Rant About It

Money Markets: Reduce Your Risks – Part 1

Posted by rantaboutit on March 21, 2007

Most investors are hypocrites when it comes to the stock market. In the bull market they are raving about the stock market, where as in the bear market, they cannot stop cursing it. In the bear market alot of investors get out of the stock market and park their money in the money market, that offers an alternative to high risk investments.

Introduction to Money Market
Money market is one of the significant type of fixed income market. Money market securities are issued by governments, financial institutions and large corporations. These instruments are very liquid and considered safe. They are better known as a place for large institutions and government to manage their short-term cash needs. Because they are extremely conservative, money market securities offer significantly lower returns than most other securities.

How is Money Market different from Bond Market ?
The difference between the money market and the bond market is that the money market specializes in very short-term debt securities.

How is Money Market different from Stock Market ?
One of the main differences between the money market and the stock market is that most money market securities trade in very high amount which limits access for the individual investor. Also in case of money market, firms buy and sell securities in their own accounts, at their own risk, whereas in the stock market, a broker acts as an agent to buy and sell. Add to that, there is no central trading exchange in case of money market, but just transactions over the phone or electronic systems.

How to Get Access to Money Market ?
The easiest way to gain access to the money market is through a money market mutual fund or through a money market bank account. Some money market types, like Treasury bills, may be purchased directly. They can also be acquired through other large financial institutions with direct access to these markets.

Types of Money Market
There are different instruments in the money market, offering different returns and different risks. Let us take a look at the major money market instruments.

Treasury Bills (T-bills)
Treasury Bills are short-term securities (say 3-month, 6-month or 1-year maturity). T-bills are purchased at less than their face value. On maturity the full face value is returned. For example, if you bought a 90-day T-bill at $9,800 and held it until maturity, you would be returned $10,000.

To buy a T-bill, a bid has to be submitted either non-competitively or competitively. In non-competitive bidding, the full amount determined at the auction will be returned. With competitive bidding, based on the desired returns, the bid maybe a success or a failure.

Advantage

  • Their popularity is mainly due to their simplicity and affordability.
  • One of the safest investments in the world, since it is backed by U.S. government.
  • They are exempt from state and local taxes.
  • They are short-term investments instead of being locked for a longer time frame.
Disadvantage
  • The returns from this investment are not great compared to bonds, certificates of deposit and money market funds.
  • The investment cannot be liquidated before maturity date.
Certificate of Deposit (CD)
Certificate of deposit is a fixed term deposit, also known as time deposit. CDs are issued by commercial banks but can be bought through a brokerage firm. They have a maturity period ranging from 3-months to 5-years with a specified interest rate. Interest rates depend on various factors like current interest rate in the market, money invested, maturity period. A fundamental concept to understand when buying a CD is the difference between annual percentage yield (APY) and annual percentage rate (APR).

Advantage

  • CDs have a higher yield compared to T-Bills due to their slightly higher risk factor. (ie. What is the bank goes out of business)
  • Almost every bank offers CDs, which means they are easily accesible. This also means you have multiple options to get the best rates.
  • CDs are relatively safe and will earn more than in a savings account.
Disadvantage
  • CDs cannot be withdrawn instantly as desired similar to a checking account. A huge fine can be levied if the funds are withdrawn prior to maturity.
  • The returns from this investment are not very exciting compared to many other investments.
Commercial Paper
Borrowing money from banks for a short-term can be sometimes frustrating process. In response to that, commercial paper gained popularity among corporations. Commercial paper is an unsecured, discounted, short term loan issued by a corporation. Maturity period is no more than 9 months.

Advantage

  • Safe investment because the financial situation of a company can easily be predicted over a few months.
  • Only companies with high credit ratings issue commercial paper.
  • Higher returns than T-bills.

Disadvantage

  • They are not afforable to everyone, since commercial papers are issued in the range of $100,000 or more.
  • Small-time investors can only invest in commercial paper indirectly through money market funds.
Conclusion: When the stock market looks volatile and too risky, money markets can provide an excellent alternative. Their short-term maturity make them more attractive. Obviously the returns are not very thrilling, but there are times when even the most ambitious investor puts some cash on the sidelines. There are a few more instruments i did not cover in this post, which would be covered in Part-2. Hope this post opened your eye to money market securities. To be continued…

Recommended Books:

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(Source: Investopedia)

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Posted in Educational, Investment, Money Market | 1 Comment »

Interesting Stories That You Missed

Posted by rantaboutit on March 19, 2007

Over the past few days i came across some interesting news/facts which deserves some limelight.
Basic Material ETFs
ETFs that focus on large-cap companies with exposure to basic materials have had nice returns for the year. Why is that so ? Analyst believe U.S. economy is growing and a growing economy needs materials. Returns on the 2 popular ETFs are
  • Vanguard Materials ETF (VAW) = 8.3%
  • Materials Select Sector SPDR (XLB) = 7.5%
Top companies in both of these ETFs are: Du Pont (DD), Dow Chemical (DOW), Alcoa (AA), Monsanto (MON), and Phelps Dodge (PD).

