STOCK MARKET STOCK MARKET HISTORY History of stock market trading in the United States can be traced back to over 200 years ago. Historically, The colonial government decided to finance the war by selling bonds, government notes promising to pay out at profit at a later date. Around the same time private banks began to raise money by issuing stocks, or shares of the company to raise their own money. This was a new market, and a new form of investing money, and a great scheme for the rich to get richer. A little futher on the history tumeline, more specifically in 1792, a meeting of twenty four large merchants resulted into a creation of a market known as the New York Stock Exchange(NYSE). At the meeting, the merchants agreed to meet daily on Wall Street to daily trade stocks and bonds. Further in history, in the mid-1800s, United States was experiencing rapid growth. Companies needed funds to assist in expansion required to meet the new demand. Companies also realized that investors would be interested in buying stock, partial ownership in the company. History has shown that stocks have facilitated the expansion of the companies and the great potential of the recently founded stock market was becoming increasingly apparent to both the investors and the companies. By 1900, millions of dollars worth of stocks were traded on the street market. In 1921, after twenty years of street trading, the stock market moved indoors. History brought us the Industrial Revolution, which also played a role in changing the face of the stock market. New form of investing began to emerge when people started to realize that profits could be made by re-selling the stock to others who saw value in a company. This was the beginning of the secondary market, known also as the speculators market. This market was more volatile than before, because it was now fueled by highly subjective speculation about the company’s future. This was the pretext for appearance of such stock market giants as NYSE. History books tell us that the reason the NYSE is so highly regarded among stock markets was primarily because they only trade in the very large and well-established companies. It acted as a more stable investment alternative, for people interested in throwing their capital into the stock market arena. The smaller companies making up the stock market formed into what eventually became the American Stock Exchange (AMEX). Contrary to the 80-year old history, today the NYSE, AMEX, NASDAQ and hundreds of other exchange markets make a significant contribution to the national and global economy. The growth in the number of market participants led the government to decide that more regulation of the stock market was needed to protect those investing in stock. History was made in 1934, when following the Great Crash, Congress passed the Securities and Exchange Act. This act formed the Securities and Exchange Commission (SEC), which, through the rules set out by the act and succeeding amendments, regulates American stock market trading with the help of the exchanges. It also includes overseeing the requirements for a company to issue stock shares to the public and ensures that the company offers relevant information to potential investors. The SEC also oversees the daily actions of market exchanges and how they trade the securities offered. Although historically, investing in stocks was a “hobby” for the rich, an average person too soon came to realize the value of the investing in stocks vs. traditional assets like land or a house. STOCK MARKET- EXPLAINED IN BRIEF A typical dictionary definition for stock is (the capital raised by a corporation through the issue of shares entitling holders to an ownership interest (equity); "he owns a controlling share of the company's stock"). Stocks are usually explained to be a collection of shares in a company, and are also referred to as stock shares. A stock is a certificate (sheet of paper) declaring you own a small fraction of that company (corporation). To explain further lets look at some of the reasons for why a company might want to issue stock. A company issues a stock so that it might use the money from a stock offering to buy equipment, hire people, advertise, or expand facilities. Basically, stocks help companies grow Trading in stocks on the stock market is typically driven by speculation, based on company news and performance factors. There are two ways to try and find the market value of a stock. Stock value is determined using some type of cash flow, sales or earnings analysis. This form of stock valuation is based on historic ratios and statistics and aims to assign market value to a stock based on measurable attributes. Another way a stock market can be be explained is to ask one to look at how much investor is willing to pay for a particular share of stock and by how much other investors are willing to sell a stock for. In other words, it explains the market’s supply and demand. This form of stock valuation is very hard to understand or predict, and it often drives the short-term stock market trends. In 1865, the New York Stock Exchange opened its first permanent headquarters near Wall Street in New York City. The irony of stock market is that companies live and die by their stock price, yet for the most part they don't actively participate in investing and in trading their stocks within the market. Companies get funds from the securities market when they first sell a security to the public in the primary market, commonly referred to as an initial public offering (IPO). In the subsequent trading of these shares on the secondary market (what most refer to as “the stock market”), it is the average investor exchanging the stock who benefits from any appreciation in stock price. Fluctuating prices are translated into gains or losses for these investors as change of ownership of stock takes place. Individual traders investing in the