Business Commons^™

Floating Rate Notes, Steven D. Dolvin

All Chapters

As interest rates rise, bond prices fall. Given historically low interest rates, many investors are concerned about bond prices, particularly since the loose monetary policy being implemented by the Fed may trigger inflation and therefore higher future interest rates. To hedge away this interest rate risk, some investors have used inflation protected securities. The Treasury, however, just launched another alternative -- floating rate notes. The interest paid on these notes rise as market rates rise, thereby also protecting the bond's price. See article here, WSJ.

Timing Matters -- Dollar Weighted Returns., Steven D. Dolvin

All Chapters

While a mutual fund manager may make good decisions that result in a positive return, if investors time cash flows incorrectly, they will end up with lower (even negative) returns. This illustrates the difference between time weighted and dollar weighted returns. Unfortunately, the average investor succumbs to human nature, buying high and selling low, instead of the opposite. See a good summary article here, WSJ.

Covered Calls, Steven D. Dolvin

All Chapters

A Covered Call is created by purchasing stock and simultaneously writing a call on that stock. The position limits upside, as the stock will be called away if the price rises above the exercise price. But, the premium from selling the call provides extra income, which is the primary reason for executing such a strategy. See the article here, WSJ.

Retirement Planning -- Start Early, Steven D. Dolvin

All Chapters

Many people are not prepared for retirement. Older workers do not have enough money saved, and younger workers are not starting soon enough. See some survey results here, WSJ. You should also take the quiz to see where you stand.

Changing Tick Sizes?, Steven D. Dolvin

All Chapters

In 2001, exchanges began listing stock prices in penny increments, as opposed to fractions such as 1/8th or 1/16th of a dollar. The change was intended to simplify pricing and reduce bid-ask spreads. Recently, however, there has been an increasing call to move to higher increments (such as nickel or dime pricing). The rationale is that such a move would promote trading and reduce volatility. It doesn't hurt that it would also allow trading firms to generate more profit. See article here, WSJ.

Valuing Twitter's Ipo, Steven D. Dolvin

All Chapters

Twitter recently announced (via a tweet) that they would be going public. While valuation is difficult in general, it is particularly problematic for an IPO. Read a good summary article here, Yahoo!.

The Dow Shuffle, Steven D. Dolvin

All Chapters

While it is viewed as a major stock market barometer, the Dow Jones Industrial Average only follows 30 companies, and every so often the set of companies changes. The recent shuffle eliminated Alcoa, Bank of America, and HP, while adding Goldman Sachs, Visa, and Nike. The primary reason was the low prices of the eliminated companies. While most indexes are value weighted, the Dow is price weighted, meaning lower priced stocks exert little influence. This is also the reason why Apple will likely not be added -- with its "high" stock price. See a good summary here, Wall Street Journal …

Jumbo Mortgages And Securitization, Steven D. Dolvin

All Chapters

After a home buyer secures a loan from a bank (i.e., a mortgage), the bank often securitizes the loans, which means they package them for sale to investors. This process is much easier if the loans are backed by Fannie and Freddie, the government sponsored mortgage agencies. Fannie and Freddie, however, will only back loans below certain values -- the so-called jumbo loans. This amount has generally been capped at $417,000 (although higher in certain high-cost areas). Regulators plan to lower these caps, which means jumbo loans may be harder to come by since it will be more difficult to …

Preferred Stock, Steven D. Dolvin

All Chapters

Preferred stock, also called perpetual stock, is considered a type of hybrid security. It has characteristics of debt, the primary of which is a fixed dividend. However, it also has similarities to equity, in that it is equity, so the dividend is not guaranteed. So, it has higher risk than comparable bonds, but less risk (and less upside) than common stock. Moreover, the price of preferred stock is primarily responsive to changes in interest rates (i.e., like a bond). See related article here, Wall Street Journal.

Exchange Consolidation, Steven D. Dolvin

All Chapters

BATS and Direct Edge, two large electronic exchanges, are merging to form the second largest exchange operator in the United States, taking over the ranking currently held by Nasdaq. This change exhibits the transformation of the industry toward electronic trading. While electronic increases speed and likely lowers trading costs, it doesn't come without risks, as the recent Nasdaq outage illustrates. See article here, Wall Street Journal.

Even Adults Like "Happy Meals", Steven D. Dolvin

All Chapters

Higher risk companies, in order to sell bonds at lower interest rates, must often attach "sweetners" to the bond offering. Historically this has included warrants or conversion options. Recently, however, some companies have offered a combination of bonds and a loan of the company's shares, a so-called "Happy Meal." The bond buyers subsequently sell the shares short. If the company fails, the investors lose on the bonds, but make a profit on the short sale. This strategy is typically employed by hedge funds. See article here, Wall Street Journal.

P/E Ratios, Steven D. Dolvin

All Chapters

Most investors know that the PE multiple is the ratio of price to earnings. While the market price is easy to agree upon, the earnings number that should be used in the ratio is not. Some investors prefer historical earnings, while others focus on forecasted earnings. Each of these approaches can provide widely different PE estimates, making comparison difficult. .

Broker Vs. Advisor, Steven D. Dolvin

All Chapters

Over the past decade, more retail investment professionals have transitioned away from a pure broker relationship to a more advisory role. This switch is potentially good for both sides, as it reduces the incentive to churn (i.e., excessively trade) an account simply to generate commissions, while also providing a more stable revenue for the advisor. See article here, Financial-Planning.com.

Market Timing Vs. Market Efficiency, Steven D. Dolvin

All Chapters

Market timers may occasionally be correct, but it takes more than a few right calls to beat the market over the long term. In reality, this continued success is virtually impossible. See the article here, Wall Street Journal.

