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The Investment FAQ (part 13 of 20)

( Part1 - Part2 - Part3 - Part4 - Part5 - Part6 - Part7 - Part8 - Part9 - Part10 - Part11 - Part12 - Part13 - Part14 - Part15 - Part16 - Part17 - Part18 - Part19 - Part20 )
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Archive-name: investment-faq/general/part13
Version: $Id: part13,v 1.61 2003/03/17 02:44:30 lott Exp lott $
Compiler: Christopher Lott

See reader questions & answers on this topic! - Help others by sharing your knowledge
The Investment FAQ is a collection of frequently asked questions and
answers about investments and personal finance.  This is a plain-text
version of The Investment FAQ, part 13 of 20.  The web site
always has the latest version, including in-line links. Please browse

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The Investment FAQ is copyright 2003 by Christopher Lott, and is
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Neither the compiler of nor contributors to The Investment FAQ make
any express or implied warranties (including, without limitation, any
warranty of merchantability or fitness for a particular purpose or
use) regarding the information supplied.  The Investment FAQ is
provided to the user "as is".  Neither the compiler nor contributors
warrant that The Investment FAQ will be error free. Neither the
compiler nor contributors will be liable to any user or anyone else
for any inaccuracy, error or omission, regardless of cause, in The
Investment FAQ or for any damages (whether direct or indirect,
consequential, punitive or exemplary) resulting therefrom.  

Rules, regulations, laws, conditions, rates, and such information
discussed in this FAQ all change quite rapidly.  Information given
here was current at the time of writing but is almost guaranteed to be
out of date by the time you read it.  Mention of a product does not
constitute an endorsement. Answers to questions sometimes rely on
information given in other answers.  Readers outside the USA can reach
US-800 telephone numbers, for a charge, using a service such as MCI's
Call USA.  All prices are listed in US dollars unless otherwise
Please send comments and new submissions to the compiler.

--------------------Check for updates------------------

Subject: Stocks - The Dow Jones Industrial Average

Last-Revised: 10 Mar 2003
Contributed-By: Norbert Schlenker, Chris Lott ( contact me )

The Dow Jones averages are computed by summing the prices of the stocks
in the average and then dividing by a constant called the "divisor". 
The divisor for the Dow Jones Industrial Average (DJIA) is adjusted
periodically to reflect splits in the stocks making up the average.  The
divisor was originally 30 but has been reduced over the years to a value
far less than one.  The current value of the divisor is about 0.20; the
precise value is published in the Wall Street Journal and Barron's (also
see the links at the bottom of this article). 

According to Dow Jones, the industrial average started out with 12
stocks in 1896.  For all of you trivia buffs out there, those original
stocks and their fates are as follows: American Cotton Oil (traces
remain in CPC International), American Sugar (eventually became Amstar
Holdings), American Tobacco (killed by antitrust action in 1911),
Chicago Gas (absorbed by Peoples Gas), Distilling and Cattle Feeding
(evolved into Quantum Chemical), General Electric (the only survivor),
Laclede Gas (now Laclede Group but not in the index), National Lead (now
NL Industries but not in the index), North American (group of utilities
broken up in 1940s), Tennesee Coal and Iron (gobbled up by U.S.  Steel),
U.S.  Leather preferred (vanished around 1952), and U.S.  Rubber (became
Uniroyal, in turn bought by Michelin).  The number of stocks was
increased to 20 in 1916.  The 30-stock average made its debut in 1928,
and the number has remained constant ever since. 

Here are some of the recent changes. 
   * On 17 March 1997, Hewlett-Packard, Johnson & Johnson, Travelers
     Group, and Wal-Mart joined the average, replacing Bethlehem Steel,
     Texaco, Westinghouse Electric and Woolworth. 
   * In 1998, Travelers Group merged with CitiBank, and the new entity,
     CitiGroup, replaced the Travelers Group. 
   * On 1 November 1999, Home Depot, Intel, Microsoft, and SBC
     Communications joined the average, replacing Union Carbide,
     Goodyear Tire & Rubber, Sears, and Chevron. 
   * Several stocks in the index have merged and/or changed names since
     the last round of changes: Exxon became Exxon-Mobil after their
     merger; Allied-Signal merged with Honeywell and kept the Honeywell
     name; JP Morgan became JP Morgan Chase after their merger;
     Minnesota Mining and Manufacturing offically became 3M Corp; and
     Philip Morris renamed itself Altria. 

The Dow Jones Industrial Average is computed from the following 30
stocks.  The links on the ticker symbols will take you to the a page at
Yahoo that offers current quotes and charts, and the links on the names
will take you to the respective company's home page. 

Ticker Company Name
MMM 3M Corporation
AA Alcoa
MO Altria (was Philip Morris)
AXP American Express
BA Boeing
CAT Caterpillar
C CitiGroup
KO Coca Cola
DD E.I.  DuPont de Nemours
EK Eastman Kodak
XOM Exxon Mobil
GE General Electric
GM General Motors
HPQ Hewlett-Packard
HD Home Depot
HON Honeywell
INTC Intel
IBM International Business Machines
IP International Paper
JPM JP Morgan Chase
JNJ Johnson & Johnson
MCD McDonalds
MRK Merck
MSFT Microsoft
PG Procter and Gamble
SBC SBC Communications
UTX United Technologies
WMT Wal-Mart Stores
DIS Walt Disney

Here are a few resources from Dow Jones and Company:
   * Dow Jones Indexes develops, maintains, and licenses over 3,000
     market indexes for investment products.
   * The current list of companies in the DJIA and their weightings.
   * Frequently Asked Questions about the DJIA.

