Misleading Sales Practices

enny-Stock Broker: "The last stock we marketed went from $.10 to $.45 in six months."

Impressive Track Records
Many penny-stock brokerage firms point to past performance as a reason to do business with them. Such claims can be misleading. Even if a firm accurately states the lowest and highest prices of a previously-recommended stock, those prices may have been artificially created as the result of market manipulation. A large spread between the bid and ask price can distort the track record. As explained earlier, in some cases a stock may need to double in price for the investor to break even.

Television Programs or Reports and Internet listings
The fact that a stock is mentioned or even recommended on television or on an Internet Website is no guarantee that the investment opportunity is legitimate. Moreover, some television programs or reports are actually advertisements paid for by penny-stock brokerage firms.

Insured by the Securities Investor Protection Corporation (SIPC)
Penny-stock brokerage firms will often point to their SIPC coverage as proof of their legitimacy. But the SIPC insures only that if the firm goes bankrupt, customer-owned securities which are held by the firm will not be lost. The SIPC does not insure against loss from fraud or changes in the value of an investment.

State and Federal Licensing or Registration
The fact that a brokerage firm and its brokers are licensed or registered is not a guarantee against fraudulent practices. State and federal enforcement actions against licensed or registered penny-stock firms have increased dramatically in recent years.

Penny-Stock Broker: "You're getting in on the ground floor of the next Xerox!"

Humble Beginnings
An often-made sales pitch implies that all successful companies began by issuing penny stocks. The truth is that not all successful companies began by issuing penny stocks, and it is extremely unlikely that any given penny-stock company will become another Xerox. And, according to the North American Securities Administrators Association Report on Fraud and Abuse in the Penny Stock Industry, September 1989, a widely-quoted industry figure is that at least 70 percent of penny-stock investors end up losing money, even without taking into account the risks of fraud and abuse.

money game

Now let's learn about some games that you can play with your class to help them learn some of the basic concepts of economics. (By the way, it is very important in designing any lesson plan, regardless of the subject area and age level of the students, to stimulate the students imagination and to include some form of activity. One need not go crazy trying to have endless "hands on" activities that take forever and a day to set up. Likewise, one need not dream up ideas that are so refreshing and rare and interesting that no one can resist. Keep things simple. Introduce a little imagination and a little activity. Let the students themselves embellish the lesson with their own ideas.)

One variation of the game would be to pretend that the students in your class are buying Mac and PC computers. These are" futures" so each time a transaction takes place a student doesn't actually exchange money for a computer. Rather, the process influences the future value of both kinds of computers. Tell each student that she or he has $10.00 and that, initially, the price of one Mac or one PC is $3.00. The ground rules are that students take turns making purchases, and that during each turn only one transaction can take place involving the purchase or sale of only one unit.

The options that students have when it is their turn is to buy either a Mac or a PC or sell either a Mac or a PC to the dealer. When it is their turn, they must buy or sell at the current price.

Inasmuch as the purpose of the activity is to teach students how they vote with their dollars, each vote has to have an impact on the market for Mac's and PC's. The procedure you use for this game is very simplistic and should not be regarded as any attempt to mimic the actual happenings in the marketplace.

Nevertheless, the affect of a vote is as follows:

1. When a student buys a Mac, a 1 is placed in the Mac column.
2. When a student buys a PC, a 1 is placed in the PC column.
3. At the same time, when a student buys a Mac, a negative 1 is placed in the the PC column.
4. Likewise, when a student buys a PC, a negative 1 is place in the Mac column.
5. At any point in the game after a transaction has resulted in a +3 accruing in either the Mac or the PC column, then the price of that particular computer goes up by $1.00. At the same time, the price of the other computers goes down by $1.00. This change goes into effect for the next person who makes a transaction.
6. Similarly, at any point in the game after a transaction has resulted in a -3 in either the Mac or the PC column, then the price of that particular computer goes down by $1.00. And, at the same time, the price of the other computer goes up by $1.00.

The purposes of these manipulations in the cost of the computers is to artificially mimic the forces in the market place that determine the price that buyers are willing to pay for a good and the price that manufactures are willing to sell a good.

Let's suppose that Dick and Jane each have $10.00, and they go to the computer store . Initially, the cost of both a Mac and a PC is $3.00, which means that, unless the market changes, both Dick and Jane could purchase three computers and have $1.00 left.

But Dick and Jane are in for a surprise! Dick yields to Jane who goes first, and Jane buys one Mac. Then Dick buys a Mac, and when Jane has another turn, she buys another Mac. Because the column that keeps track of the number of purchases of Mac's has reached a value of 3, the bank closes to adjust the prices. The cost of the Mac now rises to $4.00 whereas the cost of the PC has dropped to $2.00.

In an effort to simplify the game while still teaching the basic concepts, the column that keeps track of the number of purchases for both computers is set at 0 in both the PC and the Mac column every time there is a price change.

The moment of truth has arrived for Dick. His net worth is one Mac computer worth $4.00 and $7.00 in cash. At this point in time, Dick's net worth is $11.00.

In contrast, Jane owns two Macs valued at $4.00 each and $4.00 cash. Thus, Jane's net worth is $12.00.

Jack has three choices, and he must make a choice. (There is no passing in this game, and the order of play can never be modified.) If Jack buys a Mac, he will have two Mac's worth $4.00 each plus $3.00 cash. Thus, Dick's net worth is $11.00. If Jack buys a PC, he will have one Mac worth $4.00, one PC worth $2.00, and $5.00. In this case, his net worth would be $11.00. If Jack sells his Mac, he would have $11.00 in cash.

Let's suppose Jack buys a PC for $2.00. That means he has one Mac worth $4.00, one PC worth $2.00, and $5.00. He is still worth $11.00. In other words, at this point in the game any one of the three options would result in Dick having the equivalent of $11.00 and Jane having the equivalent of $12.00.

Therefore, after three transactions, Jane has increased the value of her portfolio by $2.00 and Dick has increased the value of his portfolio by $1.00. Now it's Jane's turn.

Let's suppose Jane is seeing $ signs and decides to sell one of her Mac's. Thus, Jane ends up with one Mac worth $4.00 and $8.00 cash. She is still worth $12.00.

Dick is back up to bat worth $11.00, and he decides to buy another PC. He then has one Mac worth $4.00 and two PC's each worth $2.00, and $3.00 cash. He still is worth $11.00, or a dollar less than Jane.

An interesting thing has happened! The bank closes because in the tally columns for both the Mac's and the PC's, the absolute value is 3. Mac has -3, and PC has +3. According to our rules, this means that the value of the Mac now drops to $3.00, and the value of the PC rises to $3.00. Both computers have returned to their "suggested retail price" as a result of the "voting with dollars" by which Dick and Jane bought and sold computers.

Let's see what the net worth of Dick and Jane is now. Jane has one Mac worth $3.00 and $8.00 cash for a total of $11.00. Dick has one Mac worth $3.00 and two PC's each worth $3.00 plus $3.00 cash. Dick is now worth $12.00, and the shoe is on the other foot.

Let's reflect on this very simple game. It is obvious that the way I have described this game one could simply go back and forth between buying and selling computers taking advantage of KNOWING the rules. That is, both Dick and Jane know that anytime an absolute value of 3 occurs in either or both columns that keep track of the number of transactions, the bank will close, and the value of the computer will change.

However, suppose many people are playing this game, no one has contact with any other participant, and no one has access to the data on the number of transactions accumulated by either computer. That would be a whole new ball game with the players truly having to speculate on the future value of the computers.

Moreover, the game can be further modified to allow the plays to make multiple purchases each time they have a turn. For instance, if the cost of a PC is $1.00 and a player has $12.00, that player could end up with twelve computers each of which is worth $1.00 but all of which have the potential of increasing in value. And this is very likely what will happen. (Of course, it is possible, but very unlikely, that there might be no demand for PC's or Mac's and that dealers could lose their shirts.)


A GENERAL RULE OF THUMB IS TO BUY GOODS WHEN THEY ARE CHEAP AND SELL THEM WHEN THEY ARE EXPENSIVE.

Obviously this is an over simplification. For example, several years ago most motor oil manufacturers switched from oil cans to plastic oil containers with screw caps. Before this big change, a popular item in auto parts stores was a plastic funnel that would fit on top of an oil can that had two openings placed in it with a can opener. This device made it easy and less messy to add oil to a motor.

But as soon as oil cans disappeared from the market, the demand for funnel caps dried up.