Municipal Bond Risk -- Detroit, Steven D. Dolvin

All Chapters

Municipal bonds usually have a lower yield to maturity than comparable US Treasury bonds. While this would normally be indicative of lower risk, it is purely a function of the tax advantages they provide. However, as the recent Detroit, MI bankruptcy filing suggests, municipals do indeed carry higher risk. (See article here, Yahoo! Finance.)

Ipo Advice, Steven D. Dolvin

All Chapters

IPOs generally experience a positive first day return, so-called underpricing. However, this return primarily accrues to those who are fortunate enough to receive an allocation of shares at the offer price. A recent article in the Wall Street Journal provides some advice for those interested in investing in IPOs. See the article here.

Bonds = Safe Investment?, Steven D. Dolvin

All Chapters

As the recent offering of bonds by Apple illustrates, bonds are subject to their own types of risk. In particular, price risk exists since prices react to changes in interest rates. As is the case with the Apple bonds, a recent rise in rates has significantly reduced the price of these bonds, leading to a capital loss for bondholders. See article here, International Finance Review.

Pray For A Bear Market?, Steven D. Dolvin

All Chapters

Most investors save for retirement using company sponsored 401(k) plans -- making investments into the account every month. This is a form of dollar cost averaging. For this type of investment, a bear market might be the best situation, as it will enable investors to buy more shares at lower prices. Since we want to "buy low and sell high," this downward volatility might actually help us. This is counter to what many people would think. See a related article here, Wall Street Journal.

Options For Everyone?, Steven D. Dolvin

All Chapters

Options (and derivatives in general) are often painted by the media as financial time bombs. While they can be used for speculative trading, they can also be used for hedging as well. Unfortunately, many smaller investors are not skilled in their use, which has led to significant losses for many. See article here, NY Times.

Central Banks Propel Equity Markets, Steven D. Dolvin

All Chapters

Japan's central bank recently instituted a significant expansionary monetary policy. The market's immediate response was to increase, and the rise has continued since the announcement. Easy money provides liquidity. While this can be offset by inflation, the lack of wage growth has kept inflation muted. Thus, equity markets have responded favorably. See article here, The Economist.

Trading Issues, Steven D. Dolvin

All Chapters

This is an excellent read on the mechanics of market microstructure, particularly as it relates to "mini-crashes" in individual stocks: Erroneous Combustion, CFA Institute.

This article discusses the efficacy (or lack thereof) of the new limit up / limit down circuit breakers on individual stocks: The Trade.

Man Vs. Machine, Steven D. Dolvin

All Chapters

It has always been difficult (if not impossible) to consistently beat the market -- so called "market efficiency." However, it may be even more difficult with the advent of quantitative systems trading -- i.e., algorithmic trading. (See article here, WSJ.)

Hot Market?, Steven D. Dolvin

All Chapters

Initial Public Offerings (IPOs) have increased in size and number during the recent bull market. IPOs tend to follow market cycles, particularly in environments where volatility is less pronounced. This gives firms more pricing stability, combined with increased investor appetite -- obviously the right mix for IPOs. ()

Margin Debt, Steven D. Dolvin

All Chapters

Margin debt hit its highest level ($379.5 billion) since July 2007. The increase is being driven by low rates and a rising market. As history shows, however, this level of debt could accelerate a small downturn in the market. (See article here, WSJ.)

Target Date Funds, Steven D. Dolvin

All Chapters

Target Date (or "lifecycle") Funds are investments on "auto pilot." Fund managers allocate assets across funds based on the set (target) retirement date and manage the allocation accordingly as time passes. These funds are best suited as "all or nothing" investments, meaning investors should put all their money in a target date fund or else manage their assets on their own. Unfortunately, many investors allocate funds to lifecycle investments as if it were its own investment category. This is particularly true in retirement plans where participants often exhibit the "1/n" phenomenon, allocating there money equally across the "n" investments in …

Google Search, Steven D. Dolvin

All Chapters

A recent study (See paper here, Nature) finds that the level of searches by particular terms is highly correlated to overall portfolio returns, particularly when trading strategies are based on these terms. The idea is that the search terms are a predictor of trading behavior, whether bullish or bearish.

Efficient Markets?, Steven D. Dolvin

All Chapters

Market efficiency comprises two aspects. First, markets respond quickly to new information. Secondly, and often overlooked, the market responds accurately to this information. The recent twitter hoax (See article here, USA Today) is just one example of the market responding quickly to new information. Whether it is accurate or not is where the debate rages.

Circuit Breakers, Steven D. Dolvin

All Chapters

Following the "Flash Crash" in 2010, the SEC implemented new trading curbs. Following continued discussion, these curbs have been updated once again--for both individual stocks and the market as a whole. See this Bloomberg article and this NYSE summary.

Exit Strategies, Steven D. Dolvin

All Chapters

Unfortunately, picking the next winning stock is only half the battle. Many investments have strong gains, but end up losing because investors fail to exit their holdings at the right time. Trailing stop orders are one way to help mitigate this issue. (See article here, Yahoo Finance.)

History Lesson: Momentum, Steven D. Dolvin

All Chapters

We often talk about buying low and selling high, but many individual investors often do the opposite. Particularly in retail accounts and 401(k) plans, investors are often "late to the party," waiting until the market hits a high to reenter. This behavioral bias results in momentum that may drive the market higher, but how long is the key question. Further, investors would be better suited taking a more disciplined periodic investment approach. With the market just hitting a high, this issue is currently at play. (See article here, WSJ.)