--------------------Check for updates------------------

Subject: Stocks - Other Indexes

Last-Revised: 27 Jan 1998
Contributed-By: Rajiv Arora, Christiane Baader, J.  Friedl, David Hull,
David W.  Olson, Steven Pearson, Steven Scroggin, Chris Lott ( contact
me )

US Indexes:

AMEX Composite
     A capitalization-weighted index of all stocks trading on the
     American Stock Exchange. 
     The 100 largest non-financial stocks on the NASDAQ exchange. 
NASDAQ Composite
     Midcap index made up of all the OTC stocks that trade on the Nasdaq
     Market System.  15% of the US market. 
NYSE Composite
     A capitalization-weighted index of all stocks trading on the NYSE. 
Russell 1000
     The Russell 2000 Index measures the performance of the 2,000
     smallest companies in the Russell 3000 Index, which represents
     approximately 10% of the total market capitalization of the Russell
     3000 Index.  As of the latest reconstitution, the average market
     capitalization was approximately $421 million; the median market
     capitalization was approximately $352 million.  The largest company
     in the index had an approximate market capitalization of $1.0
     billion.  Visit their web site for more information:
Russell 2000
     Designed to be a comprehensive representation of the U.S. 
     small-cap equities market.  The index consists of the smallest 2000
     companies out of the top 3000 in domestic equity capitalization. 
     The stocks range from $40M to $456M in value of outstanding shares. 
     This index is capitalization weighted; i.e., it gives greater
     weight to stocks with greater market value (i.e., shares * price). 
     Visit their web site for more information:
Russell 3000
     The 3000 largest U.S.  companies.  Visit their web site for more
Standard & Poor's 500
     Made up of 400 industrial stocks, 20 transportation stocks, 40
     utility, and 40 financial.  Market value (#of common shares * price
     per share) weighted.  Dividend returns not included in index. 
     Represents about 70% of US stock market.  Cap range 73 to 75,000
Standard & Poor's 400 (aka S&P Midcap)
     Tracks 400 industrial stocks.  Cap range: 85 million to 6.8
Standard & Poor's 100 (and OEX)
     The S&P 100 is an index of 100 stocks.  The "OEX" is the option on
     this index, one of the most heavily traded options around. 
Value Line Composite
     See Martin Zweig's Winning on Wall Street for a good description. 
     It is a price-weighted index as opposed to a capitalization index. 
     Zweig (and others) think this gives better tracking of investment
     results, since it is not over-weighted in IBM, for example, and
     most individuals are likewise not weighted by market cap in their
     portfolios (unless they buy index funds). 
Wilshire 5000
     The Wilshire 5000 consists of all US-headquartered companies for
     which prices are readily available.  This historically has excluded
     pink sheet companies, but as the technology for data delivery has
     improved, so has the list of names in the index, now over 7000. 
     Needless to say, some of these are quite small.  The index is
     capitalization weighted.  Since several companies included in the
     S&P 500 are headquartered outside of the U.S., it is not true that
     the Wilshire 5000 contains the S&P 500.  For more information about
     the Wilshire indexes, visit their web site:

Non-US Indexes:

CAC-40 (France)
     The CAC-Quarante, this is 40 stocks on the Paris Stock Exchange
     formed into an index.  The futures contract on this index is
     probably the most heavily traded futures contract in the world. 
DAX (Germany)
     The German share index DAX tracks the 30 most heavily traded stocks
     (based on the past three years of data) on the Frankfurt exchange. 
FTSE-100 (Great Britain)
     Commonly known as 'footsie'.  Consists of a weighted arithmetical
     index of 100 leading UK equities by market capitalization. 
     Calculated on a minute-by-minute basis.  The footsie basically
     represents the bulk of the UK market activity. 
Nikkei (Japan)
     "Nikkei" is an abbreviation of "nihon keizai" -- "nihon" is
     Japanese for "Japan", while "keizai" is "business, finance,
     economy" etc.  Nikkei is also the name of Japan's version of the
     WSJ.  The nikkei is sometimes called the "Japanese Dow," in that it
     is the most popular and commonly quoted Japanese market index. 
JPN  JPN is a modified price-weighted index that measures the aggregate
     performance of 210 common stocks actively traded on the Tokyo Stock
     Exchange that are representative of a broad cross section of
     Japanese industries.  Japanese prices are translated without a
     currency conversion, so the index is not directly affected by
     dollar/yen changes.  JPN is closely related, but not identical, to
     the Nikkei Index.  Options are traded on US exchanges. 
Europe, Australia, and Far-East (EAFE)
     Compiled by Morgan Stanley. 

--------------------Check for updates------------------

Subject: Stocks - Market Volatility Index (VIX)

Last-Revised: 26 Jan 2003
Contributed-By: Jack Krupansky (jack "at", Chris Lott (
contact me )

The Market Volatility Index (VIX) is a measure of implied volatility in
trading of S&P 100 futures (specifically the OEX futures contract) on
The Chicago Board Options Exchange.  The index is calculated based on
the prices of 8 calls and puts on the OEX that expire in approximately
30 days.  Values for VIX tend to be between 5 and 100. 

So what is 'implied volatility'? To understand this, first consider the
factors that go into the pricing of options.  One of them is
'volatility'.  It's simply the extent to which the price of something
has changed over a year, measured as a percentage.  An option on a more
volatile stock or future will be more expensive.  But options are just
like any other asset and as really priced based on the law of supply and
demand.  If there is an excess of supply compared to demand, the price
will drop.  Conversely, if there is an excess of demand, the price
rises.  Since all the other parameters of the option price are
predictable or measurable, the piece that relates to demand can be
isolated.  It's called the 'implied volatility'.  Any excess or deficit
of demand would suggest that people have a difference in expectation of
the future price of the underlying asset.  In other words, the future or
'expected volatility' will tend to be different from the 'historic

The CBOE has a rather complex formula for averaging various options for
the S&P 100 futures to get a hypothetical, normalized, 'ideal' option. 
The volatility component can be isolated from the the price of this
ideal option.  That's VIX.  Although both 'put' and 'call' options are
included in the calculation, it is the 'put' options that lead to most
of the excess demand that VIX measures. 