In contrast, in 1974 those distributors who were lucky enough to have stockpiled gasoline were in pretty good shape. Almost overnight the value of gasoline went through the roof. The OPEC oil embargo sharply moved the supply curve to the left, and there was a severe shortage of gasoline and other oil-based products. Initially, the demand for gasoline remained the same because people still had cars that got low mileage, and people still had to use their cars to go to and from work. The demand curve began to change--shift to the left-- as automakers offered more fuel efficient cars and people were encouraged to car pool and use public transportation.


MORE VARIATIONS

The basic design used in the above example can be applied to many different situations and can be made more complicated and more interesting according to the interest and skill level of those involved.

For example, suppose that you want your students to understand the financial section of the newspaper that contains information about foreign exchange rates, the worth of the dollar, and the price of gold and silver. To begin with you would want to discuss with your students their own experiences of traveling to other countries and how they purchased material and nonmaterial goods, or what are typically referred to as goods and services, such as basketballs and haircuts. Students living along the North Coast of the United States have probably traveled to Canada and have had experience with using U.S. dollars to purchase Canadian dollars.

As of July 18, 1996, the exchange rate for U.S. and Canadian dollars was .7324 and 1.3654. In this example, if an American were traveling to Canada, she could buy 1.3654 Canadian dollars for each U.S. dollars. Thus, the American traveler would feel as if she had "more money" in Canada, although the cost for goods and services might be elevated to reflect the exchange rate.

In contrast, a Canadian traveler to the United States would need to spend 1.3654 Canadian dollars for 1 U.S. dollar. The Canadian would feel as if he had "less money" but, at least along the border, the purchasing power of his fewer U.S. dollars would be comparable to the equivalent amount of Canadian dollars.

The reason for this is no mystery. Vendors on both sides of the border have similar costs to do business. The entire region, because of the market place forces at work, will have arrived at a juncture of the demand and supply curves for all goods and services. Whatever that particular price is can be expressed in either U.S. or Canadian dollars. This is why one finds signs along the boarder such as, "This vending machine does not accept Canadian money." For instance, soft drink machines increasing accept paper money. If a resident of Detroit could use Canadian dollars to buy a can of Pepsi that costs $1.00 is U.S. dollars with Canadian dollar bills at a vending machine designed to accept U.S. dollar bills, that resident would, in effect, be buying a Pepsi for $.75. The owner of the vending machine would have to protect herself against this by setting the machine so that it would not accept Canadian money.


VOTING WITH DOLLARS

In this variation each student is given $35.00 U.S. dollars. Let us pretend that this is the late 1960's and that the old gold standard is in place with one ounce of gold being worth $35. (Today the average price of gold is about $385 per Troy ounce, and the value of gold fluctuates according to the pressures exerted by the market in terms of demand and supply for gold and other precious metals, such as silver, which averages about $5.00 per ounce.) The students follow the same procedure as they did with the Mac/PC game except that this time they can purchase Francs, Marks, Pounds, or Yen. To begin with $1.00 Dollar = 4 Frances = 4 Marks = 4 Pounds = 4 Yen.

The one big difference in this version of the game is that the value of the Dollar remains at 1 whereas the value of the other four currencies can vary from 1 to n. The purpose of this restriction is to help students have a frame of reference. This is the same reasoning for using the old gold standard. As students become more astute, the value of both the dollar and gold can float according to the pressures of the market.

Each time someone buys any of the five currencies, a 1 is placed in the column of the currency purchased. At the same time a -.25 is placed in the column of the other currencies. This has the effect of gradually making the sought after money more valuable and the least purchased currency more attractive to buyers. Once any column achieves an absolute value of 3, the bank closes and the value of the currency is changed. If the 3 is a positive 3, then that currency drops by one unit.

For example, if three people buy Frances, then the value of the Franc in terms of dollars and the other currencies changes from 4 to 3. This means that the Federal Reserve Bank, for example, which is something like the bank in Monopoly, is no longer willing to give 4 Frances for 1 Dollar or 4 Marks or 4 Pounds or 4 Yen. The value of each Franc increases. If you had 3 Francs, you could buy 1 dollar or 4 Marks or 4 Pounds or 4 Yen. This is an example of deflation.

But, we have to make things interesting , so we look at the columns for the other four currencies to see which currency has been purchased the FEWEST number of times. This currency then is decreased in value by increasing it by 1 unit. In the above example, suppose that Pounds were purchased the least number of times. The bank, therefore, changes its exchange rate from 4 to 5 to make the Pound more attractive to buyers.

This is an example of inflation. It now takes more Pounds to buy goods and services. However, those who speculate in the currency market may be tempted to sell off some of their other currency to buy Pounds because you buy when it's cheap--and sell when it's more valuable. If a buyer buys up a bunch of Pounds when they are at 5 and waits till they drop to, say, 4, she can sell off the Pounds for dollars and make a profit.

The goal in currency investment is, of course, to get the largest return on your investment just as it with all investments.

Because we have frozen the dollar at one, we have to adjust the value of all currencies to the same degree when a 3 shows up in the dollar column. If the dollar has a +3, this means that it is in high demand. To make other currencies more attractive to buyers, you look for the two other currencies that have been purchased the least. BOTH OF THESE CURRENCIES ARE THEN DEVALUED BY ONE UNIT TO MAKE THEM MORE DESIRABLE.

For example, if the dollar has been purchased three times but the Yen and Mark only once, then the Yen and Mark would each be changed from 4 to 5.

To illustrate, on July 19, 1996, the value of the Franc expressed in Dollars was .1986. If one had one Franc, he only had the equivalent of .1986 Dollars. Likewise, one dollar was equivalent to 5.0345 Francs. If there were a sudden large upward increase in the demand for Francs by U.S. citizens, it is likely that sellers of dollars would receive fewer Francs per dollar.

In contrast, if there were a sudden increase by France for U.S. goods and nonmaterial goods, the Franc might be devalued to the point that French consumers--or anyone holding Francs as an investment--would need more Francs to purchase the same goods and services they might have previously been able to purchase before the shift of the demand curve.

France would be exporting Francs and importing U.S. goods. Countries strive to export goods and import the currency of the countries who are buying their goods. Countries end up in trouble when their citizens buy too many imported goods, especially when there are competing similar goods made and sold in their own country. This has the effect of exporting that country's currency to the countries that manufacture and sell the goods to that country. This means, then, that the citizens of the country who are importing, say, dollars, are able to buy more goods than the citizens of the United States who have exported their dollars in exchange for foreign goods.

In a very simplified way, when we speak of a shift of either the demand curve or the supply curve, we are saying that there has been a significant change in the behavior of consumers and suppliers beyond the typical day-to-day changes in the market price of any particular good or service, which is characterized by the intersection of the downward sloping demand curve and the upward sloping supply curve.



USING FORMULAS TO CALCULATE TRANSACTIONS



It is possible and desirable for students to learn how to use spreadsheet to perform the above calculations. These calculations are what one might typically find in a BASIC or FORTRAN program. They involve loops and IF,THEN statements.

In spreadsheet these formulas would be found listed as Nested If Functions. An example of what one of these formulas might look like would be as follows:

=IF(B2>=3,C2-1,IF(AND B2<=-3,C2+1)).

In this particular example, cell B2 would be the location on the spreadsheet where the number of transactions involving a particular currency were stored. Cell C2 represents the value of the currency, and let us assume the starting value is 4.

Let's suppose B2 represents Francs. At the start of a game, the value in B2 would be 0. Each time someone buys a Franc, the value in B2 increases by 1. Likewise, each time someone has purchased another currency, then 1 is subtracted from 0.

At some point in the game one of the two above possibilities is likely to occur. When that happens, then the value of the currency , which is indicated in C2, changes. If at least three people have purchased Francs, then the value changes from 4 to 3. This means that because of the demand for Francs, the bank is no longer willing to give 4 Francs away for 1 Dollar or 4 Marks or 4 Pounds or 4 Yen, for example.

In contrast, if the value in B2 reaches -3 or lower, then the opposite occurs in C2; that is, the value of C2 changes from 4 to 5. Because of the small demand for Francs, the bank wants to encourage people to buy Francs.

For most classroom situations it would be better to do all of the above calculations on the board. The most important point is to teach students about economics. Teaching students how to create and run formulas in spreadsheet is important, but that is another matter. Ideally, students should be "turned lose" to pursue spreadsheet on their own as well as coming up with their own unique variations. Encourage your students to improvise, to use what they have learned.
EXAMPLE OF HOW TO WRITE A NESTED IF FUNCTION FORMULA IN SPREADSHEET

=IF(B2>=3,C2-1,IF(AND B2<=-3,C2+1)).

Reading Price Quotations

Reading Price Quotations The price of most mutual fund shares can be found in many newspapers, including The Wall Street Journal. The listings for closed-end funds are contained in the stock quotation section. The listings for open-end funds are separate, and are organized by the name of the fund family as illustrated in the accompanying chart of fictitious companies. An explanation of how to read the chart follows.