market acquire the full capital gain or loss after transaction costs. The original company that issues the stock does not participate in investing and taking of any profits or losses resulting from these transactions because this company is not supposed to have any monetary interest in stock market transactions. From the start there was not need to explain that individuals couldn’t realistically be buying shares of stock directly from the company. Stock market brokers have facilitated the obstacle of individual buyers dealing with companies issuing the stock. A stock broker is someone who performs transactions in stock on a stock market as an agent of their clients who are unable or unwilling to trade for themselves. A firm that buys stock from the company and resells it to the investors is known as the underwriter. Technology and internet have made investing in the stock market incredibly accessible to the mainstream public. Electronic trading began to grow in popularity by mid 1960s and by 1968 NASD (National Association of Securities Dealers) created the National Association of Securities Dealers Automatic Quotation System or NASDAQ. The trading floor of the ‘new stock market’ is now virtual computer space driven by 21st-century technology that makes investing in stock market EASY. The new technology brings news and other info to the investor, and stock trades can now be done from around the world at lightning speed. Internet stock market trading continues to grow and a special study by the SEC found that as of the second quarter of 1999 there were 9.7 million investors with online trading accounts. BULL OR BEAR MARKET Most people who have been investing in or following the stock market for some time are probably well familiar with the terms bear and bull market. What does it really mean? A bull market refers to a market that is on the rise. It is indicated by a sustained increase in stock market share prices. In such times, investors are convinced that the uptrend will continue in the long term. Typically, the country's economy is strong and employment levels are high. A bull market is a rising market. On the other hand, a bear market is one that is in decline. In bear market stock share prices are continuously dropping, resulting in a downward trend that investors believe will continue in the long-run, which, in turn, perpetuates the spiral. During a bear market, the economy will typically slow down and unemployment will rise as companies begin laying-off workers. Generally speaking, since the market is determined by investing parties’ attitudes, these terms also denote how investor's feel about the market and the ensuing trend. There are several characteristics that are particular to whether a market is a bull or a bear overall. In a bull market, there is strong demand and weak supply for stocks. As a result of this, stock prices will rise as competition will drive the prices up. The opposite holds true for the bear market. There is a strong relationship between the market and an overall economic conditions. Since the companies whose stocks are trading on the exchanges are the participants of the greater economy, the stock market and the economy are strongly connected. A bear market is associated with a weak economy as most companies are unable to record huge profits because consumers are not spending nearly enough—this decline in profits, of course, directly affects the way the market valuates stocks. In a bull market, the reverse occurs as people have more money to spend and are willing to spend it, which, in turn, drives and strengthens the economy. How Do I React? In a bull market, the ideal choice for an individual investing in stock market is to take advantage of rising prices by buying early in the trend and selling his or her stock shares when they have reached their peak. Obviously, determining exactly when the bottom and the peak will occur is impossible. Because on the whole, investors have a tendency to believe that the market will rise (thus bullish), investors are more likely to make profits in a bull market. As prices are on the rise, any losses should be minor and temporary. If investing during the bull market, an investor can actively and confidently invest in more equity with a higher probability of making a return. Investing in a bear market gives a higher chances of losses because stock prices are continually losing value and the end is not often in sight. Even if you do decide to invest with the hopes of an upturn, you are likely to take a loss before any turnaround occurs. Thus, most of the profitability under bear market conditions will be found in short selling or investing in safer investments such as fixed-income securities. While in bear mode, an investor may also turn to "defensive stocks," whose performances are only minimally affected by changing trends in the market and are therefore stable in both economic gloom and boom. These are industries such as utilities, often owned by the government and are necessities that people buy regardless of the economic condition. MAIN STOCK MARKET PLAYERS If one is interested in investing it is valuable to know who the main players in the stock market game are. The main players in the stock market are the exchanges. Exchanges are where the sellers are matched with buyers to both facilitate trading and to help set the price of the stock shares. As mentioned in the history section, the primary exchanges are the NASDAQ, the New York Stock Exchange (NYSE), all of the ECNs (electronic communication networks) and several other regional exchanges like the American Stock Exchange and the Pacific Stock Exchange. Not too long ago, all of the trading was done through the traditional exchanges (like the NYSE, American and Pacific Exchanges), but today most of the stock market trading is done through the NASDAQ, which uses ECNs and other firms with access to the NASDAQ to facilitate