The VIX is said to to measure market sentiment (or, more interestingly,
to indicate the level of anxiety or complacency of the market).  It does
this by measuring how much people are willing to pay to buy options on
the OEX, typically 'put' options which are a bet that the market will
decline.  When everything is wonderful in the world, nobody wants to buy
put insurance, so VIX has a low value.  But when it looks like the sky
is falling, everybody wants insurance in spades and VIX heads for the
moon.  Practically, even in the most idyllic of times, VIX may not get
below 12 or 13.  And even in the worst of panics, in 1998, VIX did not
break much above 60. 

Many view the VIX as a contrarian indicator.  High VIX values such as 40
(reached when the stock market is way down) can represent irrational
fear and can indicate that the market may be getting ready to turn back
up.  Low VIX values such as 14 (reached when the market is way up) can
represent complacency or 'irrational exuberance' and can indicate the
the market is at risk of topping out and due for a fair amount of profit
taking.  There's no guarantee on any of this and VIX is not necessarily
by itself a leading indicator of market action, but is certainly an
interesting indicator to help you get a sense of where the market is. 

Here are some additional resources for the VIX:
   * The current VIX number from Yahoo Finance^VIX&d=1d
   * A brief explanation from the CBOE
     Options Corner of 30 Aug 2001
   * James B.  Bittman's book (at on Trading Index Options

For more insights from Jack Krupansky, please visit his web site:

--------------------Check for updates------------------

Subject: Stocks - Investor Rights Movement

Last-Revised: 24 Jun 1997
Contributed-By: Bob Grumbine (rgrumbin at, Chris Lott ( contact
me )

The investor rights movement (sometimes called shareholder rights or
shareholder activism) involves people who try to use their shares to
make publically traded companies more accountable to their shareholders. 
(Please don't confuse this issue with the topic of the rights of an
individual investor with respect to the broker or brokerage firm in case
of disputes, etc.) One of the most common goals that current investor
rights activists aim for is changing the election process of company
boards of directors so that each and every director is elected at once,
as opposed to the stagger system that is commonly used. 

This article will give you a sense of the flavor, color, and some of the
directions of what's currently going on in the area of stockholder
rights.  The key points: (1) you must have your shares registered in
your own name to have any real chance of participating; (2) having
gotten your shares registered, you need to read in detail every proposal
in the proxy statements sent by the companies (or by others in some
cases), to determine how to vote your own shares; and (3) if you have
the time and energy to attend some annual meetings personally, you
yourself can become a stockholder rights activist, voting not only your
own shares but any others for which you obtain proxies and, subject to
certain rules and procedures, even having your proposal(s) printed in
the annual proxy statements for other shareholders to read and vote

Ok, now the details.  The absolute best sources of information about
investor rights activists are the proxy statements which each and every
one of the companies in which you own stock are required to send to you
each and every year as part of their process of getting their in-house
chosen directors elected.  Some names stand out clearly as being the
kind of people you are looking for. 

Ever since I was knee-high to a ticker tape, I have admired the work of
the Gilbert brothers and Wilma Soss, three of the longest-term most
dedicated activists for investor rights ever to grace the annual
meetings of major corporations.  It has been more than 35 years since I
was knee-high to a ticker tape, so Lewis D.  Gilbert and Wilma Soss have
both passed on.  However, John J.  Gilbert remains alive, well, and
active in promoting the stockholder right of cumulative voting for
directors, so that even in the most monolithic corporations held largely
by trustees indifferent to the legitimate interests of the real owners
of the shares, there can be elected at least some voice for the rights
and interests of actual owners. 

A more recent activist on the single crucial issue of reinstating the
election of directors annually , instead of the stagger system, has been
Mrs.  Evelyn Y.  Davis, Watergate Office Building, 2600 Virginia Avenue
N.W., Suite 215, Washington, D.C.  20037.  As in fact it has been used
in far too many instances, the stagger system facilitates incompetent or
malicious managers keeping effective control of boards of directors for
at least two years and sometimes longer beyond the time it becomes
obvious to stockholders that the existing board is acting outrageously
against the interests of the owners of the company.  As she points out
in one of her proxy proposals, "the great majority of New York Stock
Exchange listed corporations elect all their directors each year" which
"insures that all directors will be more accountable to all shareholders
each year and to a certain extent prevents the self-perpetuation of the
Board." Rationally behaving directors have no legitimate worry about
getting elected every year.  It is only those who are doing wrong
against the owners, or who intend to do so, who have any need for the
"stability" hogwash that so many staggered board companies spew forth as
justification for their anti-stockholder provisions. 

Along with the general purpose activists, there are frequently holders
of stock in particular companies, sometimes even former officers or
directors, who conclude that the current actions or inactions of the
existing set of officers and directors are just plain wrong and need to
be redirected or changed, usually in some quite specific ways.  To find
out about any of these you really must have your shares in all of the
companies that you own registered in your own name , so that you
yourself appear on the stockholder lists.  To be sure, some of the
better quality brokers do make an effort to pass along mailings which
they are requested to send to you by the companies you own but in which
they hold the actual shares.  Even those better quality people are
usually very delayed and you're going to miss most or all of the
individual company activists who see brokerage house shares as being
owned by people who just plain don't care about the real companies and
who aren't likely to read or understand any of the issues involved. 
Rightly or wrongly, that does seem to be their view, and if you are
someone who actually does care about the companies you own, getting your
shares registered in your own name is the only way you're really going
to have a chance of being kept informed about what's going on. 