1 The first column is the abbreviated name of the fund. Several funds listed under a single heading indicate a family of funds.

2 The second column is the Net Asset Value (NAV) per share as of the close of the preceding business day. In some newspapers, the NAV is identified as the "bid price"—the amount (per share) you would receive if you had redeemed your shares that day (less any deferred sales charges). Each mutual fund determines its net asset value every business day by dividing the market value of its total assets, less liabilities, buy the number of shares owned by the investors. On any given day, you can determine the value of your holdings by multiplying the NAV by the number of shares you own.

3 The third column is the offering price or, in some papers, the "ask price"—the price you would have paid if you had purchased shares that day. The offering price is the NAV plus any sales charges. If there are no sales charges, and "NL" for "no-load" appears in this column, and the offering price is the same as the NAV. To figure the sales charge percentage, divide the difference between the NAV and the offering price by the offering price. Here, for instance, the sales charge is 7.2% ($14.52-$13.47=$1.05 divided by $14.52=0.072 or 7.2%).

4 The fourth column shows the change, if any, in net asset value from the preceding quotation—in other words, the change over the most recent one-day trading period. This fund, for example, gained eight cents per share.

Other abbreviations in these columns indicate important information about specific funds. The abbreviations are usually explained in a "key" at the beginning or end of the columns.

What are the risks of Penny-Stock Investments?

Inability to Sell Stock and Receive Cash
Some penny-stock brokerage firms resist investors' attempts to sell their stocks for cash. The broker might become "unavailable" to an investor who wishes to sell, or the broker might refuse to accept the sell order unless the investor agrees to buy penny stock in another company which the brokerage firm is marketing.

What are the risks of Penny-Stock Investments?

Lack of Information About The Investment
Unlike most large, well established companies, many companies that issue penny stock do not make quarterly and annual reports available to the public. This lack of information about the company's operating history and financial health increases the risk to the investor. The market price of such stock can be based more on the aggressive marketing of the selling broker than on the real value of the company.

Penny-Stock Broker: "What did I tell you! Your stock is up 100% . . . SELL? Are you kidding ? This is no time to sell!"

What are the risks of Penny-Stock Investments?

Risk of Substantial, Immediate Loss
With penny stocks, the "spread" between the price at which the investor can buy the stock from the brokerage firm ("ask price") and the price at which the investor can sell the stock to the brokerage firm ("bid price") is often very large. At the time the stock is purchased, the investor may suffer a substantial "paper loss" on the investment. For example, if a stock has an ask price of 20 cents and a bid price of 10 cents, the investor would suffer an immediate paper loss of 50%. The bid price of the stock would have to double for the investor to break even.

What are the risks of Penny-Stock Investments?

Risk of Being Overcharged
Brokerage firms selling penny stocks generally do not earn their profits through commissions. Instead, they make money by charging the investor an undisclosed "mark-up" above the price the firm has paid for the stock. Although excessive mark-ups are illegal, some firms nevertheless charge mark-ups of 100% or more.

What are the risks of Penny-Stock Investments?

Risk of Manipulation
Because many penny stocks are traded by a single brokerage firm or by a small group of firms, it is easy for them to manipulate the stock price. After the brokerage firms acquire a large number of shares at a low price, they can manipulate the stock by creating an artificial demand to drive up the price. When manipulation occurs, the stock's price may not reflect the true value of the company, but rather the artificial demand created by aggressive marketing. The price may then collapse after the broker and other persons involved in the manipulation sell their shares.

Penny-Stock Broker: "Since my firm is a 'market maker' in this stock, we can get it for you without charging you a commission."

What are the risks of Penny-Stock Investments?

While there are risks with any investment, certain risks are greater with penny stocks. Some of the risks are:

Risk of Manipulation

Risk of Being Overcharged

Risk of Substantial, Immediate Loss

Lack of Information About The Investment

Inability to Sell Stock and Receive Cash


Come back and check out more information about all these in depth. More to come later!

Please come back!!

Investing 401(k) Balances in Company Stock

The recent corporate scandals at several large, publicly traded firms such as Enron and WorldCom were particularly devastating for many employees of these firms, who had invested their retirement assets heavily in company stock. Such behavior is a clear violation of diversification principles - one study finds that the additional risk associated with investing in company stock has an average cost equivalent to 42% of the stock's value. Yet despite the risks, such behavior is common - more than 50% of retirement assets are invested in company stock at many firms, and more than 80% at some large firms including Procter & Gamble, Anheuser-Busch, and Pfizer.

Many firms encourage employees to hold company stock by making matched contributions to retirement accounts, or 401(k)s, in stock and in some cases by restricting employee's rights to sell this stock for some period of time. Yet employees ultimately determine the role of company stock in their portfolio via two decisions - how to allocate their own contributions across the available investment options (including company stock) and whether to reallocate their 401(k) holdings at any point in time.

In "Employees' Investment Decisions about Company Stock" (NBER Working Paper 10228), James Choi, David Laibson, Brigitte Madrian, and Andrew Metrick focus on one factor that is likely to affect employees' investment decisions: past returns on the company's stock. Specifically, the authors ask whether plan participants are momentum investors, who invest more in company stock when the stock has recently done well and less when it has done poorly, or contrarian investors, who do the opposite. The authors use changes in stock returns at three large firms from 1992 to 2000 to identify the effect of returns on the investment decisions of 94,000 plan participants.

The authors begin by offering a snapshot of the average plan participant at these firms. This employee has a 401(k) balance of $89,000, of which 18% is invested in company stock and 46% is invested in other equities. The employee makes a voluntary contribution of 8.7% of salary to the 401(k) plan, and one-tenth of that contribution is directed to company stock. Six years after enrolling in the plan, 80% of participants have changed the allocation of their contribution among the various asset classes or made a reallocation of their assets between asset classes (a "trade"). Very few participants make more than one trade every two years.

The authors first examine participants' decisions to allocate part of their payroll contributions to company stock when they first join the plan. They find that a higher return on company stock over the past year is associated with allocating more of the contribution to company stock and less to other equities, with the amount allocated to all equities unchanged. Thus, company stock returns have a mostly compositional effect on overall equity contributions. Interestingly, higher returns on the S&P 500 Index have a very similar effect.

Next, the authors examine participants' decisions to change the allocation of their payroll contributions. They find that higher returns on company stock lead participants to shift more of their contribution into both company stock and other equities. By contrast, higher returns on the S&P 500 Index lead participants to reduce their contribution to company stock and raise their contribution to other equities, with the total share in equities rising. Overall, the authors conclude that participants are momentum investors when making decisions about investment flows.

Finally, the authors examine participants' decisions to rebalance their portfolios by making trades among the various asset classes. They find that high returns on company stock induce participants to sell company stock and buy other equities. Thus participants are contrarian investors when making trading decisions, rebalancing their portfolio away from company stock when the stock has done well.

Persistent high returns on company stock over time will result in a 401(k) account that is heavily weighted towards company stock, absent action by the plan participant to rebalance the portfolio. The authors' findings suggest that this concentration of 401(k) assets in company stock will be exacerbated by participants' tendency to increase the share of their contributions allocated to company stock when the stock is doing well, but is also mitigated by participants' tendency to rebalance their portfolio away from company stock.

nasdaq 5000

Promote Equal Regulation of Market Centers

Not that many years ago, the NMS could be divided fairly clearly into groups of stocks, each with its own particular mix of market centers. The traditional auction exchanges – NYSE and the American Stock Exchange LLC ("Amex") – dominated trading in their listed stocks, with some dealer participation on the regional exchanges and in the third market. Market makers dominated trading in Nasdaq stocks.

Today, these historical divisions are disappearing. For Nasdaq stocks, automated quote-driven market centers (such as Nasdaq's SuperMontage, the Archipelago Exchange,⁴ and Inet ATS, Inc. ("Inet")) have captured more than 50% of share volume. For Amex stocks (for which approximately 39% of share volume now is represented by two extremely active exchange-traded funds (“ETFs”) -- the QQQ and SPDR), Amex now handles approximately 27% of the volume, with the remaining balance split among Archipelago, Inet, and others. The NYSE has retained approximately 75% of the volume in its listed stocks, but other market centers are attempting to raise the level of competition and increase their share of trading. Moreover, the NYSE and Amex have sought to add automated facilities that are integrated with and complement their traditional exchange floors.

The intensified competition, or threat of competition, in the NMS in recent years has benefited investors by reducing trading costs and prompting better, more efficient services. The rules that govern the NMS, however, need to be updated to reflect the new market conditions. Many rules, for example, were developed separately for listed markets and the Nasdaq market. This disparity makes little sense today when the level of trading volume and the identity and character of participating market centers are becoming more similar for both listed and Nasdaq securities.

