate of return, the investment has a zero NPV.

If it is greater than the required rate of return, the investment has a positiveNPV.



If it is less than the required rate of return, the investment has a negativeNPV.

PRESENT VALUE FORMULA

Let PV = Present Value

FVn = Future Value at time n

r = interest rate (or discount rate) per period.

( )PV FV

rn n=

+

1

1

FUTURE VALUE FORMULA

Let PV = Present Value

FVn = Future Value at time n

r = interest rate (or discount rate) per period.

( )FV PV rn

n= +1



The Stock Market

EQUITY SECURITIES represent the ownership of a corporation. For example,if an investor purchased 50 shares out of 1000 outstanding XYZ shares,this investor owns 50/1000 of the XYZ Corporation.

A privately owned company goes public by selling all or parts of itsownership to investors to raise capital. By purchasing common stock, youactually own a part of the company’s assets and stand to participate in itsprofitability.

SHAREHOLDERS or STOCKHOLDERS have the right to vote for the Board ofDirectors and on corporate matters.

Over the years, studies have shown that successful stock investing is amatter of time rather than a matter of timing. That's because stock pricescan move up and down dramatically on a day-to-day basis but, over thelong-term, build wealth better than any other investment vehicle.

From the investment point of view, there are two main reasons whyinvestors are interested in investing in equity securities: dividend paymentsand the growth of the stock's market value.

A DIVIDEND represents that portion of the net earnings of the corporation,which is distributed to stockholders.

A combination of the current earnings and financial status of the companyplus potential investors' perceptions of the company's future earnings andfinancial status determine the Market Value of a company's shares. Thus,as a company grows and becomes more successful, the value of theshares increases.

GOING PUBLIC

The first time companies issue stock, is called GOING PUBLIC. After that,they can raise additional money, or capital, by selling additional stock.



To take a company public, which means making it possible for investors tobuy the stock, the management makes an INITIAL PUBLIC OFFERING (IPO).

The company goes to INVESTMENT BANKERS who agree to UNDERWRITE thestock offering - that is, to buy all the public shares at a set price and resellthem to the general public, hopefully at a profit.

The company has to prepare a PROSPECTUS, a legal document containing adetailed analysis of the company’s financial history, its products, itsmanagement’s background and experience.

THE PRICE

The Price

Whether a company’s stock is listed on a stock exchange or traded over-the-counter, two prices are always quoted the bid and the offer.

If selling shares, you are interested in the bid, the highest price offered bya buyer. If buying shares, you want to know the offer, the lowest price atwhich one or more shareholders have agreed to sell.

Prices are still quoted in points and fractional points (1/8, ¼, 3/8, ½, 5/8,…)

The Spread

The difference between the bid price and the offer is the SPREAD. Thespread varies usually between 1/8 and $1. A larger spread may indicategreater risk to market makers or low trading activity.



The Ticker

Every public company has a TICKER SYMBOL or a stock symbol by which it iseasily identified.

Reading the Newspaper

52-weeks

Hi Lo Stock Sym Div Yld% PE Vol 100s Hi Lo Close Net Chg677/8 501/2 Disney DIS $.44 .6 26 32001 691/8 673/4 685/8 +7/8

52 Weeks Hi/Lo The highest and lowest prices paid for Disney's stockduring the past year. The numbers are expressed inpoints, but represent dollar amounts. In this case, 677/8

is the same as $67.875. Knowing the highs and lows forthe past 52 weeks can help an investor evaluate astock's current price.

Stock The name of the company.

Sym The stock's trading symbol. To avoid confusion and tosimplify the order process, every stock that is traded onan exchange or in the OTC market is assigned asymbol. Some newspapers do not provide the stock'strading symbol, but instead provide an abbreviation ofthe company's name.

Div Short for dividend. For each share of stock owned, aDisney shareholder should receive 44 cents from thecompany's annual profits. Payment is usually made on aquarterly basis. Not all companies pay dividends all thetime. The company's Board of Directors decideswhether a dividend will be paid and its amount.

Yld% The yield, or rate of return, on a stockholder'sinvestment. It is figured by dividing the annual dividendby the current price of the stock. Disney stockholdersearn .6 percent of today's stock price from dividends.



Investors who want income from their stock look for ahigh yield.

PE Short for price/earnings ratio. The price of a share ofstock divided by the company's earnings per share forthe last year. Investors use the P/E ratio to decide if astock is over or under priced.

Vol 100s The total amount of stock traded during the previousday. On that day, 3,200,100 shares of Disney stockchanged hands. The number does not include odd lotsor sales of less than 100 shares.

Hi and Lo The highest price paid for Disney stock during theprevious day was $69.125 (or 691/8). The lowest was$67.75 (or 673/4).

Close The last price paid for Disney at the end of the previousday was $68.625 (or 685/8).

Net Chg The last price on the previous day, $68.625 (or 685/8),was 87.5 cents (or 7/8 of a dollar) more than the lastprice on the preceding day. Brokers call this "closing up7/8."

THE SUPPLY AND DEMAND

There is an old saying on Wall Street that a stock is worth what somebodyis willing to pay for it. Moreover, that is true - the price of a stock isdetermined by buyers. As they gain new information, investors decidewhether they are willing to pay more for a stock or less. Their changingperceptions continually push stock prices up or down.

Simply put, the price of a stock - or for any product or service, for thatmatter - is determined by supply and demand. The supply of stocks isbased on the number of shares a company has issued, or sold to thepublic. People wanting to buy those shares from the people who alreadyown them create the demand for stocks. If people think they will makemoney on a stock, they will want to buy it.



But here's the catch: supply is limited, and not everyone who wants to owna company's stock can. The more people desire to own a stock, the morethey will be willing to pay for it. High demand for a stock pushes up itsprice. Similarly, as the value of a stock increases, owners are morereluctant to sell it.

The rise continues until prospective buyers decide the price has gone toohigh. Then, fewer people are willing to buy the stock at the high price.Stockowners who are anxious to sell must lower the price at which they arewilling to sell. The stock's price falls until investors believe the stock isagain worth the price at which owners are willing to sell.

THE COMPANY FINANCIAL HEALTH

The laws of supply and demand explain why stock prices fluctuate. How doinvestors and analysts arrive at their decisions as to whether a stock isworth buying or selling at a given price? Above all, they examine thefinancial health of the company offering the stock. Investors are not likely toput a high value on stock in a company that is going to lose money. Theylook for a business with a history of making strong profits and consistentlypaying healthy dividends.

While history is important, investors also analyze a company's futureprospects. A company with a poor profit history might have a promisingfuture, and one with a good history might be on the way down. Therefore,careful investors also review how a company fares against its competitionand whether it's being run by experienced, responsible people who keepup with current trends. If a company is viewed by potential investors asincreasing efficiency or producing new, innovative products, its stock islikely to rise in price.

Alternatively, trouble on the horizon - damaging lawsuits, threats of a strike,more intense competition, or more stringent regulation - can depress thevalue of a company's stock. When a major oil company announced that itwas filing for bankruptcy, for instance, the value of its stock dropped 11percent.

A report that someone or some company is trying to buy a certain businessusually pumps up that business's stock prices. That is because thepurchaser has to buy a majority of the stock to gain control of the company.To do so, the suitor must persuade stockholders to sell their stock byoffering an attractive price or their shares.



Sentiment may also count. For example, when the owners of the BostonCeltics basketball team offered shares of stock in 1986, analysts suggestedthat the stock was overvalued. But investors - most of them Celtic fans -had a high regard for the team and were willing to pay the price to beassociated with it.