Tax Efficient ETFs
Many of the newer ETFs are more specialized which could effect their tax efficiency in different ways.
Here are 5 funds that are top-rated for consistent returns and tax efficiency:
  1. iShares MSCI Austria Index (EWO): 5-year return of 36% and over that time lost 0.4% to tax costs.
  2. iShares Russell 2000 Value Index (IWN): 5-year return of 13% and over that time lost 0.5% to tax costs.
  3. Vanguard Small Cap Value Index (VBR): 3-year return of 14% and over that time lost 0.5% to tax costs.
  4. iShares Russell Mid Cap Value Index (IWS): 5-year return of 15% and over that time lost 0.7% to tax costs.
  5. Vanguard Value Index (VTV): 3-year return of 13% and over that time lost 0.5% to tax costs.
China Raise Interest Rates
China’s central bank said it would raise both its lending and deposit rates by 0.27 % points to bring investment and credit growth in check and help balance the economy. The one-year benchmark yuan deposit rate would rise to 2.79% from 2.52%. The one-year benchmark lending rate is to rise to 6.39% from 6.12%.

Energy Market
John Segner, manager of the AIM Energy fund, which has 17% average returns over the last decade said that the energy market will see a temporary improvement in the supply-demand balance in 2007, but will then return to a supply shortage in 2008 and 2009. Demand will continue to rise, driven by India and China, but supply from non-OPEC countries, particularly Venezuela, Nigeria, Iran and Iraq, won’t rise sufficiently.

No Wal-Mart Bank
Wal-Mart Stores Inc. (WMT) is dropping its bid to establish a bank after months of heated debate over whether the world’s largest retailer should be allowed to gain the added financial power of a federally insured bank. Wal-Mart announced that it was withdrawing its application for a bank charter, which aroused widespread opposition from banks, lawmakers and consumer groups, and spurred debate within Congress and before the Federal Deposit Insurance Corp.

Top Subprime Mortgage Lenders With Q4 Originations

  1. HSBC Finance (HSBC) – $12.3 billion
  2. New Century Financial (NEWC.PK) – $12.2 billion
  3. Countrywide Financial (CFC) – $10.1 billion
  4. WMC Mortgage (GE) – $9.0 billion
  5. First Franklin (Merrill Lynch) (ML) – $7.8 billion
  6. Wells Fargo (WFC) – $7.4 billion
  7. Option One (H&R Block) (HRB) – $6.1 billion
  8. Fremont Investment & Loan (FMT) – $6.0 billion
  9. Washington Mutual (WM) – $5.7 billion
  10. CitiFinancial (Citigroup) (C) – $5.0 billion
Life Cycle ETF for Investors
TD Ameritrade (AMTD) plans to offer an ETF that rebalances frequently. The ETF will be a life cycle ETF with a target date for the investor, who will choose a year close to when he plans to retire. Life-cycle funds invest in multiple asset classes and become more conservative as time passes.

Cisco buys WebEx

Cisco (CSCO) bought WebEx (WEBX) for $3.2 billion. WebEx is a specialist on online conferencing and collaboration, and one of the most successful players in the software as a service segment. Buying WebEx creates a new point of competition with Microsoft (MSFT) which offers various collaboration tools of its own.

Microsoft buys Tellme Networks
Microsoft (MSFT) will buy privately held voice-recognition software company Tellme Networks for a estimated price of $800 million. The purchase will give Microsoft several promising new capabilities, particularly in mobile search. Tellme Networks already does more mobile search support than Google and Yahoo combined. Microsoft already offers a product that combines e-mail, instant messaging and VoIP into one voice-activated client; but the Tellme acquisition gives it advanced, enterprise-class speech recognition technology.

Wal-Mart Movies
Wal-Mart Stores (WMT) will team up with Fox Broadcasting to offer movies and television shows on its new online download service, and the collaboration between Amazon (AMZN) and TiVo (TIVO) to offer recordable content for download. This is bad news for competitors Netflix (NFLX) and Blockbuster (BBI).