Section 11A(c)(1)(F) of the Exchange Act grants the Commission rulemaking authority to assure equal regulation of all markets for NMS securities. Today, in many respects, the same rules apply across all U.S. equity markets. For instance, all broker-dealers have an obligation to seek to obtain best execution for their customers’ orders – specifically, to seek to obtain the most favorable terms available under the circumstances.⁵

In other respects, however, there is disparity in rules across markets, and the Commission believes the proposals set forth in Regulation NMS will help further the statutory objective of assuring equal regulation of all markets for NMS securities. For example, the market for listed securities currently has a trade-through rule affirming the principle of price priority, while the market for Nasdaq securities does not. The proposed trade-through rule would address this disparity. In addition, certain market centers currently charge substantial fees for access to their displayed quotes, while other market centers are not permitted to assess such charges. The proposed access rule would address this disparity. Finally, some market centers currently engage in sub-penny quoting, while others do not. The proposed sub-penny rule would establish a uniform quoting convention.

stock market crash of 1929

George Mehales lost everything in the stock market crash of 1929, including his restaurant. "The first day of October in 1929 made me feel like I was rich . . . (then,) I was wiped out . . . I had nothing left." Mehales, a Greek immigrant who lived in South Carolina, was just one of many inexperienced investors who hoped to get rich quick in the rapidly growing market of the 1920s. The stock market can be a good place to invest some of your money, but it is also risky, especially if you do not know much about stocks.The Great Crash affected everyone, even those who had not bought stocks. People ran to their banks to get their savings, fearing the banks would run out of money.

question and answers about ETF's

1. How are actively managed ETFs likely to be structured, managed and operated?

Actively managed ETFs will likely be structured in a manner similar to existing index-based ETFs.

2. How will investors use, and benefit from, actively managed ETFs?

The growth over the last few years in index-based ETFs reflects investors' growing understanding and acceptance of the benefits and features that ETFs offer over traditional index-based open-end management investment companies, or mutual funds.¹ Since January, 1993 over 100 ETFs have been introduced that now have over $80 billion in assets. A research study conducted by Financial Research Corporation on "The Future of Exchange Traded Funds" found that the primary reasons for investor interest in ETFs are tax efficiency, trading flexibility, lower expense ratios, diversification and continuous pricing.² One need only compare the growth rate of index-based ETFs to that of traditional index mutual funds to demonstrate investor demand for the more flexible ETF product.

Actively managed ETFs could provide many of the same features and benefits as the existing ETFs. For example, actively managed ETFs that allow in-kind creation and redemption may experience increased tax efficiency over traditional actively managed mutual funds.

Actively managed ETFs will provide significant benefits to investors by expanding competition within the industry and providing additional choices for investors. They are likely to be used in a variety of ways, from investing 401k plans and wrap accounts, to trading vehicles for a particular universe of stocks or style of investing.

3. Would the exemptive relief that the Commission has granted to index-based ETFs be appropriate for actively managed ETFs?

Each application will have to be examined individually, based on its own unique circumstances. However, in general we would expect similar relief, although it is possible that additional relief may be necessary for some actively managed ETFs, as well as different representations and conditions in the exemptive application and the Commission's order for a particular fund's management and operations.

4. Are there any new regulatory concerns that might arise in connection with actively managed ETFs?

Possibly, although this is difficult to predict without actual experience. Each ETF exemptive application will have to be examined individually based on its own unique circumstances. We do not believe however, that there are any concerns or issues that cannot be dealt with by Commission's staff in the exemptive process, through prospectus disclosure and through Commission oversight.

Concept Release IV. Areas for Comment

A. Index-Based vs. Actively Managed ETFs

5. For purposes of the Concept Release, the Commission assumed that any ETF that would not seek to track the performance of a market index by either replicating or sampling the index securities in its portfolio would be an actively managed ETF. Is this an appropriate way to distinguish between index-based and actively managed ETFs?

The Commission has assumed that any ETF that does not seek to track the performance of a market index by either replicating or sampling the index securities in its portfolio would be actively managed. This would include leveraged and short index funds that seek to achieve a multiple (or the reverse) of the performance of a market index. We do not believe that the leveraged and short index funds should be considered active. These funds operate in virtually the same manner as ordinary index funds. Rather, investment objective and strategy, the degree of adviser discretion and flexibility and perhaps the contents of the portfolio, are key in determining whether a fund is actively managed.

6. Are there any reasons to distinguish between different types of actively managed ETFs?

If so, we think these distinctions will be primarily with respect to disclosure, or from a sales and marketing perspective, as well as based on a fund's investment strategy and methodology. However, this will be consistent with the way different types of actively managed mutual funds and UITs are currently distinguished. Active management is a broad description. In many cases active management involves an advisor making constant discretionary decisions on the investment merits of a specific security, sector, country, currency etc. In other cases active management may be a "rules-based" or "top picks" investment process, with very little discretion. "Rules-based" means a defined set of guidelines for the inclusion and deletion of securities in a portfolio, consistently applied, and made publicly available. "Top picks" is used here to describe well-defined and publicized lists of securities published by securities firms, which form the basis for packaged or basket products. Some active ETFs that are "rules-based" or "top picks" portfolios may disclose portfolio composition files on a frequency that is consistent with index-based ETFs, and are likely to operate the same way. Creation and redemption features may vary; some actively managed ETFs may require cash creations and/or redemptions. As noted in the Concept Release, ETFs issue shares only in large aggregations or blocks, called "Creation Units". An investor may purchase a Creation Unit with a "Portfolio Deposit" equal in value to the aggregate NAV of the aggregate ETF shares in the Creation Unit. The Portfolio Deposit generally consists of a basket of securities that mirrors the composition of the ETF's portfolio, and usually also includes a small amount of cash to account for the difference between the value of the basket of securities and the NAV of the ETF shares. ETF shares are not redeemable from the ETF except in Creation Unit aggregations. An investor presents a Creation Unit to the ETF for redemption, and receives a "Redemption Basket". The Redemption Basket usually contains the same securities in the Portfolio Deposit, along with a small amount of cash. However, some actively managed ETFs could have different creation and redemption baskets, i.e. the composition of the Portfolio Deposit would differ from the Redemption Basket.

7. If there are different types of actively managed ETFs, are there any reasons to regulate the various types differently?

This question cannot be answered unless specific types of actively managed ETFs are modeled in terms of their operation and then compared. Generally, any such reasons should be allowed to emerge on a case-by-case basis through applications for exemption by specific funds.

Concept Release IV. Areas for Comment
B. Operational Issues Relating to Actively-Managed ETFs

8. Is it important that ETFs be designed to enable arbitrage and thereby minimize the probability that ETF shares will trade at a large premium or discount?

Yes. The ability to arbitrage and thereby limit premia/discounts in secondary market prices is a significant factor in the acceptance and usage of ETFs by investors. The ability to arbitrage enhances market liquidity, efficiency and price discovery and would be an important factor for all investors using actively managed ETFs. It is in the interest of an actively managed ETF sponsor to work to insure that its product is not susceptible to significant premia or discounts for any sustained period of time. However, what is an acceptable level of premium/discount must be judged in the context of the particular exemptive application and ETF.

An important element in achieving a successful product is the availability of and appropriate disclosure of current information as to per-share portfolio value of the ETF throughout the trading day. In order to provide information to the market, the Exchange disseminates every 15 seconds over Network B of the Consolidated Tape Association an "indicative portfolio value" reflecting the fluctuating intra-day value for each ETF listed on the Exchange. [In the case of the replicated UIT ETFs, this indicative portfolio value is based on the applicable index.] The indicative portfolio value is calculated by a securities market information provider, and disseminated on a per-share basis every 15 seconds during the regular Amex trading hours of 9:30 a.m. to 4:00 p.m. Eastern time. The equity securities included in the indicative portfolio value generally reflect the same market capitalization weighing as the Portfolio Deposit which is part of the Creation Unit. This information is very important to the market in terms of achieving efficient pricing, and arbitrage.

9. In considering whether to grant the exemptive relief necessary to permit actively managed ETFs, should we be concerned about whether their shares will trade at a significant premium or discount?