AN INDUSTRY’S FINANCIAL HEALTH

Another important factor to consider is the health of a company's wholeindustry.

A company's stock prices may go up or down depending on whetherinvestors think its industry is about to expand (grow bigger) or contract(grow smaller). For example, a company may be doing well financially, butif its industry is declining, investors might question the company's ability tokeep growing. In that case, the company's stock price may fall.

Many industries expand and contract in cycles. For example, home buildingdeclines when interest rates rise.

ECONOMIC TREND

In addition to events surrounding a specific industry or company, analystscarefully watch what they call economic indicators - general trends thatsignal changes in the economy.

An essential indicator is the change in the rate of economic growth asmeasured by the Gross National Product (GNP). GNP measures the totalproduction of goods and services in our economy. If it is rising, then short-term business prospects are improving. Another important indicator is theinflation rate. Inflation occurs when prices are rising rapidly. During aninflationary period, a company's costs may rise faster than it can increaseits prices; so its profits shrink.

In addition, the inflation rate has a major influence on another importantindicator, interest rates. Rising interest rates mean that the government,businesses and consumers must pay more to borrow money. Therefore,the government's budget deficit increases, businesses may delay theirplans for new projects, and consumers don't spend as much. That can setthe stage for a recession - a period of slow economic growth.



Analysts also monitor the U.S. budget deficit - the gap between the moneythe Federal Government takes in and the money it spends. When thedeficit grows, the Government has to increase its borrowing of money thatwould otherwise be available to businesses to expand and consumers tospend.

Many other indicators signal changes in the economy. Among them arestock prices, unemployment rates (the percentage of U.S. workers whocannot find jobs), and changes in the value of the dollar (the amount offoreign currencies that can be purchased for each U.S. dollar).

These indicators are more than just numbers. They point to changes in theway ordinary people spend their money - and, in turn, how the economy islikely to perform. If unemployment rates are falling, or if people are gettinggood values for their money, they are probably going to feel optimisticabout the economy. They are more likely to spend money, benefitingcompanies and stock prices.

WORLD AND NATIONAL EVENTS

Nothing alters people's attitudes toward saving and investing more thantheir perceptions of a major news event. For example, when a nation hasdeclared war, stock prices may go up. That's because a country at warneeds armaments, supplies for troops, spare parts, and huge amounts offuel. Therefore, companies gear up to produce and sell more goods.

News of other events can push stock prices down. If fighting between Iranand Iraq, for example, flares up in the Persian Gulf, U.S. stock prices maydrop. That's because fighting may decrease the supply of oil coming fromthat region. Consequently, oil may become more expensive and the cost ofall U.S. goods that rely on oil or petroleum products may increase.

People are reluctant to invest unless they feel confident about the future ofthe economy. If investors are not sure how a major event will affect thenation's economy, they are likely to hesitate about investing in securities.For example, if investors are uncertain of a new president's attitude towardbusiness, stock prices may drop while investors await developments.



HOW TO VALUE A STOCK?

The price of a stock is not by itself any indication of value by itself. Stocksare analyzed based on a multitude of criteria, including Price/Earnings ratioand dividends.

EARNINGS PER SHARES (EPS)

The portion of a company’s profit paid on each share of common stock. It iscalculated after paying taxes and preferred shareholders and bondholders

PRICE/EARNINGS RATIO

A company’s stock price is greatly influenced by its earnings growth. TheP/E is calculated by dividing the stock price by the company’s annualearnings per share.

SHARE PRICE ÷÷ EARNINGS PER SHARE = P/E

Company earnings are anticipated and estimated, therefore you can seehow a stock’s P/E reflects investors’ feelings about the company’s futureprospects.

The higher the P/E, the more earnings growth investors are expecting.Stocks with a higher P/E, usually over 20, are considered riskier thanstocks with lower growth.

THE STOCK PRICE

PRICE = EPS (ANNUAL) X P/E



DIVIDENDS

The total return of a stock investment includes dividends paid by thecompany in addition to share-price gains. Newer companies generallyreinvest profits, but as they mature, nearly all large public companies paycash dividends to share-holders out of their earnings. A company’s Boardof Directors decides if a dividend is to be paid and how much.

Dividends generally increase in line with company profits.

The percentage of a company’s retained earnings paid as dividends is thePAYOUT RATIO. The typical payout ratio is 25 to 50 percent of companyearnings. Dividends are paid quarterly to shareholders, designated ownersof record. To qualify, shares must have been purchased before the ex-dividend date, approximately three weeks before the dividend is paid.

Dividends may also be paid in shares of stock when its Board of Directorsfeel that the money can be best used to expand the business or developnew products.

As you might expect, when many corporations increase their dividends, it isconsidered positive for the stock market. Indeed, dividend yields are anindicator of corporate growth and profitability as well as investment value.

Stocks that pay dividends regularly are known as INCOME STOCK, whilethose that pay little or no dividend while reinvesting their profit are knownas GROWTH STOCKS.

The Dividend Yield

The Dividend Yield is the percentage of purchase price you get backthrough dividends each year.

For example, if you buy a stock for $100 a share and receive $4 per share,the stock has a dividend yield of 4%. However, if you get $4 per share onstock you buy for $50 a share, your yield would be 8%.



STOCK SPLIT

If a company determines that it stock price is too high to interest investors,it may split the shares to lower the price. Although a split changes thenumber of outstanding shares, it has no effect on shareholder equity, anddividends are adjusted accordingly. Sometimes the announcement of asplit increases the stock’s market value, but often is has no effect at all.

A STOCK SPLIT may be a distribution of any whole or fractional number ofshares for each share held.

A reverse split decreases the number of outstanding shares. A companymay reverse split its stock when the price is too low for its stock to be usedas collateral for borrowing money or is too costly to trade.

VALUABLE STOCK MARKET TERMS

Common Stock

Most often corporations offer equity ownership in the form of COMMON

STOCK. Many corporations issue just one class of common stock to raisecapital; however, there can be different classes of common stock issued bythe same corporation in the market, such as Class A and Class B stocks.Terms of each class issued by the corporation are detailed in theprospectus.

Each common stockholder is entitled to dividend payments, and the right tovote their shares at annual meetings. In some cases, shareholders havethe opportunity to purchase newly issued shares at below market pricebefore they are offered to the public.

Preferred stock

PREFERRED STOCK is sometimes called a hybrid security because it hassome characteristics of both equity and debt securities. It is like commonstock in that it earns dividends, and has no maturity date. It is as if debt in



that the amount of each dividend paid to the preferred stockholders ispredetermined. This is different from the dividend payments on commonstock for which the dividend rate may fluctuate depending on theperformance of the corporation. For example, an investor owns 1000preferred shares of XYZ Corporation and the company declares a 10%dividend rate annually. This investor will receive a dividend of $100annually, or $25 quarterly. This income calculation is very similar to debtinstruments, where investors are paid according to a stated interest rate.One other difference between preferred and common stock is that thepreferred stockholder has little or no voice in the management of thecorporation.

They reduce the investor’s risk but limit reward.

There are five distinct types of preferred stock. These are cumulativepreferred, participating preferred, convertible preferred, prior preferred, andcallable preferred stocks.

In case of liquidation of the corporation, the debt holders and preferredstockholders are ranked ahead of common stockholders for claims on boththe assets and income of the corporation.

The Right to Vote

Owning a stock gives you the right to vote on important company issuesand policies.

Most shareholders vote by PROXY, an absentee ballot they receive beforethe annual meeting. On the other hand, they have the option of attendingthe meeting and voting in person.

Book Value

Theoretical historical value (not market value) of a company’s assets afterall debts are paid.