Along with some who really are, or who have purported to be, concerned
about investor rights, you will also find many things included in the
proxy statements which look to me to be part of an "investor wrongs"
movement.  I refer to things such as religious bigot groups insisting
that no American company do business with the nationals of any nation
which does not welcome their peculiar bigotries with open arms.  I've
run across (and seen in action at annual meetings) so many of those
malicious anti-business twits, that I do feel the need to caution you
that not every proponent of issues for the annual stockholder's meeting
has even considered (1) the best interests of the company, (2) the best
interests of any stockholders other than their own peculiar set of
bigots, or (3) the fundamentally rational requirements for business
organizations to do business anywhere, let alone on a multinational
scale of activities.  Just a cautionary note that I think desirable,
having referred you to the proxy statements as a source of contacts. 

For more information on shareholder rights and activism, try these
   * Corporate Governance: enhancing wealth creation through increased
   * Greenway Partners, shareholder activism for the 1990's and beyond.
   * Infoseek's index.
   * LENS is an activist money manager.

--------------------Check for updates------------------

Subject: Stocks - Initial Public Offerings (IPOs)

Last-Revised: 7 Nov 1995
Contributed-By: Art Kamlet (artkamlet at, Bill Rini (bill at

This article is divided into four parts:
  1. Introduction to IPOs
  2. The Mechanics of Stock Offerings
  3. The Underwriting Process
  4. IPO's in the Real World

1.  Introduction to IPOs

When a company whose stock is not publicly traded wants to offer that
stock to the general public, it usually asks an "underwriter" to help it
do this work.  The underwriter is almost always an investment banking
company, and the underwriter may put together a syndicate of several
investment banking companies and brokers.  The underwriter agrees to pay
the issuer a certain price for a minimum number of shares, and then must
resell those shares to buyers, often clients of the underwriting firm or
its commercial brokerage cousin.  Each member of the syndicate will
agree to resell a certain number of shares.  The underwriters charge a
fee for their services. 

For example, if BigGlom Corporation (BGC) wants to offer its privately-
held stock to the public, it may contact BigBankBrokers (BBB) to handle
the underwriting.  BGC and BBB may agree that 1 million shares of BGC
common will be offered to the public at $10 per share.  BBB's fee for
this service will be $0.60 per share, so that BGC receives $9,400,000. 
BBB may ask several other firms to join in a syndicate and to help it
market these shares to the public. 

A tentative date will be set, and a preliminary prospectus detailing all
sorts of financial and business information will be issued by the
issuer, usually with the underwriter's active assistance. 

Usually, terms and conditions of the offer are subject to change up
until the issuer and underwriter agree to the final offer.  The issuer
then releases the stock to the underwriter and the underwriter releases
the stock to the public.  It is now up to the underwriter to make sure
those shares get sold, or else the underwriter is stuck with the shares. 

The issuer and the underwriting syndicate jointly determine the price of
a new issue.  The approximate price listed in the red herring (the
preliminary prospectus - often with words in red letters which say this
is preliminary and the price is not yet set) may or may not be close to
the final issue price. 

Consider NetManage, NETM which started trading on NASDAQ on Tuesday, 21
Sep 1993.  The preliminary prospectus said they expected to release the
stock at $9-10 per share.  It was released at $16/share and traded two
days later at $26+.  In this case, there could have been sufficient
demand that both the issuer (who would like to set the price as high as
possible) and the underwriters (who receive a commission of perhaps 6%,
but who also must resell the entire issue) agreed to issue at 16.  If it
then jumped to 26 on or slightly after opening, both parties
underestimated demand.  This happens fairly often. 

IPO Stock at the release price is usually not available to most of the
public.  You could certainly have asked your broker to buy you shares of
that stock at market at opening.  But it's not easy to get in on the
IPO.  You need a good relationship with a broker who belongs to the
syndicate and can actually get their hands on some of the IPO.  Usually
that means you need a large account and good business relationship with
that brokerage, and you have a broker who has enough influence to get
some of that IPO. 

By the way, if you get a cold call from someone who has an IPO and wants
to make you rich, my advice is to hang up.  That's the sort of IPO that
gives IPOs a bad name. 

Even if you that know a stock is to be released within a week, there is
no good way to monitor the release without calling the underwriters
every day.  The underwriters are trying to line up a few large customers
to resell the IPO to in advance of the offer, and that could go faster
or slower than predicted.  Once the IPO goes off, of course, it will
start trading and you can get in on the open market. 

2.  The Mechanics of Stock Offerings

The Securities Act of 1933, also known as the Full Disclosure Act, the
New Issues Act, the Truth in Securities Act, and the Prospectus Act
governs the issue of new issue corporate securities.  The Securities Act
of 1933 attempts to protect investors by requiring full disclosure of
all material information in connection with the offering of new
securities.  Part of meeting the full disclosure clause of the Act of
1933, requires that corporate issuers must file a registration statement
and preliminary prospectus (also know as a red herring) with the SEC. 
The Registration statement must contain the following information:

   * A description of the issuer's business. 
   * The names and addresses of the key company officers, with salary
     and a 5 year business history on each. 
   * The amount of ownership of the key officers. 
   * The company's capitalization and description of how the proceeds
     from the offering will be used. 
   * Any legal proceedings that the company is involved in. 

Once the registration statement and preliminary prospectus are filed
with the SEC, a 20 day cooling-off period begins.  During the
cooling-off period the new issue may be discussed with potential buyers,
but the broker is prohibited from sending any materials (including Value
Line and S&P sheets) other than the preliminary prospectus. 

Testing receptivity to the new issue is known as gathering "indications
of interest." An indication of interest does not obligate or bind the
customer to purchase the issue when it becomes available, since all
sales are prohibited until the security has cleared registration. 