Yes. However, actively managed ETFs, like index-based ETFs, should not experience significant "sustained" premia/discounts due to the open-end structure which allows shares outstanding to increase and decrease upon demand, and due to the availability of current market information such as indicative portfolio value throughout the trading day. The iShares MSCI ETFs (formerly known as WEBS) provide the best evidence in assessing the potential for significant and sustained premia/discounts in actively managed ETFs. These products, unlike SPDRs, MidCap SPDRs, DIAMONDS, and QQQs, are optimized index portfolios investing in foreign markets which are often closed while the ETF trades in the U.S. In the fall of 1997, after the start of the Thai currency crisis, the WEBS Hong Kong ETF experienced a large increase in the number of buy orders; this, combined with the underlying market being closed and uncertainty as to the levels the Hong Kong market would open caused the WEBS Hong Kong ETF to experience a premium greater than 20% to the last NAV. However, once the underlying market reopened and purchaser of Creation Units could be initiated, the WEBS Hong Kong ETF opened the next day with a reversal of such premium.

We note that if certain actively managed ETFs were to trade at a significant sustained discount they likely would not survive due to their open-end nature, because investors would buy the ETF shares at far less than NAV and redeem Creation Units, obtaining NAV and causing the ETF to shrink below an economic level for its sponsor.

Planning Your Estate

Planning your estate is to distribute your assets according to your wishes after your death. Successful estate planning transfers your assets to your beneficiaries quickly and usually with minimal tax consequences. The process of estate planning includes inventorying your assets and making a will and/or establishing a trust, often with an emphasis on minimizing taxes. This pamphlet provides only a general overview of estate planning. You should consult an attorney, or perhaps a CPA or tax advisor for additional guidance.

Do I Need to Worry?

You may think estate planning is only for the wealthy. If your assets are worth $1,000,000 or more, estate planning may benefit your heirs. That's because generally taxable estates worth in excess of the amounts in the chart below may be subject to federal estate taxes, with rates as high as 45% to 50% of the taxable estate.

Adding up the value of your assets can be an eye-opening experience. By the time you account for your home, investments, retirement savings and life insurance policies you own, you may find your estate in the taxable category.

Even if your estate is not likely to be subject to federal estate taxes, estate planning may be necessary to be sure your intentions for disposition of your assets are carried out.

YEAR	EXCLUSION AMOUNT	HIGHEST ESTATE TAX RATE
2002	$1,000,000	50%
2003	$1,500,000	49%
2004	$1,500,000	48%
2005	$2,000,000	47%
2006	$2,000,000	46%
2007	$2,000,000	45%
2008	$2,000,000	45%
2009	$3,500,000	45%

It is also important to note that estate taxes are scheduled to be repealed in 2010. However, if Congress does not affirmatively extend the repeal, in 2011 the estate tax law will revert to the provisions in effect in 2001 including a $1,000,000 exclusion amount and a 55% highest estate tax rate.

Taking Stock

The first step in estate planning is to inventory everything you own and assign a value to each asset. Here's a list to get you started. You may need to delete some categories or add others.

• Residence
• Other real estate
• Savings (bank accounts, CDs, money markets)
• Investments (stocks, bonds, mutual funds)
• 401(k), IRA, pension and other retirement accounts
• Life insurance policies and annuities
• Ownership interest in a business
• Motor vehicles (cars, boats, planes)
• Jewelry
• Collectibles
• Other personal property

Once you've estimated the value of your estate, you're ready to do some planning. Keep in mind that estate planning is not a one-time job. There are a number of changes that may call for a review of your plan. Take a fresh look at your estate plan if:

• The value of your assets changes significantly.
• You marry, divorce or remarry.
• You have a child.
• You move to a different state.
• The executor of your will or the administrator of your trust dies or becomes incapacitated, or your relationship with that person changes significantly.
• One of your heirs dies or has a permanent change in health.
• The laws affecting your estate change.

How Estates Are Taxed

Federal gift and estate tax law permits each taxpayer to transfer a certain amount of assets free from tax during his or her lifetime or at death. (In addition, as discussed in the next section, certain gifts valued at $11,000 or less can be made that are not counted against this amount.) The amount of money that can be shielded from federal estate or gift taxes is determined by the federal applicable credit. The credit is used during your lifetime when you make certain taxable gifts, and the balance, if any, can be used by your estate after your death.

Keep in mind that while you can plan to minimize taxes, your estate may still have to pay some federal estate taxes. What's more, your estate may be subject to state estate or inheritance taxes, which are beyond the scope of this pamphlet. An estate planning professional can provide more information regarding state taxes.

Minimizing Estate Taxation

There are a number of estate planning methods that can be used to minimize federal taxes on your estate.

Giving away assets during your lifetime. Federal tax law generally allows each individual to give up to $11,000* per year to anyone without paying gift taxes, subject to certain restrictions. That means you can transfer some of your wealth to your children or others during your lifetime to reduce your taxable estate. For example, you could give $11,000 a year to each of your children, and your spouse could do likewise (for a total of $22,000 per year to each child). You may make $11,000 annual gifts to as many people as you wish. You may also give your child or another person more than $11,000 a year without having to pay federal gift taxes, but the excess amount will count against the amount shielded from tax by your applicable credit. For example, if you gave your favorite niece $33,000 a year for the last three years, you would have reduced your applicable credit by $66,000 (a $22,000 excess gift each year).

* The annual gift tax exclusion will be adjusted for inflation, as measured by the Consumer Price Index (CPI) published by the Department of Labor. The increases will be in multiples of $1,000. This exclusion applies only to a gift of a present interest in property. Therefore, gifts made intrust generally will not qualify for this exclusion.

The marital deduction shields property transferred to a spouse from taxes. Federal tax law generally permits you to transfer assets to your spouse without incurring gift or estate taxes, regardless of the amount. This is not, however, without its drawbacks. Marital deductions may increase the total combined federal estate tax liability of the spouses upon the subsequent death of the surviving spouse. To avoid this problem, many couples choose to establish a bypass trust.

Bypass trusts or credit shelter trusts can give a couple the advantages of the marital deduction while utilizing the unified credit to its fullest. Let's say, for example, that a married couple has a federal taxable estate worth $2 million (or $1,000,000 each). Using the marital deduction, if one spouse dies in 2003 the full $1,000,000 can be left to the other spouse without incurring taxes. However, when the second spouse dies in 2004 and passes his or her $2 million estate on to their children, taxes will be levied on the excess over the amount of assets shielded by the applicable credit ($2,000,000 - $1,500,000 = $500,000 subject to estate tax).

With a bypass or credit shelter trust, the first spouse to die can leave the amount shielded by the applicable credit to the trust. The trust can provide income to the surviving spouse for life, then upon the death of the surviving spouse the assets are distributed to beneficiaries, such as children. This permits the spouse who dies first to fully utilize his or her applicable credit. If the trust document is drawn properly, the assets in the trust are not included in the surviving spouse's estate. Thus, the surviving spouse's estate will be smaller and can also utilize the applicable credit. In the example above, the surviving spouse's estate would not have to pay federal estate taxes. Because both partners have made use of their applicable credit, the couple is able to pass on a substantial estate tax free to their beneficiaries.

Charitable gifts are not taxed as long as the contribution is made to an organization that operates for religious, charitable or educational purposes. Check to see if the organization you want to give money to is an eligible charity in the eyes of the Internal Revenue Service. You, or your estate may be entitled to a tax deduction for contributions to a qualifying charity. Consult your tax advisor.

Life insurance trusts can be designed to keep the proceeds of a life insurance policy out of your estate and give your estate the liquidity it needs. Generally, you can fund a life insurance trust either by transferring an existing life insurance policy or by having the trust purchase a new policy.* To avoid inclusion in your estate, such trusts must be irrevocable—meaning that you cannot dissolve the trust or change the terms of the trust if you change your mind later. With proper planning, the proceeds from life insurance held by the trust may pass to trust beneficiaries without income or estate taxes. This gives them cash which may be used to help pay estate taxes or other expenses, such as debts or funeral costs.

* Transferring an existing policy may have gift tax consequences. Consult your tax advisor.

Estate planning is very complex and is subject to changing laws. This pamphlet by no means covers all estate planning methods. Be sure to seek professional advice from a qualified attorney, and perhaps a CPA or estate planner. The money you spend now to plan your estate can mean more money for your beneficiaries in the long run.

References & Special Offers

REFERENCE MATERIALS

Plan Your Estate
Denis Clifford and Cora Jordan, Nolo Press
Life Advice® readers save up to 40% on the purchase of Nolo products by calling 1-800/728-3555 and mentioning promo code DMET or visit www.nolo.com.

Estate Planning Made Easy
By David T. Phillips and Bill S. Wolfkiel
Dearborn Financial Publishing $21.95

The American Bar Association Guide to Wills and Estates
Times Books $13.00

PAMPHLETS FROM THE FEDERAL GOVERNMENT

The quarterly Consumer Information Center catalog lists more than 200 helpful federal publications. For your free copy, write: Consumer Information Catalog, Pueblo, CO 81009, call 1-888-8-PUEBLO or find the catalog on the Net at www.pueblo.gsa.gov.