Debt /Equity Ratio

A measure of a company’s financial solvency. Debt is the total cash acompany owes creditors; equity is the dollar value assigned to shareholderownership. The relationship between the two is an indicator of a company’sfinancial condition.

Tender Offer

Offer from a company or group to purchase several of a company’s shares.The bidding entity sends a document to the shareholders outlining theterms of the offer. Shareholders are not obliged to tender (sell) theirshares, but generally it is in their interest to do so, since the offered pricemight be the highest price at which the stock will trade in the near future orperhaps ever again.

Insider Trading

Illegal trading in securities based on confidential information to which onlyinsiders (such as a company’s accountants, lawyers, and employees) areprivy. Industry computers detect heightened trading activity in certainstocks, which allows suspicious trades to be traced and investigated forinsider-trading abuse.

Warrant

The right to purchase a certain number of a company’s shares at a fixedprice prior to a specified future date. Companies that plan to issue stock orraise cash by selling shares held in reserve issue warrants.

Program Trading

Some of the big investors speed up the process of buying and sellingstocks by using program trading techniques that involve placing large



orders by computer. The programs are sometimes triggered automatically,when prices hit predetermined levels.

Such sudden buying or selling can cause abrupt price changes or evendramatic shifts in the entire market. The stock market crash of 1987occurred, at least in part, because of program trading triggered by fallingprices. To prevent potentially catastrophic program trades, trading nowshuts down in a major sell-off to let things cool down.

Rule of 72

Quick calculation to determine how long it takes to double an investment ata given interest rate. Divide 72 by the rate of interest earned to get thenumber of years it takes money to double.

For example, if an investment earns 8% annually, it takes 9 years todouble.

Capitalization

In order to fully appreciate market price in a comparative sense, one musttake into account the capitalization of the companies in question. This isdefined as the amount derived by multiplying the current market price bythe number of outstanding shares.

CAPITALIZATION = MARKET PRICE PER SHARE X SHARES OUTSTANDING

Arbitrage

ARBITRAGE is the method whereby investors buy a security in one marketand simultaneously sells it in another market, when legally able to do so.Arbitrage techniques differ from market to market but traditionally they havebeen confined to two or more markets which happen to trade the samesecurity, for instance the NYSE and Pacific Stock Exchanges. The processis very rapid and is based upon even the smallest of price differentials.



Blue Chips

Blue Chips is a term borrowed from poker, where the blue chips are themost valuable, and refers to the stocks of the largest, most consistentlyprofitable corporations.

Bull Market Vs Bear Market

A bull market is a period during which stock prices are generally rising. Abear market is a period which stock prices are generally falling. Each ofthese is fueled by investors' perceptions of where the economy and themarket are going.

If investors believe they are in the midst of a bull market, or one seemslikely, they will feel confident that prices are going up. Their ownconfidence helps to keep stock prices rising. During a bear marketinvestors believe stock prices will fall. They hesitate to invest in stocks, andtheir own concerns help keep stock prices down. A bull or bear market canlast anywhere from several months to several years.

SHORT SELLING

The most common form of stock investing is buying long. When you are“LONG A STOCK”(meaning you owe the stock), the most you can lose is theamount of cash you invested. However, if an investor believes that theprice of a company’s shares will decline, he may speculate by selling the



stocks short. SELLING A STOCK SHORT involves selling borrowed shares withthe expectation that the price will fall, providing the opportunity to buy themback cheaper - sell high, buy low - The short seller’s profit is the differencebetween the buy and sell prices, less commissions.

You borrow shares from your broker, sell them and get the money. Thenyou wait, expecting the price of the stock to drop. If it does, you buy theshares at the lower price and repay the broker to settle the loan (plus someinterest and commission). Buying shares back is called COVERING THE

SHORT POSITION.

BUYING WARRANTS

Warrants are a way to wager on future prices. Warrants guarantee, for asmall fee, the opportunity to buy stock at a fixed price during a specificperiod. Investors buy them if they think a stock’s price is going up.

For example, you might pay $1 a share for the right to buy XCo. Stock at$10 within 5 years. If the price goes up to $14 and you EXERCISE (use) yourwarrant, you save $3 every share. You can then sell the shares at a higherprice to make a profit.

Companies sell warrants if they plan to raise money by issuing new stockor selling stocks they hold in reserve.

BUYING ON MARGIN

Investors who want to buy stock but do not want to pay the full price canLEVERAGE their purchase by buying on margin. They set up a MARGIN

ACCOUNT with a broker, sign a margin agreement, and maintain a minimumbalance. Then they can borrow 50% of the price of the stock and use thecombined funds to make the purchase.

Investors who buy on margin pay interest on the loan portion of theirpurchase but do not have to repay the loan itself until they sell the stock.



Despite its advantages, buying on margin can be very risky. For example,the price of the stock you buy could drop so much that selling it would notraise enough cash to repay the loan to your broker. To protect themselvesin cases like this, brokers issue a MARGIN CALL if the value of yourinvestment falls below 75% of its original value. That means you have toput additional money into your margin account.



The Fixed Income SecuritiesThe Money Market Vs The Capital Market

The Individual as aLender

Investors willing tolend money

Corporate BondsU.S. Treasury Bonds

Municipal Bonds

Corporations use bonds* to raise capital to pay for expansion, modernization* to cover operating expenses* to financnce corporate take-overs or other changes in management structure

States, cities, counties and townsissue bonds* to pay for public projects: schools, highways, stadiums,...* to supplement their operating budgets

The U.S. Treasury floats debtissues* to pay for a wide range of government activities* to pay off national debt

BondMatures

* Investor gets par value at maturity* Investor gets interest payment at specific intervals



Money Markets

Money Market Vs Capital Market

LONG TERM DEBT refers to debt that has a maturity of one year or longer.This type of debt is traded on what is called the CAPITAL MARKET whileSHORT TERM DEBT refers to debt that has a maturity of less than one year.This type of debt is traded on what is called the MONEY MARKET, as theliquidity of these instruments makes them almost as fluid as money. Acompany or government would issue short term debt in order to covertemporary shortfalls in cash flows. An investor would buy short-term debtto earn interest on excess cash.

The second type of capital available to companies -debt- is divided intomany classifications. Debt is the most widely used method of raising capitaland the capitalization of the major money and bond markets exceeds thatof the stock markets many times over.

The major classifications are quite simple: debt is broken down into twoshort- and long-term instruments. Short-term debt is traded on the moneymarkets while the long-term debt trades on the bond markets.

As debt markets, the primary function of the money markets is toredistribute funds from those economic units in society possessing asurplus to those in deficit. Since most of these markets are institutional innature, surplus households do not normally lend directly to deficitborrowers but do so through financial intermediaries. The intermediaries inthe money markets are financial institutions and banks whose verybusiness it is to perform this function.

Behind this maze of operations which occurs in daily in money markets,one basic economic distinction has to be made. This has to do with thedifference between the PRIMARY AND THE SECONDARY MARKETS. As withequities, only a primary market operation actually raises money for theborrower. If the original investor decides not to hold the instrument untilmaturity and sells it in the secondary market, the borrower is no longeraffected since it already has its money. Then the buying and selling ofthese instruments become a matter of importance only for investors.



Most money market instruments are sold on what is known as a DISCOUNT

basis; that is, they are sold at a price lower than par and pay back principalat redemption. The example employed here will use a Treasury bill of one-year maturity returning 10%. The price the investor will pay will be 90% ofpar, or in bond market terms, simply 90. At redemption, 100% will be paidback.

The Federal Government, state and local governments, and corporateentities issue American money market instruments.