A final prospectus is issued when the registration statement becomes
effective (when the registration statement has cleared).  The final
prospectus contains all of the information in the preliminary prospectus
(plus any amendments), as well as the final price of the issue, and the
underwriting spread. 

The clearing of a security for distribution does not indicate that the
SEC approves of the issue.  The SEC ensures only that all necessary
information has been filed, but does not attest to the accuracy of the
information, nor does it pass judgment on the investment merit of the
issue.  Any representation that the SEC has approved of the issue is a
violation of federal law. 

3.  The Underwriting Process

The underwriting process begins with the decision of what type of
offering the company needs.  The company usually consults with an
investment banker to determine how best to structure the offering and
how it should be distributed. 

Securities are usually offered in either the new issue, or the
additional issue market.  Initial Public Offerings (IPO's) are issues
from companies first going public, while additional issues are from
companies that are already publicly traded. 

In addition to the IPO and additional issue offerings, offerings may be
further classified as:

   * Primary Offerings: Proceeds go to the issuing corporation. 
   * Secondary Offerings: Proceeds go to a major stockholder who is
     selling all or part of his/her equity in the corporation. 
   * Split Offerings: A combination of primary and secondary offerings. 
   * Shelf Offering: Under SEC Rule 415 - allows the issuer to sell
     securities over a two year period as the funds are needed. 

The next step in the underwriting process is to form the syndicate (and
selling group if needed).  Because most new issues are too large for one
underwriter to effectively manage, the investment banker, also known as
the underwriting manager, invites other investment bankers to
participate in a joint distribution of the offering.  The group of
investment bankers is known as the syndicate.  Members of the syndicate
usually make a firm commitment to distribute a certain percentage of the
entire offering a nd are held financially responsible for any unsold
portions.  Selling groups of chosen brokerages, are often formed to
assist the syndicate members meet their obligations to distribute the
new securities.  Members of the selling group usually act on a " best
efforts" basis and are not financially responsible for any unsold

Under the most common type of underwriting, firm commitment, the
managing underwriter makes a commitment to the issuing corporation to
purchase all shares being offered.  If part of the new issue goes
unsold, any losses are distributed among the members of the syndicate. 

Whenever new shares are issued, there is a spread between what the
underwriters buy the stock from the issuing corporation for and the
price at which the shares are offered to the public (Public Offering
Price, POP).  The price paid to the issuer is known as the underwriting
proceeds.  The spread between the POP and the underwriting proceeds is
split into the following components:

   * Manager's Fee: Goes to the managing underwriter for negotiating and
     managing the offering. 
   * Underwriting Fee: Goes to the managing underwriter and syndicate
     members for assuming the risk of buying the securities from the
     issuing corporation. 
   * Selling Concession - Goes to the managing underwriter, the
     syndicate members, and to selling group members for placing the
     securities with investors. 

The underwriting fee us usually distributed to the three groups in the
following percentages:

   * Manager's Fee 10% - 20% of the spread
   * Underwriting Fee 20% - 30% of the spread
   * Selling Concession 50% - 60% of the spread

In most underwritings, the underwriting manager agrees to maintain a
secondary market for the newly issued securities.  In the case of "hot
issues" there is already a demand in the secondary market and no
stabilization of the stock price is needed.  However many times the
managing underwriter will need to stabilize the price to keep it from
falling too far below the POP.  SEC Rule 10b-7 outlines what steps are
considered stabilization and what constitutes market manipulation.  The
managing underwriter may enter bids (offers to buy) at prices that bear
little or no relationship to actual supply and demand, just so as the
bid does not exceed the POP.  In addition, the underwriter may not enter
a stabilizing bid higher than the highest bid of an independent market
maker, nor may the underwriter buy stock ahead of an independent market

Managing underwriters may also discourage selling through the use of a
syndicate penalty bid.  Although the customer is not penalized, both the
broker and the brokerage firm are required to rebate the selling
concession back to the syndicate.  Many broke rages will further
penalize the broker by also requiring that the commission from the sell
be rebated back to the brokerage firm. 

4.  IPO's in the Real World

Of course knowing the logistics of how IPO's come to market is all fine
and dandy, but the real question is, are they a good investment? That
does tend to be a tricky issue.  On one hand there are the Boston
Chickens and Snapples that shoot up 50% or 100%.  But then there is the
research by people like Tim Loughran and Jay Ritter that shows that the
average return on IPO's issued between 1970 and 1990 is a mere 5%

How can the two sides of this issue be so far apart? An easy answer is
that for every Microsoft, there are many stocks that end up in
bankruptcy.  But another answer comes from the fact that all the
spectacular stories we hear about the IPO market are usually basing the
percentage increase from the POP, and the Loughran and Ritter study uses
purchase prices based on the day after the offering hit the market. 

For most investors, buying shares of a "hot" IPO at the POP is next to
impossible.  Starting with the managing underwriter and all the way down
to the investor, shares of such attractive new issues are allocated
based on preference.  Most brokers reserve whatever limited allocation
they receive for only their best customers.  In fact, the old joke about
IPO's is that if you get the number of shares you ask for, give them
back, because it means nobody else wants it. 

While the deck may seem stacked against the average investor.  For an
active trader things may not be as bad as they appear.  The Loughram and
Ritter study assumed that the IPO was never sold.  The study does not
take into account an investor who bought an issue like 3DO (THDO -
NASDAQ), the day after the IPO and sold it in the low to mid 40's,
before it came crashing down.  Obviously opportunities exist, however
it's not the easy money so often associated with the IPO market. 

Portions of this article are copyright 1995 by Bill Rini. 