HELPFUL LINKS

Planning your estate can be a daunting task. The sites we've picked out may be able to help you sort things out.

www.freeadvice.com

CourtTV
The folks at CourtTV have put together a terrific site on all things legal.

Internal Revenue Service
You can find very helpful info from this user-friendly site. Check it out for answers to your trust-related tax questions.

Nolo Press
Nolo Press has a reference library of legal information just for you. Take a look at: Will and Estate Planning.

MetLife Life Insurance
A well-designed program for financial security begins with life insurance.

This Life Advice® Program pamphlet about Planning Your Estate was produced by the MetLife Consumer Education Center and reviewed by the Division for Public Education of the American Bar Association and the Internal Revenue Service (IRS).

Updated: February 2005

money exchange

great information on money exchange, money exchange rate, foreign money exchange, foreign money exchange rate, international money exchange, international money exchange rate

Currency Conversion - Delaware Intercorp
-- input amount, select what type of currency, select what type to convert amount into

Currency Conversion - 1-Click
-- rates downloaded daily from the "Pacific Exchange Rate Service" -- input amount from base currency and select desired region for conversion

Pacific Exchange Rate Service
-- provided by Prof. Werner Antweiler, University of British Columbia, Vancouver, Canada -- includes currency conversion rates, plus alot more, -- "This service provides access to current and historic daily exchange rates through an on-line database retrieval and plotting system. Also provided is a list of all the currencies of the world with information on each country's exchange rate regime and ISO-4217 currency code. Analyses and trend projections of the Canadian Dollar, the U.S. Dollar, and the Euro are available as well. This site is dedicated to the support of academic research and teaching in the area of exchange rate economics."

Yahoo Finance
-- includes currency conversion, plus "real-time" top ten currencies, -- convert amount entered from/to


we hope you enjoyed great information on money exchange, money exchange rate, foreign money exchange, foreign money exchange rate, international money exchange, international money exchange rate

money exchange

money exchange links

great information on money exchange, money exchange rate, foreign money exchange, foreign money exchange rate, international money exchange, international money exchange rate

---

Currency Conversion - Delaware Intercorp
-- input amount, select what type of currency, select what type to convert amount into

Currency Conversion - 1-Click
-- rates downloaded daily from the "Pacific Exchange Rate Service" -- input amount from base currency and select desired region for conversion

Pacific Exchange Rate Service
-- provided by Prof. Werner Antweiler, University of British Columbia, Vancouver, Canada -- includes currency conversion rates, plus alot more, -- "This service provides access to current and historic daily exchange rates through an on-line database retrieval and plotting system. Also provided is a list of all the currencies of the world with information on each country's exchange rate regime and ISO-4217 currency code. Analyses and trend projections of the Canadian Dollar, the U.S. Dollar, and the Euro are available as well. This site is dedicated to the support of academic research and teaching in the area of exchange rate economics."

Yahoo Finance
-- includes currency conversion, plus "real-time" top ten currencies, -- convert amount entered from/to

we hope you enjoyed great information on money exchange, money exchange rate, foreign money exchange, foreign money exchange rate, international money exchange, international money exchange rate

money exchange

money exchange links

great information on money exchange, money exchange rate, foreign money exchange, international money exchange

---

Currency Conversion - Delaware Intercorp
-- input amount, select what type of currency, select what type to convert amount into

Currency Conversion - 1-Click
-- rates downloaded daily from the "Pacific Exchange Rate Service" -- input amount from base currency and select desired region for conversion

Pacific Exchange Rate Service
-- provided by Prof. Werner Antweiler, University of British Columbia, Vancouver, Canada -- includes currency conversion rates, plus alot more, -- "This service provides access to current and historic daily exchange rates through an on-line database retrieval and plotting system. Also provided is a list of all the currencies of the world with information on each country's exchange rate regime and ISO-4217 currency code. Analyses and trend projections of the Canadian Dollar, the U.S. Dollar, and the Euro are available as well. This site is dedicated to the support of academic research and teaching in the area of exchange rate economics."

Yahoo Finance
-- includes currency conversion, plus "real-time" top ten currencies, -- convert amount entered from/to

we hope you enjoyed the great information on money exchange, money exchange rate, foreign money exchange, international money exchange

What are hedge funds?

What are hedge funds?

Like mutual funds, hedge funds pool investors' money and invest those funds in financial instruments in an effort to make a positive return. Many hedge funds seek to profit in all kinds of markets by pursuing leveraging and other speculative investment practices that may increase the risk of investment loss.

Unlike mutual funds, however, hedge funds are not required to register with the SEC. This means that hedge funds are subject to very few regulatory controls. Because of this lack of regulatory oversight, hedge funds historically have generally been available solely to accredited investors and large institutions. Most hedge funds also have voluntarily restricted investment to wealthy investors through high investment minimums (e.g., $1 million).

Historically, most hedge fund managers have not been required to register with the SEC and therefore have not been subject to regular SEC oversight. However, in December 2004, the SEC issued a final rule and rule amendments that require certain hedge fund managers to register with the SEC as investment advisers under the Investment Advisers Act by February 1, 2006.

actively managed ETF

Recently, the concept of an "actively managed ETF" has attracted significant attention, even though many of the details regarding the potential operations of actively managed ETFs are apparently still in development. Unlike an index-based ETF, an actively managed ETF would not seek to track the return of a particular index by replicating or sampling index securities. Instead, an actively managed ETF's investment adviser could select securities consistent with the ETF's investment objectives and policies without reference to the composition of an index.

Because of their unique operations, index-based ETFs first must apply to the Commission to obtain exemptive relief from certain provisions of the Act. For example, exemptive relief is necessary for index-based ETFs to redeem ETF shares only in large aggregations and for ETF shares to trade at negotiated prices in the secondary market. An actively managed ETF also would be required to obtain exemptive relief from the Act.

Before we can grant the exemptions necessary to permit the introduction of actively managed ETFs, we must conclude that the exemptions are in the public interest and consistent with the protection of investors and the purposes of the Act. As part of this process, we are issuing this release to seek comment from the public regarding the concept of actively managed ETFs. We expect that this concept release will generate comments and ideas from a wide range of parties, including individual and institutional investors, shareholder organizations, financial planners, investment advisers, fund organizations, market makers, arbitrageurs, ETF sponsors, and national securities exchanges. Our goal is to gain a better understanding of the various perspectives on the concept of actively managed ETFs. We then will be able to evaluate better any proposals for these types of products as they are presented to us through the exemptive process on a case-by-case basis.

How Existing ETFs Operate

How Existing ETFs Operate

Regardless of the organizational structure of an ETF, all existing ETFs operate in essentially the same manner. Unlike typical open-end funds or UITs, ETFs issue shares only in large aggregations or blocks (such as 50,000 ETF shares) called "Creation Units." An investor, usually a brokerage house or large institutional investor, may purchase a Creation Unit with a "Portfolio Deposit" equal in value to the aggregate NAV of the ETF Shares in the Creation Unit. The investment adviser or sponsor of the ETF announces the contents of the Portfolio Deposit at the beginning of each business day. The Portfolio Deposit generally consists of a basket of securities that mirrors the composition of the ETF's portfolio. Because the purchase price of the Creation Unit must equal the NAV of the underlying ETF shares, the required Portfolio Deposit generally also includes a small amount of cash to account for the difference between the value of the basket of securities and the NAV of the ETF shares. The value of a Creation Unit typically exceeds several million dollars. After purchasing a Creation Unit, the investor may hold the ETF shares, or sell some or all of the ETF shares to investors in the secondary market.

1. Secondary Market Trading

Like operating companies or closed-end funds, ETFs register offers and sales of shares under the Securities Act and list their ETF shares for trading on a national securities exchange under the Securities Exchange Act of 1934 ("Exchange Act"). As with any listed security, investors also may trade ETF shares in off-exchange transactions. In either case, ETF shares trade at negotiated prices. The development of the secondary market in ETF shares depends upon the activities of the exchange specialist assigned to make a market in the ETF shares and upon the willingness of Creation Unit purchasers to sell ETF shares in the secondary market.