TREASURY BILL OR T-BILL

TREASURY BILLS are issued so that the central government can finance itsshort-term cash needs, and are auctioned at regular intervals. Theynormally come in a variety of term structures, with 3 months, 6 months and1 year being the most common.

They are the lowest money market yields available because thegovernment is considered the highest quality credit risk in the country.

Since a large and ready secondary market exists for Treasury Bills, theirprices will vary during their outstanding lives. If interest rate conditionschange, the price of the bill will also change reflecting this.

COMMERCIAL PAPER

COMMERCIAL PAPER, a type of promissory note, is issued by largecorporations, and generally not secured by any collateral. CP is used tofinance short term cash needs of a corporation. The issuer promises topay the buyer of the paper a set amount on a future date. When issued,CP usually has a maturity date of 1 to 3 months.

Large investors who have excellent credit ratings may sometimes be ableto negotiate favorable terms with issuers, such as arranging short term CPfor as little as 3 days.



Traditionally, CP was issued at a discount (known as DISCOUNT PAPER) butit is increasingly being issued at par. CP may be issued as either STRAIGHT

PAPER having a fixed rate, or FLOATING RATE PAPER having interest ratesthat vary periodically.

CP may be resold on the secondary market to other investors. As such, anissue of CP may have many owners over its lifetime.

CP issued by companies with excellent credit is called "PRIME CP". PrimeCP can either be sold directly to the public, called DIRECTLY PLACED PAPER,or through a dealer. The latter type of paper is called DEALER PAPER andgenerally carries a longer maturity term than directly placed paper.

Types of CP include Financial Paper, Industrial Paper, Line of CreditPaper, and Eurocommercial Paper.

FINANCIAL PAPER is CP that is issued by a financial company such asGeneral Motors Acceptance Corporation (GMAC).

INDUSTRIAL PAPER is CP issued by a non-financial firm such as a publicutility.

LINE OF CREDIT (LOC) PAPER is a note issued by smaller or less marketablefirms and is accepted by a Letter of Credit from a bank, which guaranteesthat payment will be made to the investor who accepts this LOC. Smallerfirms and cross-border firms may opt to use LOC Paper as they do nothave to disclose financial data to the public upon registering, but onlyfurnish this information to the bank. LOC paper is sold at a discount.

EUROCOMMERCIAL PAPER is CP issued, at either par or at a discount, byEuropean corporations. It is denominated in U.S. dollars but payablethrough foreign banks or foreign branches of U.S. banks.

BANKER’S ACCEPTANCE

A business that owes money to a second party may go to a bank andarrange for that bank to pay the money that is owed directly to the secondparty. The bank agrees to pay on behalf of the business and charges astated interest rate for the loan. The business agrees to repay full principal



and interest at the end of the term of the loan. This arrangement is knownas a BANKER'S ACCEPTANCE (BA). Businesses usually enter into this typeof arrangement in order to finance the purchase of goods from othercountries.

Before the loan is repaid, the bank can sell the BA on the secondarymarket to an investor. This investor now is due to receive the repayment ofthe loan from the business. The bank guarantees payment on the BA; ifthe business does not pay the loan, the investor has the legal right tocollect the money from the bank that originated the BA. BAs are issued ata discount.

CERTIFICATES OF DEPOSIT

As the name indicates, CDs are a type of security that acknowledges acertain deposit of money in a bank with terms to pay the depositor aspecific interest rate plus the principal amount deposited, at a specificfuture date (MATURITY DATE). CDs are issued in negotiable form (may beresold) or non-negotiable form (may not be resold). If negotiable, thedepositor that receives the CD from the bank may choose to either hold theCD until it matures, or sell the CD on the secondary market. If the CD issold, the buyer now has claim to the principal and interest that is due atmaturity. CDs can be sold repeatedly but the originating bank may notpurchase the CD that it issued.

Banks that have excellent financial standing are called "prime banks" andthe CDs that they issue are referred to as "prime CDs". This is becausethe bank has a recognized ability to honor the maturity payments. PrimeCDs have a minimum denomination of $1 million.

Most CDs are denominated in the currency of the country in which they areissued. Eurodollar CDs, however, represent U.S. dollars that aredeposited in foreign banks or foreign branches in U.S. banks. U.S. dollardenominated CDs, issued by foreign banks through foreign branches in theU.S. market, are called Yankee CDs.



THE EURODOLLAR MARKET

After WW2, the US dollar demand increased in international transactions,replacing sterling as the premier reserve currency. In the 1960s, the U.S.began to run large balance of payments deficits. This meant that manydollars were being held in the hands of non-American citizens andcorporations. This created a large pool of offshore dollars, ultimatelynicknamed “EURODOLLARS”. This term denotes dollars held in banksoutside the US, primarily in Europe and also in other offshore bankingcenters.

Eurodollars have their own market rate quoted by the major banks inLondon holding and trading eurodollars. The rate is quoted on a termbasis, in addition to overnight money. The usual term structures are 1, 3, 6,9 and 12 months, and 3 and 5 years. Rates for these terms are quoted ona spread basis, called the interbank rate. A quote of 11-11 ¼ % means thata bank will take a deposit at 11% and loan (to a prime customer) at 11 ¼%. It is from the offer side of this spread that the eurodollar rates derives itsname, LIBOR; the London, Inter-Bank Offered Rate.



The Bond Market

In order to raise capital, a firm may issue DEBT SECURITIES. Issuing debtsecurities is, in effect, taking out a loan, with the buyers of the securitybeing the lenders. The issuer of a debt security is therefore obligated topay the buyers of the security INTEREST according to a predeterminedschedule, and to return the investment PRINCIPAL to the investor at aspecified future date, known as MATURITY DATE.

Creditor Vs Owner

Debt has one general advantage over equity which again serves tounderscore the basic differences between these two forms of financing.Bond holders are CREDITORS of the issuer, not OWNERS. This means thatcreditors are senior to equity holders in the capital structure of a company.In the event that bankruptcy arises, bond holders must be paid before theequity holders are compensated. This holds true for the payment of interestas well as the payment of principal.

For the company, on the other hand, this also means it will be able to raisethe money it requires without adding new shareholders to the rolls.Bondholders are, for the most part, a silent majority whose interests aremore muted and less politically and organizationally significant than theinterests of actual owners of a company.

Registration

All new security issues must be registered with the Securities andExchange Commission (SEC). REGISTRATION involves the filing of financialstatements regarding the firm and other related information. A firm wishingto issue debt must qualify by possessing adequate financial status withinestablished guidelines. Issuing debt places constraints on the firm;because the firm has an obligation to repay creditors, it must maintain theability to meet these commitments.

A debt security is usually registered in the name of the owner. Theregistered holder's name will appear on the debt certificate and on the



books of the paying agent. Registered holders receive the interestpayments and any applicable corporate action notifications.

Figuring a Bond’s worth

The Value of a bond is determined by the interest it pays and by what’shappening in the economy.

An interest rate of a bond never changes, although other interest rates do.If the bond is paying more interest than is available elsewhere, investorswill be willing to pay more to own it. If the bond is paying less, the reverseis true. When interest rates drop, the value of existing bonds usually goesup.

If the bond investors buy at par, and holds the bond to maturity, INFLATION

(or the shrinking value of the currency) is the worst enemy. Generally,when inflation is up, interest rates go up. Conversely, when inflation is low,so are interest rates. It’s the change in interest rates that causes bondprices to move up or down.