--------------------Check for updates------------------

Subject: Stocks - Mergers

Last-Revised: 9 Apr 1997
Contributed-By: George Regnery (regnery at

When one firm takes another over, or merges with another, a number of
things can happen to the firm's shares.  The answer is, it depends. 

In some cases, the shares of one company are converted to shares of the
other company.  For instance, 3Com announced in early 1997 that it was
going to purchase US Robotics.  Every US Robotics shareholder will
receive 1.75 shares of 3Com stock. 

In other cases, one company simply buys all of the other company's
shares.  It pays cash for these shares. 

Another possibility, not very common for large transactions, is for one
company to purchase all the assets of another company.  Company X buys
all of Company Y's assets for cash, which means that Company Y will have
only cash (and debt, if they had debt before).  Of course, then company
Y is merely a shell, and will eventually move into other businesses or

--------------------Check for updates------------------

Subject: Stocks - Market Capitalization

Last-Revised: 11 Mar 1997
Contributed-By: Chris Lott ( contact me )

The market capitalization (or "cap") of a stock is simply the market
value of all outstanding shares and is computed by multiplying the
market price by the number of outstanding shares.  For example, a
publically held company with 10 million shares outstanding that trade at
US$20 each would have a market capitalization of 200 million US$. 

The value for a stock's "cap" is used to segment the universe of stocks
into various chunks, including large-cap, mid-cap, small-cap, etc. 
There are no hard-and-fast rules that define precisely what it means for
a company to be in one of these categories, but there is some general
agreement.  The Motley Fool offers these guidelines:
   * Large-cap: Over $5 billion
   * Mid-cap: $500 million to $5 billion
   * Small-cap: $150 million to $500 million
   * Micro-cap: Below $150 million According to these rules, the example
listed above would be a small-cap stock. 

When reading a mutual fund prospectus, you may see the term "median
market cap." This is just the median of the capitalization values for
all stocks held by the fund.  The median value is the middle value;
i.e., half the stocks in the fund have a market capitalization value
below the median, and the other half above the median.  This value helps
you understand whether the fund invests primarily in huge companies, in
tiny companies, or somewhere in the middle. 

--------------------Check for updates------------------

Subject: Stocks - Outstanding Shares and Float

Last-Revised: 30 Jan 2001
Contributed-By: Chris Lott ( contact me )

Data that are frequently reported about a stock are the number of shares
outstanding and the float.  These two bits of information are not the
same thing, although they are closely related.  In a nutshell, the
outstanding shares are those held by the public (but possibly restricted
from trading), and the float is the number of shares held by the public
and available to be traded. 

If that was not clear, let's begin at the beginning.  When a company
incorporates, the articles of incorporation state how many shares are
authorized.  For example, the company could
incorporate and have 1,000,000 (one million) shares.  This is the number
of authorized shares.  At the moment of incorporation, these shares are
held in the company treasury (at least that's what people say); the
number of outstanding shares and the float are both zero. 

Next our example company sells some percentage of the authorized shares
to the public, possibly via an inital public offering (IPO).  The
company chooses to sell 10% of the authorized shares to the public.  In
addition, as part of going public, the company grants 10% of the
authorized shares to employees etc., but these people cannot sell their
shares for six months.  So after the IPO, the public (i.e., not the
company) holds 200,000 shares, and the rest is in the treasury.  So we
say that the number of shares outstanding is 200,000.  However, due to
various restrictions placed on the employees, their share holdings
cannot be traded.  While the restriction on insiders (commonly called a
lockup) is in force, just 100,000 shares are available for trading, and
the float is just 100,000 shares. 

You may have heard the term "thin float" in connection with an IPO. 
This refers to the practice of allowing just a small percentage of the
authorized shares to be sold to the public in the IPO.  In cases where
demand was high (and the supply was artificially low), the result was
large jumps in price on the first day of trading. 

When a company buys back its own shares on the open market and returns
these shares to the company treasury, this reduces both the float and
the number of outstanding shares.  If a company has sufficient cash to
purchase shares, in theory these purchases could eventually buy all the
shares outstanding, which is essentially the same as taking the company

Perhaps it is obvious, but when a company splits its shares, the number
of authorized shares is affected by the split.  For example, if a large
company had 100 million shares authorized and implemented a 2 for 1
split, then after the split the company has 200 million shares

--------------------Check for updates------------------

Subject: Stocks - Preferred Shares

Last-Revised: 22 Oct 97
Contributed-By: John Schott (jschott at

Preferred stocks combine characteristics of common stocks and bonds. 
Garden-variety preferred shares are a lot like general obligation
bonds/debentures; they are called shares, but carry with them a set
dividend, much like the interest on a bond.  Preferred shares also do
not normally vote, which distinguishes them from the common shares. 
While today there are a lot of different kinds of hybrid preferred
issues, such as a call on the gold production of Freeport McMoran Copper
and Gold to the point where they will deliver it, this article will
consider characteristics of the most ordinary variety of preferred

In general, a preferred has a fixed dividend (as a bond pays interest),
a redemption price (as a bond), and perhaps a redemption date (like a
bond).  Unlike a stock, it normally does not participate in the
appreciation (or drop) of the common stock (it trades like a bond). 
Preferreds can be thought of as the lowest-possible grade bonds.  The
big point is that the dividend must be paid from after-tax money, making
them a very expensive form of capitalization. 

One difference from bonds is that in liquidation (e.g.  following
bankruptcy), bond holder claims have priority over preferred shares,
which in turn have priority over common shares (in that sense, the
preferred shares are "preferred").  These shares are also preferred
(hence the name) with respect to payment of dividends, while common
shares may have a rising, falling or omitted dividends.  Normally a
common dividend may not be paid unless the preferred shares are fully
paid.  In many cases (sometimes called "cumulative preferred"), not only
must the current preferred dividend be paid, but also any missed
preferred dividends (from earlier time periods) must be made up before
any common dividend may be paid.  (My father once got about a $70
arrearage paid just because Jimmy Ling wanted to pay a $0.10 dividend on
his common LTV shares.)