ETF shares purchased in the secondary market are not redeemable from the ETF except in Creation Unit aggregations. If an investor presents a Creation Unit to the ETF for redemption, the redeeming investor receives a "Redemption Basket," the contents of which are identified by the ETF investment adviser or sponsor at the beginning of the day. The Redemption Basket (usually the same as the Portfolio Deposit) consists of securities and a small amount of cash. As with purchases from the ETF, redemptions from the ETF are priced at NAV (i.e., the value of the Redemption Basket is equal to the NAV of the ETF shares in the Creation Unit). An investor holding fewer ETF shares than the amount needed to constitute a Creation Unit may dispose of those ETF shares only by selling them in the secondary market. The investor receives market price for the ETF shares, which may be higher or lower than the NAV of the ETF shares. The investor also pays customary brokerage commissions on the sale.

2. Arbitrage Opportunities

Because of arbitrage opportunities inherent in the ETF structure, ETF shares generally have not traded in the secondary market at a significant premium or discount in relation to NAV. If ETF shares begin to trade at a discount (i.e., a price less than NAV), arbitrageurs may purchase ETF shares in the secondary market and, after accumulating enough shares to equal a Creation Unit, redeem them from the ETF at NAV, and thereby acquire the more-valuable securities in the Redemption Basket. In purchasing the ETF shares, arbitrageurs create greater market demand for the shares, which may raise the market price to a level closer to NAV. If ETF shares trade at a premium (i.e., a price greater than NAV), arbitrageurs may purchase the securities in the Portfolio Deposit, use them to obtain the more-valuable Creation Units from the ETF and then sell the individual ETF shares in the secondary market to realize their profit. As the supply of individual ETF shares available in the secondary market increases, the price of the ETF shares may fall to levels closer to NAV. An exchange specialist designated to maintain a market in the ETF shares also works to provide appropriate amounts of shares in the secondary market in response to supply and demand.

In addition, because the ETF investment adviser or sponsor announces the identities of the securities in the Portfolio Deposit and Redemption Basket each day, arbitrageurs also may decide to engage in arbitrage transactions based on their need for particular securities (for example, to replace borrowed securities that the arbitrageur previously sold "short") or on their own assessment of the relative value of the Portfolio Deposit or Redemption Basket in comparison to the price of the ETF shares. As an apparent result of this arbitrage discipline, ETF sponsors and market participants report that the average deviation between the daily closing price and the daily NAV of ETFs that track domestic indices is generally less than 2%.¹⁷ With respect to ETFs that track certain foreign indices, the deviations may be more significant.¹⁸

17

See, e.g., Second Amended and Restated Application of Barclays Global Fund Advisors, File No. 812-11600, filed May 11, 2001 ("Barclays Application") at 57-58 (stating that average deviations between the daily closing price and the daily NAV of ETF shares of ETFs tracking domestic indices range from a premium of .05% to a discount of .02%). Persons may obtain copies of applications cited in this concept release for a fee from the Commission's Public Reference Branch, 450 5th Street, N.W., Washington, D.C. 20549-0102 (telephone 202/942-8090). See also John Spence, Salomon Releases ETF Premium/Discount Study, indexfunds.com, Oct. 23, 2000 (reporting that a Salomon Smith Barney study of the trading of ETF shares found that shares of ETFs tracking domestic indices had an average bid price that was a .17% discount to the ETFs' respective estimated intra-day NAVs, as recorded at random points during the trading days in September 2000), at http://www.indexfunds.com/Pfarticles/20001023_SSMBstudy_iss_etf_JS.htm.

18

See, e.g., Barclays Application at 36 (stating that the Malaysia (Free) WEBs Index Fund traded at wider spreads to NAV following the imposition of capital controls by the Malaysian government in 1998). See also Memorandum in Support of Hearing Request filed by Fund Democracy, LLC, and the Consumer Federation of America with respect to the Barclays Application (arguing that arbitrage opportunities do not ensure that the difference between the market price and NAV of ETF shares will remain narrow, and citing in particular the experience of ETFs tracking various foreign indices), available at http://www.funddemocracy.com/hearing_request_docs.htm.

stock options

Option Buying an option gives you the right to buy or sell a specific financial instrument at a specific price, called the strike price, during a preset period of time. In the U.S., you can buy or sell listed options on individual stocks, stock indexes, futures contracts, currencies, and debt securities.

If you buy an option to buy, which is known as a call, you pay a one-time premium that's a fraction of the cost of buying the underlying instrument. For example, when a particular stock is trading at $75 a share, you might buy a call option giving you the right to buy 100 shares of that stock at a strike price of $80 a share. If the price goes higher than the strike price, you can exercise the option and buy the stock, or sell the option, potentially at a net profit.

If the stock price doesn't go higher than the strike price before expiration, you don't exercise the option, and it expires. Your only cost is the money that you paid for the premium. Similarly, you may buy a put option, which gives you the right to sell the underlying instrument at the strike price. In this case, you may exercise the option or sell it at a potential profit if the market price drops below the strike price.

In contrast, if you sell a put or call option, you collect a premium and must be prepared to deliver (in the case of a call) or purchase (in the case of a put) the underlying instrument if the investor who holds the option decides to exercise it and you’re assigned to fulfill the obligation. You may choose to buy the same option you sold before assignment and offset your obligation.

The fx online trading experiment: conclusion

Conclusion

The Tokyo experiment provides four facts that support the presence of information that both is not publicly available and is important for exchange rate movements. First, the volatility of the yen/dollar rate over the lunch hour increases significantly when the trading restriction is lifted. This volatility increase cannot be due to public information since there was no change in the timing of macroeconomic announcements. Second, allowing trade over lunch produces a more even volatility pattern over the full day. This is a natural consequence of informative trades being redirected toward the lunch hour. Third, when Tokyo took a lunch break there was a significant increase in volatility just before the break. Models based on non-public information predict this: traders with superior information will choose to trade before the break to ensure that prices cannot adjust before they have opened a position. Finally, allowing trade over lunch causes the increase in pre-lunch volatility to disappear. Models based on non-public information also predict this: since there is no longer a break, traders with superior information do not face the same pressure to trade in the pre-lunch period. In sum, non-public information provides a powerful driver of trading volume, one that plays no role under the traditional macro-oriented asset market approach to exchange rates.

The Tokyo experiment: results

Now, what happened to lunch-hour volatility after the trading restriction was lifted? Lunch return volatility doubled. This increase is statistically significant and is illustrated in Figure1, which is based on three 90-minute periods. Even though this result is similar to that of French and Roll, it is perhaps more striking since most people believe that in the FX market the flow of public information is even more important for understanding volatility than in the equity market.

So what's going on? Because we have controlled for public information, the volatility increase must be coming from one of the other two explanations cited above -- non-public information and pricing errors. To discriminate between them, we can look to relevant theory for testable implications. Specifically, we can look to work on volatility patterns. It is a stylized fact that within a trading day, volatility in most financial markets is relatively high in the morning, lower midday, and then high again in the afternoon. This is typically referred to as the intraday volatility "U-shape." From Figure 1 it is clear that this holds for the foreign exchange market as well. Theory explains the volatility U-shape using non-public information. We can use this theory to provide testable implications of the presence of non-public information, for example, how the U-shape should change when lunch-hour trading is introduced. Specifically, theory predicts the U-shape will flatten: more information can be revealed through trading over the lunch period, leaving a smaller share for the morning and afternoon. Clearly, this implication of non-public information is borne out in Figure 1 as well.

There is another testable implication provided by models with non-public information. This implication relates to trading over the morning period: if non-public information is indeed driving the U-shape, then in the period with closure over lunch we should find a morning U-shape. Moreover, after the restriction is lifted we should find that the morning U-shape disappears as a full-day U-shape emerges. Figure 2 verifies that this is the case, using higher resolution hourly intervals from 9:00AM-1:00PM. The data behave just as the models based on non-public information predict.

Now the question must be confronted: What is this information that is not publicly available but clearly moves exchange rates? Of the many examples, I describe just two. First, actual FX traders, for example, often cite the fact that not all market participants have the same information about real-time trading activity. Traders at big commercial banks have a lot more customers placing large trades directly through them. This non-public information about demands allows them to forecast how the market will react when it learns about these big trades (that is, it is a motive for speculative trading). Another example, cited above, is advance knowledge of the trades of central banks during intervention operations: a dealer who first receives a central bank's order has superior information for forecasting exchange rate movements.

The Tokyo experiment: description

The Tokyo experiment addresses a key motive for FX trading: informational advantages. The experiment is based on a simple fact: in general, volatility is much higher over periods of continual trading than over otherwise similar periods that contain a closure. Why should this be so? Three possible explanations have been proposed: (1) publicly available information, like a macroeconomic announcement, arrives primarily during trading hours and therefore affects price at that time; (2) errors in pricing may be more likely during trading hours; and (3) some people may be trading on information that is not publicly available, thereby affecting price during trading hours.