For example: If Xcorp. Floats a new issue of bonds offering 6% interest.You buy some bonds at the full price (par value) of $1000 a bond. Threeyears later, interest rates are up. If new bonds costing $1000 are paying8% interest, no buyer will pay you $1000 for a bond paying 6%. To sellyour bond, you will have to offer it at a DISCOUNT. Consider the reversesituation, if the interest rates reach only 5% interest rate, you’ll be able tosell your 6% bonds for more than you paid: the PREMIUM - since buyers willagree to pay more to get a higher interest rate.

VALUE

The major factors that dictate bond prices and yields are credit quality ofthe issuer, market interest rates, length of the bond’s maturity, and supplyand demand.

"PAR" is the term used for the principal value, or the face value of a debtinstrument, and is the amount that will be paid to the holder at maturity.Debt can be sold at, below, or above par value.



A security can be issued at a DISCOUNT (below par) when the interest isscheduled to be paid only at maturity. Full par value is paid to the holder atmaturity; thus, the difference between the purchase price and the maturityvalue represents the income earned on the security. This type ofarrangement is common with money market instruments, which have short-term maturities. A zero-coupon bond is an example of a long-term debtsecurity issued at a discount.

Securities can also sell at a discount from the current accrued value ifmarket interest rates have increased since the security was issued. Asecurity with a stated rate below market value is less attractive to investors;a discounted price will help to equalize the value of the security in themarketplace.

Securities selling at a PREMIUM carry a price higher than the currentaccrued value of the par. This can happen if market interest rates havefallen since the security was issued, making the security with the relativelyhigher rate more attractive to investors.

LONG TERM DEBT refers to debt that has a maturity of one year or longer.This type of debt is traded on what is called the CAPITAL MARKET, as acompany or government would issue long term debt to raise capital tocover expenditures, which are expected to have a long-range payback.

Long term debt instruments may pay interest on a monthly, quarterly,semiannual, or annual basis, or at some other interval as stated in theprospectus.

Many types of long term debt securities exist with different interest andmaturity terms. There are also several other ways in which security typesdiffer. Descriptions of some of the most commonly traded long termsecurity types follow.

They are three major groups of bond issuers in the United States:corporations, the U.S. Government and municipalities (state and localgovernments).

Analyzing Bond Yield

YIELD is the return on an investment, calculated as a percentage of theamount invested. Nevertheless, it is not that simple because the ultimate



proceeds to be returned as principal may be more or less than your originalinvestment.

COUPON RATE is the fixed-dollar amount the issuer contracts to paybondholders until the bond matures, expressed as a percentage of the facevalue of the bond.

The CURRENT YIELD is the coupon rate on a bond divided by its currentmarket price.

Coupon rate (in money terms) Market price

Bond prices are calculated as a percentage of par and then translated inmoney terms. This percentage is usually calculated on a bond of $1000face or nominal, value. Thus, a bond paying 9% per annum, selling at $98,has its current yield calculated in the following manner:

$90 = 9.18%$980

Current yield is limited because it ignores the fundamental nature of bondrisk: time.

YIELD TO MATURITY is a bond’s annualized total return if held to maturity.

discount or premiumcoupon +/- years to maturity = YTM market price + redemption price

2

Yield to maturity is therefore the true yield on a bond, reflecting bothcurrent and future return.

YIELD TO CALL is a bond’s total annualized yield if it is called on its earliestcall date.



BUYING AND TRADING BONDS

Investors can buy bonds from brokers, banks, or directly from certainissuers.

Newly issued bonds and those trading in the secondary market areavailable from stockbrokers and from some banks. Treasuries, though, aresold at issue directly to investors without any intermediary - or anycommission.

The Federal Reserve Banks handles transactions in new Treasury issues -bonds, bills and notes.

How Trading Works?

Most already-issued bonds are traded over-the-counter (OTC). Bonddealers across the country are connected via electronic display terminals.A broker buying a bond uses a terminal to find out which dealer is currentlyoffering the best price and calls the dealer to negotiate.

VALUABLE BOND MARKET TERMS

CALL

In some instances, an issuer of long term debt may wish to repay all of theoutstanding principal on a debt security prior to the scheduled maturitydate, thereby retiring the debt. This is known as a CALL. Calls can bemade on the entire issue, or on only a portion of the issue. The right of theissuer to do this will be clearly stated in the security's prospectus.

DEFAULT

Sometimes a debt issuer DEFAULTS on an obligation by failing to pay thescheduled interest or maturity proceeds. In these cases, the owners of a



firm's debt securities are among the first in line with a claim to anyliquidation of the assets of the company. Shareholders, as owners, are lastin line.

COLLATERAL

COLLATERAL is an asset, owned or controlled by a borrower, which ispledged to a lender in exchange for a loan. The value of the collateral isgenerally equivalent to that of the loan. The lender is given ownership orliquidation rights to the collateral in case of default by the borrower,thereby giving the lender some protection against loss. Usually, some typeof collateral is required in order to take out a loan, as a guarantee that theloan will be repaid. Debt securities are often backed by collateral pledgedby the issuer. This collateral could consist of other securities, real estate,or some other asset that has a value comparable to that of the loan. Whena security is collateralized, it is referred to as "secured". A security thatdoes not have collateral behind it is "unsecured".

High-Yield (Junk) Bonds

A JUNK BOND is a bond with a credit rating of BB or lower. CREDIT RATING

services assign lower rating to less credit-worthy issuers whose so-calledjunk bonds must pay higher returns to investors for assuming greater risk.



U.S. Government Securities

The two major categories of government securities are TREASURY andAGENCY.

TREASURY SECURITIES

TREASURY SECURITIES, or Treasuries are debt obligations of the U.S.government, issued and guaranteed by the U.S. Department of theTreasury to finance government expenditures and its budget deficits.

Treasury Bills

T-BILLS are issued for 3, 6, 9 months or 1 year. They are available inmultiples of $1,000, but the minimum investment is ten bills. T-Billsresemble zero coupon bonds because they are bought at a discount fromtheir face value, and no regular payments are made to holders. Theinterest you earn is the difference between the purchase price and the$1,000 paid out at maturity.

Treasury Notes

T-NOTES are issued in increments of $1,000 for terms longer than 1 yearbut fewer than 10 years. Unlike T-bills, T-notes contain coupons and payinterest semiannually. The minimum purchase is $5,000 on maturities offewer than 5 years and $1,000 on maturities of 5 years or more.

Treasury Bonds

T-BONDS are issued in increments of $1,000 for terms longer than 10years, and pay interest semiannually. The minimum purchase through thebrokerage firm is $1,000. The 30-year long bond is a widely quoted yieldbenchmark for long-term interest rate in the United States.



Trading

PRIMARY MARKET

Treasury securities are initially offered through the Federal ReserveSystem in about 100 auctions held each year. This process involves nomore than 39 authorized primary dealers, mostly large brokerage firms andcommercial banks, who bid for blocks of securities to resell their customersfor profit.

SECONDARY MARKET

Most investors buy Treasury securities from brokers so they can know theyield prior to purchase and can sell them any time.

AGENCY SECURITIES

AGENCY SECURITIES are debt obligations of certain federally owned orsponsored government agencies. Most are repackaged mortgages onhomes owned by U.S. citizens. All agency securities are assumed to berated AAA.

Ginnie Maes (GNMA)

GINNIE MAES are MORTGAGE bonds issued by the Government NationalMortgage Association (GNMA), an organization that buys FHA and VAhome mortgages from banks and auctions them to financial institutions.The institutions package the mortgages into “pools” to create securities tomarket to investors. The government guarantees both principal and interestwhether or not homeowners meet their mortgage obligations. Ginnie Maeinterest is paid monthly and is subject to federal, state, and local taxation.