Basically, preferreds stand between the bonds and the common shares in
the pecking order.  So if a company goes bankrupt, and the bond holders
get paid off, the preferreds have next call on the assets - and unless
they get something, the common shareholders don't either. 

Some preferred shares also carry with them a conversion privilege (and
hence may be called "convertible preferred"), normally at a fixed number
of shares of common per share of preferred.  If the value of the common
shares into which a preferred share may be converted is low, the
preferred will perform price-wise as if it were a bond; that is often
the case soon after issue.  If, however, the common shares rise in value
enough, the value of the preferred will be determined more by the
conversion feature than by its value as a pseudo-bond.  Thus,
convertible preferred might perform like a bond early in its life (and
its value as a pseudo-bond will be a floor under its price) and, if all
goes well, as a (multiple of) common stock later in its life when the
conversion value governs. 

And as time has gone on, even more elaborate variations have been
introduced.  The primary reason is that a firm can tailor its cost of
funds between that of the common stock and bonds by tailoring a
preferred issue.  But it isn't a bond on the books - and it costs more
than common stock. 

In general, you won't find a lot of information on the preferred shares
anywhere.  Since they are in a never-never land, it is hard to analyze
them (they are usually somewhere low on the equity worth scale from the
common and bonds).  So they can't really carry a P/E and the like. 
Unfortunately, most come with the equivalent of the bonds indenture -
that is the "fine print" and you may have to get and read it to see just
what you have.  (I once had preferreds that paid dividends in more
shares of itself and in shares of another preferred, but how Interco got
itself into bankruptcy is another story.)

There are other reasons why preferreds are issued and purchased.  A lot
of convertibles are held by people who want to participate in the rise
of a hot company, but want to be insulated from a drop should it not
work out.  Here's a different strategy.  For example, I've got some
Williams Brothers Preferreds.  They pay about 8.5% and are callable in
Fall, 1997.  When I bought them (some years ago), they had just been
issued and were unrated (likely still are not).  But Williams itself is
a well-run company with strong cash flow that then needed the money fast
to buy out a customer who was in trouble.  So I bought these shares more
as I'd buy a CD.  The yield is high, the firm solid - and likely they
will pull my investment out from under me someday.  Meanwhile, it forms
a bit of my "ready cash" account.  And I can always sell it if I want

Problem is, with so many variants, there isn't always a preferred that
you'd want to buy at the current price to carry out some specific
strategy.  Naturally, not every firm has them, the issues are often
thinly traded and may not trade on the exchange of the parent firms
common (or even be listed on any exchange). 

If the preferred shares get called (i.e., converted), you normally
collect just as if common shares are bought out - in cash, no deduction. 

--------------------Check for updates------------------

Subject: Stocks - Price Basis

Last-Revised: 28 Oct 1997
Contributed-By: George Regnery (regnery at

This article presents a bit of finance theory, namely the basis for a
stock's price. 

A stock's price is equal to the net present value (NPV) of all expected
future dividends.  (See the article elsewhere in the FAQ for an
explanation of the time value of money and NPV.) A company will plow its
earnings back into the company when it believes it can use this money
better than its investors, i.e., when the investment opportunities it
has are better than its investors have available.  Eventually, the
company is going to run out of such projects: it simply won't be able to
expand forever.  When it gets to the point where it cannot use all of
its earnings, either the company will pay dividends, it will build up a
cash mountain, or it will squander the money.  If a company builds a
cash mountain, you'll see some investors demand higher dividends, and/or
the company management will waste the money.  Look at Kerkorian and

Sure, there are some companies that have recently built up a cash
mountain.  Microsoft, for instance.  But Gates owns a huge chunk of
Microsoft, and he'd have to pay 39.6% tax on any dividend, whereas he'd
have to pay only 28% (or perhaps 20%) on capital gains.  But eventually,
Microsoft is going to pay a dividend on its common shares. 

From a mathematical perspective, it's quite clear that a stock price is
equal to the NPV of all future dividends.  For instance, the stock price
today is equal to the NPV of the dividends during the first year, plus
the discounted value of the stock in a year's time.  In other words,
P(0) = PV (Div 1) + P(1).  But the price in a year is equal to the NPV
of dividends paid during the second year plus the PV of the stock at the
end of two years.  If you keep applying this logic, then the stock price
will become equivalent to the NPV of all future dividends.  Stocks don't
mature like bonds do. 

Of course it's also true that a stock's price is equal to whatever the
market will bear, pure supply and demand.  But this doesn't mean a
stock's price, or a bond's price for that matter, can't have a price
that is determined by a formula.  (Unfortunately, no formula is going to
tell you what dividend a company will pay in 5 years.) A bond's price is
equal to the NPV of all coupon payments plus the PV of the final
principal payment.  (You discount at an appropriate rate for the risk
involved).  Any investment's price is going to be equal to the NPV of
all future cash flows generated by that investment, and of course you
have to discount at the correct discount rate.  The only cash flows that
investors in stocks get are from the dividends.  If the price is not
equal to the NPV of all future cash flows, then someone is leaving money
on the table. 

--------------------Check for updates------------------

Subject: Stocks - Price Tables in Newspapers

Last-Revised: 21 Apr 1997
Contributed-By: Bruce A.  Werner (BruceWerner at, Chris Lott
( contact me )

Stock prices from the previous day's trading are printed in tables in
most newspapers Tuesday through Saturday, and the week's activity is
commonly summarized on Sunday.  These tables use an extremely
abbreviated format, including footnotes to indicate various situations. 
The tables are distributed by the Associated Press. 