To discriminate among these explanations, an insightful paper by French and Roll (1986) examined stock market closures. These closures were special, however: they occurred on what otherwise would have been normal trading days, and the cause of the closures-bookkeeping backlogs-had nothing to do with the rest of the economy. Thus, the flow of publicly available information on these days was the same as on normal trading days (as compared to, say, a holiday). They found that volatility over periods spanning these closures decreases. Since this cannot be due to a changing flow of public information, they turned to the other two possible explanations. After finding only a small role for pricing errors, they concluded that some type of information about equities that is not publicly available is the main source of high trading-time volatility.

To perform a French-Roll type analysis on the foreign exchange market one needs an experiment like theirs, namely, open and closed periods that do not differ in the flow of public information. The lifting of the trading restriction in Tokyo is just such an experiment. Three key facts support the possibility that the flow of public information remained unchanged. First, abolishing the trading restriction was not part of a broader policy reform, nor was it the work of the Ministry of Finance; rather, it was an isolated change in regime, unlikely to be correlated with Ministry of Finance policy more generally. Second, reviewing the schedule of relevant macroeconomic announcements in the subsequent months shows that no change over the lunch hour occurred. Third, the timing of some public information is endogenous and may be affected by trading rules (an issue that arises in the French-Roll paper as well since their closures were known in advance). However, an examination of the flow of news reports on the Money Market Headline News screen, a measure of public information flow commonly used by analysts, suggests that the number did not increase after lifting the restriction. Thus, the usual measures indicate that the flow of public information remained unchanged.

Explaining Trading Volume in Foreign Exchange: The three approaches

The three approaches

Until the 1970s the goods market approach was the traditional explanation for exchange rate movements. Under this approach, demand for currencies is determined largely by purchases and sales of goods. For example, an increase in exports increases foreigners' demand for domestic currency to pay for those exports. The FX trading volume this approach produces, however, is limited to the underlying volume of trade in real goods and services. This is grossly inconsistent with the data: trade in goods and services can account for less than 5% of FX trading.

In the 1970s the asset market approach emerged. It built on the earlier approach by recognizing that the demand for currencies depends not only on purchases and sales of goods, but also on purchases and sales of assets. For example, in order to purchase a Japanese government bond an investor must first purchase the yen needed to make payment. While the asset market approach clarified thinking considerably, empirical work in the 1980s could not confirm it: the macroeconomic variables that move exchange rates under this approach do not have the predicted effect. Moreover, this approach does not explain the enormity of the trading volume. The reason is that, under this approach, macroeconomic information relevant for purchasing and selling assets is publicly available, and everybody agrees on the implications of that information. In this setting, news moves the exchange rate without trading. And people do not trade with one another on the basis of different views because they all hold the same view. Thus, seen from this approach, the enormous trading volume in FX remains a puzzle.

Analyzing the Tokyo experiment--the lifting of the lunchtime trading restriction--illustrates a new approach to exchange rates, the microstructure approach. Like the asset market approach, this approach focuses on the demand for currencies as coming from purchases and sales of assets. It extends the asset market approach by loosening three of its most uncomfortable assumptions. First, microstructure models relax the assumption that all information relevant to exchange rates is publicly available. For example, bank traders, at their trading desks see trades and quotes in the market that are not observable by the public. These quotes and trades may be valuable for forecasting future exchange rate movements, even if only in the short run (e.g., seeing a central bank's intervention trade before the rest of the market). Second, the microstructure models loosen the assumption that all market participants are alike. For example, traders may disagree about the implications of a given piece of information; or they may be trading for different reasons-like hedging versus speculation. Third, this approach models the trading environment more explicitly. For example, microstructure models are explicit about the timing of trades--o

Explaining Trading Volume in Foreign Exchange: Lessons from Tokyo

The enormous volume of trading in foreign exchange (FX) markets--almost 100 times the volume on the New York Stock Exchange--has been a puzzle. Economists have turned to a variety of approaches to solve the puzzle--the goods market approach, the asset market approach, and the microstructure approach.

This Economic Letter (based on Ito, et al., 1998) focuses on the microstructure approach, with particular attention to the Tokyo market. In 1994, this market made a change in the way it does business, a change that might seem to have nothing to do with explaining trading volume. The market lifted the restriction on trading during the lunch hour (12:00-1:30). This Letter shows that, in fact, the shift from a lunchtime break to continuous trading provides a natural experiment on one of the underlying motives for trading. In itself, the Letter does not resolve the trading volume puzzle (see, e.g., Lyons 1996 for other microstructure factors that amplify volume). Understanding the motive addressed here does, however, contribute to a resolution.

The Trouble with Stock Options

"The company cost of stock options is often higher than the value that risk-averse and undiversified workers place on their options."

---

Stock options have become contentious. The root of the problem lies in widely held misperceptions concerning the cost of granting such options, according to Brian Hall and Kevin Murphy writing in The Trouble with Stock Options (NBER Working Paper No. 9784).

Stock options are compensation that give employees the right to buy shares at a pre-specified "exercise" price, normally the market price on the date of grant. The purchasing right is extended for a specified period, usually ten years. Between 1992 and 2002, the value of the options granted by firms in the S&P 500 rose from an average of $22 million per company to $141 million per company (with a high point of $238 million reached in 2000). Over this period, CEO compensation skyrocketed, largely fueled by stock options. Yet the CEO share of the total amount of stock options granted actually fell from a high point of about 7 percent in the mid-1990s to less than 5 percent in 2000-2. Indeed, by 2002 more than 90 percent of stock options were being granted to managers and employees.

Hall and Murphy argue that, in many cases, stock options are an inefficient means of attracting, retaining, and motivating a company's executives and employees since the company cost of stock options is often higher than the value that risk-averse and undiversified workers place on their options. In regard to the first of these aims - attraction -- Hall and Murphy note that companies paying options in lieu of cash effectively are borrowing from employees, receiving their services today in return for payouts in the future. But risk-averse undiversified employees are not likely to be efficient sources of capital, especially compared to banks, private equity funds, venture capitalists, and other investors. By the same token, paying options in lieu of cash compensation affects the type of employees the company will attract. Options may well draw highly motivated and entrepreneurial types, but this can benefit a company's stock value only if those employees- that is, top executives and other key figures -- are in positions to boost the stock. The vast majority of lower-level employees being offered options can have only a minor affect on the stock price.

Options clearly promote retention of employees, but Hall and Murphy suspect that other means of promoting employee loyalty may well be more efficient. Pensions, graduated pay raises, and bonuses - especially if they are not linked to stock value, as options are - are likely to promote employee retention just as well if not better, and at a more attractive cost to the company. In addition, as numerous recent corporate scandals have shown, compensating top executives via stock options may inspire the temptation to inflate or otherwise artificially manipulate the value of stock.

Hall and Murphy maintain that companies nevertheless continue to see stock options as inexpensive to grant because there is no accounting cost and no cash outlay. Furthermore, when the option is exercised, companies often issue new shares to the executives and receive a tax deduction for the spread between the stock price and the exercise price. These practices make the "perceived cost" of an option much lower than the actual economic cost. But such a perception, Hall and Murphy maintain, results in too many options for too many people. From the perceived cost standpoint, options may seem an almost cost-free way to attract, retain, and motivate employees, but from the standpoint of economic cost, options may well be inefficient.

Hall and Murphy's analysis has important implications for the current debate about how options are expensed, a debate that has become more heated following the accounting scandals. A year ago the Financial Accounting Standards Board (FASB) announced that it would consider mandating an accounting expense for options, with hopes that this would be adopted early in 2004. Federal Reserve Chairman Alan Greenspan, investors like Warren Buffet, and numerous economists endorse recording options as an expense. But organizations such as the Business Roundtable, the National Association of Manufacturers, the U.S. Chamber of Commerce, and high-tech associations oppose "expensing" options. The Bush Administration sides with these opponents, while Congress is divided on the issue.

Hall and Murphy believe that the economic case for "expensing" options is strong. The overall effect of bringing the perceived costs of options more in line with their economic costs will be fewer options being granted to fewer people - but those people will be the executives and key technical personnel who can realistically be expected to have a positive impact on a company's stock prices. The researchers also point out that current accounting rules favor stock options at the expense of other types of stock-based compensation plans, including restricted stock, options where the exercise price is set below current market value, options where the exercise price is indexed to industry or market performance, and performance-based options that vest only if key performance thresholds are reached. Current rules are likewise biased against cash incentive plans that can be tied in creative ways to increases in shareholder wealth.

Hall and Murphy conclude that managers and boards can be educated about the true economic costs of stock options and other forms of compensation, and that the asymmetries between the accounting and tax treatment of stock options and other forms of compensation must be eliminated. Proposals to impose an accounting charge for option grants would close the gap between perceived and economic costs.