Ginnie Maes are the most popular agency securities because they are veryliquid, formally backed by the full faith and credit of the U.S. government,and pay higher yields than Treasury securities.



Fannie Maes (FNMA)

FANNIES MAE are mortgage bonds issued by the Federal National MortgageAssociation (FNMA), a federally sponsored, quasi-private corporate thatprovides funds to the mortgage market by purchasing convential mortgageloans from banks and other lenders. Like Ginnie Maes, these loans arepackaged into pools by financial institutions and sold to investors. Theylack official government backing, but they are considered a moralobligation of the U.S. government. Interest is paid monthly.

Freddie Macs (FHLMC)

FREDDIE MACS are securities issued by the Federal Home Loan MortgageCorporation (FHLMC), a federally sponsored corporation that loans moneyto member institutions so they may supply conventional mortgage loans atcompetitive rates. FHLMC issues both coupon bonds and monthly on themortgage securities.

Sallie Maes

SALLIE MAES are packaged student loans purchased from financialinstitutions.

Tennessee Valley Authority

TVA is a federally owned corporate agency that was established to developthe resources of the Tennessee Valley region into one of the largestelectric utility systems in the country.



Mutual Funds

An OPEN-END investment company--usually known as a mutual fund--is acompany with a portfolio of securities managed in accordance with statedinvestment objectives and policies that will buy back shares from investorswhenever the investor wishes to sell.

The redemption price depends upon the value of the company's portfolio atthat time (the "net asset value"). There is no secondary trading market forthe shares of such companies.

CLOSED-END FUNDS resemble stocks in the way they are traded. Whilethese funds do invest in a variety of securities, they raise money only once,offer only a fixed number of shares, and are traded on an exchange (hencethe name EXCHANGE-TRADED funds) or over-the-counter. The market priceof a closed-end fund fluctuates in response to investor demand as well asto changes in the value of its holdings.

MUTUAL FUNDS are investment vehicles that purchase a variety ofsecurities. They're a few different types:

Stock mutual funds own a variety of stocks.

Bond mutual funds own a variety of bonds.

Money market funds own a diverse group of short-term debt instruments,making them highly stable, if conservative investments. Unit investmenttrusts own a group of stocks or bonds whose identity is preselected andknown by the investor before purchase.

Mutual funds are usually managed by investment specialists who decidewhat type and quantity of securities the fund will own, and when to buy andsell those securities. By purchasing shares of a mutual fund, an investorbuys a portion of all the securities in the fund, rather than actual shares ofthose securities.

For instance, if you own one of the million shares issued by a certainmutual fund, your share is worth approximately 1/1,000,000 of the totalvalue of the securities that the fund owns. And the price of your share will



fluctuate in a fairly direct relationship with the price of the securities ownedby the fund. This example is simplified, and does not take into accountcertain costs of buying or selling shares, or annual fees of owning the fund.

Some funds specialize in small, aggressive foreign stocks, while othersmight buy conservative government bonds; there are funds available forvirtually any type of investor.

Advantages of investing in mutual funds:

• The benefit of professional investment management

• Protection from the price fluctuations of individual stocks or bonds

There are several ways that investors are charged for buying, selling or justowning mutual funds--the mutual fund checklist might will help youunderstand some of the more common terms. But be sure to read theprospectus that every fund must issue before making any purchase.

Paying out the profits

A mutual fund makes money in two ways : by earning dividends or intereston its investments and by selling investments that have increased in price.The fund pays out, or distributes, its profits (minus fees and expenses) toits own investors.

INCOME DISTRIBUTIONS are from the money the fund earns on itsinvestments. CAPITAL GAIN DISTRIBUTIONS are the profits from sellinginvestments. Different funds pay their distributions on different schedules -from once a day to once a year. Many funds offer investors the option ofreinvesting all or part of their distribution in the fund.

Fund investors pay taxes on the distribution they receive from the fund,whether the money is reinvested or paid out in cash.



MUTUAL FUND CHECKLIST

The prospectus provides a detailed roadmap of a fund - coveringeverything from its objectives and fees to its portfolio holdings andmanager.

These are some of the terms you may come across in reading about mutualfunds:

Objective

Every fund has its own objective: aggressive growth, income, preservationof capital, etc. Choose carefully before investing, and make sure the fund isappropriate for your goals. The discussion of asset allocation will help youdecide what strategy is right for you.

The three-letter abbreviation following the fund name in the newspaperdescribes its investment objective.

Performance

A fund's total return is the actual increase or decrease in the value of itsinvestments, including appreciation and dividends or interest paid.Research a fund's performance over a 1, 5 and 10 year period, andcompare it with others of its kind. Moreover, remember an old maxim: pastperformance is no guarantee of future results!

Loads and fees

A LOAD, either front- or back-end, is a commission paid by the investor formutual funds purchased through a full-service brokerage firm. In thisinstance, a financial consultant provides advice regarding which funds bestsuit an investor's needs and investment objectives. A front-end load isdeducted when shares are purchased; a back-end load is deducted whenyou sell your shares, and may be contingent upon selling within a certainperiod.



In a NO-LOAD fund, an investor buys shares directly from the mutual fundcompany. While these funds carry no sales charges (and a maximum0.25% 12b-1 fee--see below), they do charge the management fees andadministrative fees found in load funds.

Finally, be sure that the company through which you invest offers a widerange of funds, and the flexibility to switch your investment from one fundto another as your needs or overall economic conditions change.

Fees charged by a fund are described in the prospectus.

MANAGEMENT FEES are annual charges to administer the fund. All fundscharge this fee, though the amount varies from a fraction of one percent toover two percent.

DISTRIBUTION FEES (12B-1 FEES) cover marketing and advertising expenses,and sometimes are used to pay bonuses to employees. About half the allthe funds charge them.

REDEMPTION FEES are assessed when shares are sold to discouragefrequent in and out trading. In contrast, a DEFERRED SALE LOAD, a kind ofexit fee, often applies only during a specific period and then disappears.

REINVESTMENT FEES are similar to loads; they are charged whendistributions are reinvested in a fund.

EXCHANGE FEES can apply when money is shifted from one fund to anotherwithin the same mutual fund company.

The Net Asset Value

The fund’s NAV is the dollar value of one share of stock in the fund, theprice a fund pays per share when you sell. It is figured by totaling thevalue of all the fund’s holdings and dividing by the number of shares.



Pension Funds

A PENSION FUND is a fund created to pay the pension benefits of retiredemployees of a corporation or other organization. Actuaries are employedto calculate the amount the company needs to contribute regularly in orderto meet their present payout requirements, and to generate cash to meetfuture obligations.

Collectively, pension funds are a strong force in the market due to the largedollar amounts invested in these funds and the volume of trading.

There are two classifications of pension funds, Defined Benefit Plans andDefined Contribution Plans.

DEFINED BENEFIT PLANS

Defined benefit plans are the largest group of pension funds and areknown simply as pension funds. They are subject to THE EMPLOYEE

RETIREMENT INCOME SECURITY ACT (ERISA) and are not taxed.

In a defined benefit plan the employer is usually the sole contributor to thisretirement fund hence the word "benefit" in the name. The employer fundsthe plan based on projected benefits to be paid, and the employee receivesa predetermined amount upon retirement, typically based on a formula ofthe employee's length of service and salary. The contributions areinvested according to the employer's investment strategies, and any profitsor losses resulting from the investments belong to the employer. Theemployee does not assume the investment risk as in a defined contributionplan but does not share in the gains either.