This article lists the most commonly used footnotes about stock prices,
the stock itself, and dividends (three parts in the following table), so
if your newspaper doesn't explain its tables, this might help.  Sources
consulted for this information include the Baltimore Sun, the New Jersey
Star-Ledger, and others; your local paper will probably be similar,
although typesetting tricks like boldface etc.  may vary across
different papers.  The long and the short of it is you want your
companies to have lots of u's and never anything that starts with v (you
have to wonder about the use of adjacent letters). 

Footnote Explanation
d Price is a new 52-week low
u Price is a new 52-week high
x Ex-dividend (ex-rights) price
y Ex-dividend and sales in full
z Sales in full
g Dividend or earnings in Canadian currency
n New issue in the past 52 weeks (i.e., the high/low aren't true 52-week
pf Preferred shares
pp Holder owes installments of purchase price
rt Rights
s Split or stock dividend of more than 25% in the past 52 weeks
un Units
v Trading was halted on the primary market
vj Bankrupt, reorganizing, etc. 
wd When distributed
wi When issued
wt Warrants
ww With warrants
xw Without warrants
a Also extra(s)
b Annual rate plus stock div. 
c Liquidating div. 
e Declared or paid in preceding 12 months. 
f Annual dividend rate increased. 
i Declared or paid after stock dividend or split up
j Paid this year, div.  omitted, deferred or no action taken at last
div.  meeting. 
k Declared or paid this year, an accumulative issue with div.  in
r Declared or paid in preceding 12 months plus stock div. 
t Paid in stock in preceding 12 months, est.  cash value on ex-div.  or
ex-dist.  date
boldface Stock's price changed 5% or more from previous day
underline Stock's trading volume equalled or exceeded 2 percent of the
total number of shares outstanding. 
triangle Stock reached a 52-week high (pointing up) or low (pointing

--------------------Check for updates------------------

Subject: Stocks - Price Data

Last-Revised: 30 Jan 2002
Contributed-By: Chris Lott ( contact me )

Many people have asked me "how can I get the closing price for stock XY
on date Z." A common variant is to get the close of the Dow Jones
Industrial Average (or other stock index) for some given date or range. 
The answer is that you need to find a provider of historical data (also
called historical quotes).  If all you need is the open, close, and
volume for a stock on some date, you're in luck, because this is
available at no charge on the web (see below).  However, if you want
detailed data suitable for detailed analysis, such as the full report of
every trade, you probably will have to pay for it. 

Don't forget that the most reliable way to find a stock's price on a
given day is to visit a library with good newspaper archives.  Look up
the newspaper for the following day (most likely on microfilm) and print
the section from the financial pages where the closing price appears. 
Print that page, and be sure to print the portion of the page showing
the date.  This may be the best way for people who are trying to
establish a cost basis for some shares of stock. 

Yahoo's historical stock price data goes back to about 1970.  You can
download the data in spreadsheet format.  They even use friendly ticker
symbols for the stock indexes (e.g., the ticker for the Dow Jones
Industrial Average is DJIA).

--------------------Check for updates------------------

Subject: Stocks - Replacing Lost Certificates

Last-Revised: 19 Feb 1998
Contributed-By: Richard Sauers (rsauers at, Bob Grumbine
(rgrumbin at, Chris Lott ( contact me )

If a stock holder loses a stock certificate through fire, theft, or
whatever, shares registered in the stock holder's name (as opposed to
so-called "street name") can be replaced fairly quickly and easily. 

To replace a lost certificate, begin by contacting the company's stock
transfer agent.  If you don't know the transfer agent, contact the
company to find out; Value Line or Standard & Poor's Corporation Records
(probably available at your friendly local library) are a good source
for the contact addresses of the company itself. 

Tell the transfer agent the approximate date the certificate was issued. 
The transfer agent will ask you to post a bond, called a surety bond,
that indemnifies the transfer agent.  The cost of the surety bond
required is typically 3% of the value of the certificate.  (The transfer
agent will be able to recommend a surety company.) Once the bond is
posted, the transfer agent should be able to reissue the missing
certificate with no further ado. 

If you hold shares in your name, you might consider preparing yourself
for this eventuality by keeping a copy of the stock certificate (it will
show the number, transfer agent, etc.) separate from the original. 

--------------------Check for updates------------------

Subject: Stocks - Repurchasing by Companies

Last-Revised: 11 Nov 1996
Contributed-By: Bob Bose (bobbose at

Companies may repurchase their own stock on the open market, usually
common shares, for many reasons.  In theory, the buyback should not be a
short term fix to the stock price but a rational use of cash, implying
that a company's best investment alternative is to buy back its stock. 
Normally these purchases are done with free cash flow, but not always. 
What happens is that if earnings stay constant, the reduced number of
shares will result in higher earnings per share, which all else being
equal will result, should result, in a higher stock price. 

But note that there is a difference between announcing a buyback and
actually buying back stock.  Just the announcement usually helps the
stock price, but what really counts is that they actually buy back
stock.  Just don't be fooled into believing that all "announced share
buybacks" are actually implemented.  Some are announced just for the
short term bounce that usually comes with the announcement.  Those types
of companies I would avoid as management is out to deceive their

--------------------Check for updates------------------

Compilation Copyright (c) 2003 by Christopher Lott.

User Contributions:

Gerri Pisciotta
My employer accidentally advised the company handling the 401k investment that I had been terminated, when in fact I had not. As a result, withdrawals discontinued from my pay and I missed a couple years of contributions. Since I never withdrew from the plan, is my employer liable for making up these contributions? If I made a lump sum catchup contribution,could they do the same?
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Truly lots of awesome tips!
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