Emerging markets ETFs
During the recent meltdown emerging markets ETFs were hit bad, but Russia seemed to be one of the hardest hit. The Russian RTS index is now down 9.6% for the year. This makes Russia the worst performer year-to-date among major global benchmarks. Falling commodity prices, particularly oils and metal puts more pressure on the Russian market as well as other emerging markets which tend to have a commodity-driven economy.

Posted in Asia, China, Exchange Trade Funds, Oil, Walmart | 2 Comments »

Stock Option Backdating: Turn Back Time

Posted by rantaboutit on March 19, 2007

Every now and then you come across some scandal in the news about stock option backdating. Media ranting about how the company management cheated the investors by backdating the stock options. Whether you understand stock options backdating or not, one thing you know for sure, that a bunch of crooks did something wrong and tried to dupe everyone and finally got caught. If you are not aware what that means or vaguely understand it…this would be good time to get it right.
Some executives would love to turn back time when it comes to their stock options. Do you know why ? Pretty straight-forward actually. The day the option is granted, some executives would love to backdate them, that is set them to an earlier date when the stock was trading at a lower price. What is the Result…Instant Profits !!

Lets explore what options backdating is and what it means for companies and their investors.

Company Do’s and Dont’s
Companies can issue and price stock option grants as they see fit, but this will all depend on the terms and conditions of their stock option granting program. Majority of public companies handle their employee stock options programs in the traditional manner.

  • They grant their executives stock options with an exercise price equivalent to the market price at the time of the option grant.
  • They also fully disclose this compensation to investors.
  • They deduct the cost of issuing the options from their earnings as they are required to do under the Sarbanes-Oxley Act of 2002.
  • The facts disclosed cannot be made unclear or confusing.
What investors care about the most is that all the details of the grant be disclosed (date of the granted option and the exercise price). The backdating concern occurs when the company does not disclose the facts behind the dating of the option. Therefore most companies avoid options backdating. Better safe than sorry. But there are some companies that have bent the rules by hiding the facts. The options backdating scandal seems harmless but it can prove to be quite costly to shareholders.

Costly After Effects of Stock Option Backdating

  • Bad press after the accusation resulting in drop of investor confidence.
  • Company’s reputation becomes irreparable resulting in disinterested new investors.
  • Restate their financials to reflect the costs associated with previous options.
  • Lawsuit filed by shareholders for filing false earnings reports.
  • Substantial fines levied by regulatory bodies for fraud.
  • Executives involved may face penalties levied by the Justice Department (for lying to investors, which is a crime), and the IRS for filing false tax returns.
Anyone of these effects would cause the stock prices of the company to plummet, leading to substantial losses for their shareholders.

Few Real-Life Example
According to a study more than 2,000 companies used options backdating in some form to reward their senior executives between 1996 and 2002.

  • Brocade Communications (BRCD) manipulated its stock options grants and then failed to inform investors. When finally brought to light, they had to restate earnings. They are also subject to civil and a criminal action. Although the company continues to defend itself against the charges, its stock has dropped by more than 70% between 2002 and 2007.
  • UnitedHealth (UNH) reported that it would have to restate earnings for the last 11 years, and that the total amount of restatement could approach, or even exceed, $300 million.
  • Network Appliance (NTAP) has secretly backdated options grants for several years. For seven years, a majority of Network Appliance directors & top officers engaged in stock options backdating.
  • Apple (AAPL) last year looked at 42,077 stock-options grants made on 259 dates from October 1996 to January 2003. Of those, 6,428 grants on 42 dates were found to be not dated properly.
How To Keep Check on Option Backdating
  • With the advent of Sarbanes Oxley, companies will be less likely to mislead investors in the future. Earlier an executive didn’t have to disclose his/her stock option grants until the end of the fiscal year in which the grant was given. Now grants must be filed electronically within 2 business days of an issue or grant. This means that corporations will have less time to backdate their grants. It also provides investors with timely access to pricing information.
  • Securities & Exchange Commission will not approve changes to the listing standards of the NYSE and the Nasdaq that require shareholder approval for compensation plans.
Conclusion: Stock option backdating is a dirty trick company executives try to pull. If caught, could be absolutely detrimental to the company, executives and the stock price. Stockholders’ portfolio can take a big hit because the stock price has the potential to take a huge dip. Long term investors should keep themselves well informed about company compensation plans and granted options. Any early sign of trouble, would be a good time to get out of the stock and avoid future losses.

Recommended Books:

Sponsors:

(Source: Investopedia)

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