DEFINED CONTRIBUTION PLANS

Defined contribution plans are more commonly termed 401(K) or savingsplans. The plans are subject to the Employee Retirement Income SecurityAct (ERISA) and are not taxed.



In contrast to a defined benefit plan, regular contributions are made to adefined contribution plan by the employee with a preset matching amountup to a certain percentage made by the employer. The employee decideshow to allocate these contributions between the available investmentoptions offered by the employer such as various stock, bond and moneymarket funds. The employee contributions are pre-tax dollars. Theemployee bears all the investment risk and although the money is slatedfor retirement, there are specific hardship withdrawals that may be madeprior to retirement based on Internal Revenue Service regulations.

Employers tend to favor defined contribution plans over defined benefitplans since employee participation is voluntary and therefore the employeris less liable.

Employees favor defined contribution plans because the amount ofcontributions and investment allocations are flexible, and withdrawals areallowed for specific reasons before retirement.



Markets for Derivative Securities

THE LANGUAGE OF OPTIONS

Option are the RIGHT to buy or sell a specific item for a preset price duringa specified period of time.

OPTION buyers have rights. Option sellers have obligations. An optionscontract gives the option purchaser the right to buy (for a CALL OPTION) orsell (for a PUT OPTION) the underlying security at a pre-specified price by acertain date. Sellers of options, on the other hand, are obligated to buy (fora put option) or sell (for a call option) the UNDERLYING SECURITY (or cash forindex options) if the option is exercised by an option holder, but keeps thepremium paid by the purchaser for the option.

Unlike other investments where the risks may have no limit, options offer aknown risk to buyers. An option buyer absolutely cannot lose more than theprice of the option, the premium. Because the right to buy or sell theunderlying security at a specific price expires on a given date, the optionwill expire worthless if the conditions for profitable exercise or sale of thecontract are not met by the expiration date. An uncovered option seller, onthe other hand, faces unlimited risk, because it obligates the seller to eitherbuy (puts) or sell (calls) the underlying security at the market price. Likestock, options can be sold or bought after the initial transaction. If an optionbuyer or seller changes his investment strategy, the investor can sell orbuy the option contract any time prior to the expiration date.

Option Purchaser's Rights Option Seller's Obligations

Buy Call: right to buy Sell Call: obligation to sell

underlying security underlying security

Buy Put: right to sell Sell Put: obligation to buy

underlying security underlying security



Options are sold as CONTRACTS. An equity options contract generallyrepresents 100 shares of the underlying common stock, and is settled withthe delivery of the underlying stock. Index options, however, represent theunderlying companies, and are settled in cash.

The number of shares covered, the expiration date and the strike price orexercise price are all standardized. The price of the option or the premiumis the primary variable, and generally is dependent on the option's exerciseprice relative to the price of the underlying security, the time untilexpiration, stock and stock index volatility, dividends and interest rates.

There are two types of options contracts: CALLS and PUTS. Call optionscontracts allow the purchaser to buy the underlying security, while theseller of a call is obligated to sell the underlying security. Put optionscontracts allow the purchaser to sell the underlying security, while theseller of a put is obligated to buy the underlying security. The strike price orexercise price is the price at which the holder can buy the stock (for calloptions) or sell the stock (for put options). Each options contract specifiesan expiration date in addition to the strike price. The expiration date is thelast day an options contract can be exercised. Most options expire on theSaturday after the third Friday of each expiration month.

There are two types of exercise styles: American and European. Theseterms refer to when the options are exercisable and have nothing to do withthe geographic location of the markets in which the options are traded.American-style options may be exercised by the holder on any businessday up to the expiration date. European-style options may be exercisedonly on the last business day before expiration.

Call options are referred to as "IN THE MONEY" when the strike price is belowthe market price of the underlying security. Call options are "OUT OF THE

MONEY" when the strike price is above the market price. For put options, thereverse is true. A put option is "in the money" when the market price of theunderlying security is below the strike price. On the other hand, put optionsare "out of the money" when the market price of the underlying is above thestrike price of the option. Options are "AT THE MONEY" when the marketprice equals the strike price, a situation which rarely occurs. Therefore,these options are sometimes referred to as "NEAR THE MONEY".



FUTURES

Futures contracts are financial assets just like stocks and bonds, but withsome important differences. These differences are what make futures suchan appealing investment for traders. Many tend to think that futures arecomplicated to understand and consequently, miss many opportunities bynot trading them. It helps to remember a simple but true formula thatapplies to futures trading as surely as it does to trading in stocks, bonds,real estate, and even old comic books and hockey cards. Money is made ifyou "buy low and sell high". With futures, you can sell before you buy, soour simple rule can also read: Money is made if you "sell high and buyback low". Keeping this rule in mind puts you on your first step to becominga successful trader.commodity futures broker, futures trader, commoditiesfutures trading, financial and commodity futures markets, paper trading, fullservice broker assisted accounts.

What is a Futures Contract?

A standard textbook definition reads something like this:

A commodity futures contract is a firm commitment to deliver or receive aspecific quantity and quality a commodity during a designated month at aprice determined by open auction on a futures exchange.

This sounds more complicated than it actually is. Let's take an example.Suppose you, being hungry and health conscious, go to a grocery store tobuy bananas. You select some bananas, take them to the cashier (expresslane, of course), and pay for them. The bananas are now yours. This is asimple transaction which you have probably done many times before. Theexchange of money in return for goods, in this case, bananas, occurs now,in the present. A futures transaction is just like this with one difference, theexchange of money for goods is deferred until some time in the future. Thisis why futures contracts are regarded as deferred delivery contracts. Tocontinue with the example, buying banana futures would work somethinglike this: You go to the grocery store, select the bananas that you want,and tell the cashier, "I'll buy these bananas tomorrow at the price they aremarked at now." The cashier agrees to sell you the bananas tomorrow.When you return the following day, you pay for the bananas (at yesterday'sprice) and then take them home. Of course, the futures market doesn'tquite work exactly like this, but the idea is the same.commodity futuresbroker, futures trader, commodities futures trading, financial and



commodity futures markets, paper trading, full service broker assistedaccounts.

Buying a Futures is Like Buying on Lay-Away

Have you ever bought clothes, appliances, or furniture on lay-away?Buying on lay-away is just like buying a futures contract. You agree to buymerchandise at a particular price sometime in the future, say, in two weekswhen your paycheck comes in. The store agrees to sell the merchandise toyou at that price, and holds it for you for two weeks. You probably have toput down a small amount of money to guarantee the transaction. In twoweeks, you return with the full balance owing and the merchandise isyours. (This is when the exchange of goods and money takes place.) If theprice of the item went up during the two week period, do you pay the higherprice? NO. The price you pay was decided when you put the item on lay-away and is fixed over the holding period. Let's take a closer look at thesimilarities of buying on lay-away and buying a futures contract. With afutures contract, the underlying merchandise is known, just like onlay-away. For example, you can by a futures contract on gold, lumber, porkbellies, swiss francs, and many other items. The underlying item orcommodity is described specifically in the contract specifications which, inturn, are determined by the futures exchange on which it trades. Like lay-away, the price of a futures transaction is agreed upon initially betweenthe buyer and seller, and remains fixed over the holding period, or length ofthe contract. The small amount of money that you need to deposit for lay-away is also required for buyers and sellers of a futures contract and iscalled margin. Finally, the full price of the commodity must be paid onlyupon contract expiration at which point you take delivery, if you boughtfutures, or make delivery, if you sold futures, of the underlying commodity.(Don't worry. You don't have to make or take delivery if you don't want to.You can instead offset or square your position.) However, while you cantransact on lay-away at almost any department store, transactions infutures can only be done on futures exchanges. These exchanges arelocated primarily in Chicago and New York.commodity futures broker,futures trader, commodities futures trading, financial and commodity futuresmarkets, paper trading, full service broker assisted accounts.

Understanding a Futures Price

When you buy a futures contract, the price represents the price at whichyou are committed to buying the underlying commodity when the futures



contract expires. Similarly, when you sell a futures contract, the pricerepresents the price at which you are committed to selling the underlyingcommodity when the futures contract expires. (Not all futures contractsrequire physical delivery upon expiration, some are simply settled by cash.)For example, if you buy a COMEX December gold futures at $380 perounce, then you have the obligation to buy 100 ounces of gold at a price of$380 per ounce in December when the futures expires. (COMEX, whichstands for the Commodities Exchange in New York, is the futures exchangeon which gold futures trade. COMEX has set the quantity of gold underlyingthe contract at 100 ounces.) The price of gold futures constantly fluctuatesin response to several factors such as supply and demand, interest rates,and prices of other precious metals. However, no matter what the price ofgold does after you buy the futures, you will be able to buy gold at theprice of $380 per ounce - you have locked in this purchase price.

Futures prices are often different than cash prices for the same commodity.You may find in some cases that futures prices are consistently above cashprices, in which case the futures are said to be trading at a forwardpremium, or you may find that futures prices are consistently below cashprices, in which case the futures are said to be trading at a forwarddiscount. Whether a futures price is at a forward premium or discountdepends upon cost-of-carry considerations, and these may change overtime. Consequently, a futures price can move, for example, from a forwarddiscount to a forward premium. This can happen for commodity futures inwhich there is a shortage of immediate supply of the underlyingcommodity.commodity futures broker, futures trader, commodities futurestrading, financial and commodity futures markets, paper trading, full servicebroker assisted accounts.

Futures as an Investment

When you buy a futures, you lock in a purchase price for the underlyingcommodity. Similarly, when you sell a futures, you lock in a selling price ofthe underlying commodity. How, then, do you make money trading futures?Well, futures prices move around all of the time, that is, they are volatile.Prices of agricultural commodities, for example, may rise in response tounfavorable weather conditions, increased demand by importers, or spreadof plant diseases, and fall in response to abundant supplies or a shift inconsumer preference. If prices go up after you buy a futures contract, thenyou earn profit since the futures contract has increased in value. Forexample, if you buy one gold futures at $340 per ounce and two weekslater, the price of gold futures is trading at $350 per ounce, then yourfutures contract is now worth $10 per ounce more than when you bought it.



One futures contract represents 100 ounces of gold, so the total profit onyour gold futures position is $1,000. That's the thrill. Be careful, though.Gold prices could have fallen instead, in which case you would havesuffered a loss. As a trader, your challenge is to anticipate pricemovements correctly and make the appropriate trade. If you expect pricesto rise, you will buy futures and if you expect prices to decline, you will sellfutures. If your expectations turn out to be correct, then you will makemoney. If not, you will lose money. Realistically, it is virtually impossible tobe right all of the time. In fact, many traders are wrong more often thanright. BUT, they can still be successful traders.

Offsetting Contracts

As a trader looking to profit from movements in futures prices, you do notwant to actually buy or sell bushels of oats, or bars of gold, or whatever isthe underlying commodity of the contract. So, you will not hold a futurescontract to its expiration. In practice, only a small percentage of futurescontracts traded are actually held to delivery. Instead, you will close orsquare your futures position by enterring an equal but opposite trade - forexample, buying if you previously sold or selling if you previously bought.By offsetting a futures contract, the trader cancels any obligation he has tomake or take delivery of the underlying commodity. The difference betweenthe price of the futures contract when the trade was initiated and the pricewhen it is offset is the net gain or loss on the trade. Offsetting must bedone prior to contract expiration,and these differ depending upon thefutures in question. Expiration dates for many futures contracts can befound in Futures and Options Contract Specifications in Step 4: TheTrader's Handbook.commodity futures broker, futures trader, commoditiesfutures trading, financial and commodity futures markets, paper trading, fullservice broker assisted accounts.



Sources and Bibliography

State Street, Boston

n Global Investor Services Group - International Jacques Philippe Marson, Executive Vice President

n Global Pricing Services in Global Financial Technology Services

n State Street Brokerage,Thomas J. Bryant, Senior Trader

Boston Stock Exchange, Boston

n William G. Morton Jr, Chairman and Chief Executive Officer

n William I. Lee, III, Senior Vice President Customer Service andCommunication

n K. and S. Inc., Specialists Boston Stock ExchangeKenneth M. King, President

n Ward, Conary and Murphy Inc., Member Boston Stock ExchangeN. Withney Conary

n and especially Kathleen M. Radulki, Sales Associate, who organized myagenda at the Exchange on the Floor

Books

n The Wall Street Journal Guide to understanding money & investing

n Financial Industry Topics for Custody Services , State Street Bank



n Invest without stress, Anne Farrelly

n Foundations of financial markets and institutions, Fabozzi, Modigliani, Ferri

n A Guide to the Financial Markets, Charles R. Geisst

n The Super Traders, Secrets & Successes of Wall Street’s Best & Brightest,Alan Rubenfeld

n Reuters Glossary

Internet Resources

http://www.statestreet.com State Streethttp://www.quote.com cotations bancaireshttp://www.ml.com merryl lynch investor guidehttp://www.finweb.com/ finance infohttp://www.networth.galt.com finance infohttp://nt-mis-pri01.ssb.com/finind.htm liens avec les banques`(intranet)http://www.nyse.com/ New York Stock Exchangehttp://www.reuters.com reutershttp://www.bloomberg.com/welcome.html

bloomberg

http://www.utexas.edu/world/lecture/ Site des cours financiers (syllabus)http://www.dowjones.com dowjoneshttp://www.telerate.com/ dow jones telerate, priceshttp://emea.telerate.com/ telerate europehttp://www.amex.com american stock exchangehttp://www.nasdaq.com/ nasdaqhttp://www.euro.net/innovation/Finance_Base/Fin_encyc.html

Financial Encyclopedia

http://www.stockroom.org/ graphical representation of keyfinancial indicies and market sectors

http://www.telesph.com telesphere, price providerhttp://www.ejv.com/ Bridge Price providerhttp://www.stocksmart.com/ beyond the news, and provides the

understanding with which Investors cansecure their future prosperity.

http://www.investorsedge.com/ prices, portfolio analysishttp://www.etrade.com/ first electronic trading service available



on the webhttp://www.wallstreetcity.com/ online financial services for individual

and professional investors.http://www.dbc.com/ consumer-oriented financial

information.http://www.pcfn.com/ news, investment databases, research,

on-line trading, and realtime marketquotes using Telesphere's GlobalTicker

http://www.brill.com/expert.html A World Wide Web guide to mutualfund resources.

http://www.secapl.com/secapl/quoteserver/mw.html

market watch, indexes every 3 minutes

http://www.muller.com/muni.html Muller price vendorhttp://www.jjkenny.com/ J.J.Kenny price vendorhttp://www.bourse.be Belgium stock exchangehttp://www.bourse-de-paris.fr Bourse de Parishttp://www.sec.gov/consumer/weisktc.htm

What Every Investor Should Know

http://www.sec.gov/index.html The U.S. Securities and ExchangeCommission

http://www.whitehouse.gov/ white househttp://www.whitehouse.gov/fsbr/esbr.html

Economic Statistics Briefing Room(ESBR)

http://stats.bls.gov/cpihome.htm Consumer Price Index

Documents

Guide to Financial Industry