trading. One of the foremost and most prominent exchanges for investing in the stock market is the New York Stock Exchange (NYSE). It is also is one of the largest stock market exchanges in the world. The NYSE is operated by the not-for-profit corporation New York Stock Exchange, Inc, with its main building located at 18 Broad Street, at the corner of Wall Street, in New York City, New York, U.S.A. It is home to some 2,800 companies whose stock is valued at nearly $15 trillion in global market capitalization. Investing your money on NYSE, unlike those on some other more "virtual" exchanges (e.g. NASDAQ), always involve face-to-face communication in a particular physical location. There is a podium/desk on the trading floor for each of the members of the stock exchange. Exchange members interested in buying and selling a particular stock on behalf of investors meet in a predetermined spot, where a NYSE employee facilitates the stock price negotiations between buyers and sellers. A different kind of stock market exchange arose in the later part of the 20th century and has changed the landscape of the stock market. NASDAQ, which is an acronym for National Association of Securities Dealers Automated Quotations, is a stock market run by the National Association of Securities Dealers. The Nasdaq National Market consists of over 3000 companies that have a national or international shareholder base, meet stringent financial requirements, and agree to specific corporate governance standards. It began trading on February 8, 1971 as the the world's first electronic stock market. Fueled by the growth of internet stock trading, NASDAQ became the largest American stock exchange by 1999, with over half the companies traded in the United States listed. NASDAQ is made up of the NASDAQ National Market and the NASDAQ SmallCap Market. Although the market is based primarily in the United States, NASDAQ has many aliances worldwide, so that today investing in the stock market is a global activity. NASDAQ allows multiple stock market participants to trade through its electronic communications networks (ECNs) structure . To ensure that in chaotic stock market conditions, those placing small market orders are not ignored NASDAQ created a feature known as The Small Order Execution System (SOES). Before the advent of the internet, full service stock brokerage firms like Merryl Lynch have dominated the market. As discount brokers embraced the Internet market, full service brokerage firms pretty much ignored what was happening. They didn't feel they were really competing on price. Instead, they felt their differentiating factors were research recommendations and a relationship with a broker. They didn't believe their customers were very concerned about price when investing. In addition, it was tough for them to figure out how to incorporate low-priced Internet services into their business models. Most full service brokers are paid commissions out of the fat transaction fees charged to customers. If they were to provide low-cost trading, how could they provide their brokers with generous compensation? As a result, investors have been running from full service stock brokers into the hands of firms offering cheap Internet trades. This boom in internet-based stock market investing brought many companies to the front, including such big names as E-trade, TDWaterhouse etc. STOCK TYPES Blue Chip Stocks The stock market term "blue chip" comes from poker, where the blue chips carry the highest value. Large, established firms with a long record of profit growth, dividend payout and a reputation for quality management, products and services are referred to as Blue Chip companies. These firms are generally leaders in their industries and are considered likely candidates for long-term growth. Because Blue Chip companies are held in such high esteem, they often set the standards by which other types of companies in their fields are measured. Well-known blue chips include IBM, Coca-Cola, General Electric and McDonald's. Blue chip stocks are included in the Dow Jones Industrial Average, an index comprised of 30 companies that are all major players in their respective industries. Popular among individual and institutional investors alike, the 30 stocks listed on the Dow account for about one fifth of the total market value (over $8 trillion) of all U.S. stocks. The types of Investors blue chip stocks attract are the ones who seek investments that pay moderate dividend yields and grow. These types of stock are usually priced high because of their demand, have relatively low volatility and deliver a steady stream of dividends. The main downside is that, since they are so large, they have little room to appreciate, compared to smaller, up-and-coming types of stock. Penny Stocks Penny stocks are low-priced, speculative stocks that are very risky. These stocks are generally issued by the type of companies with a short or erratic history of revenues and earnings. They are the lowest of the low in price and many stock market exchanges choose not trade them. Penny stocks (also called designated securities) have these specific qualities: they sell for less than $5, they are sold over the counter (but not on the NASDAQ), and their companies have 2 million dollars or less in net tangible assets. They are listed daily on the Pink Sheets. The appeal of penny stocks comes from their low price. Though the odds are against it, if the company that issued them suddenly finds itself on a growth track, their stock share price can rise rapidly. This type of stocks is popular among small speculators. Income Stocks Income stocks are stocks that pay higher-than-average dividends over a sustained period. These above average dividends tend to be paid by large, established companies with stable earnings. Utilities and telephone company stocks are often classified as income stock types. Income stocks are popular with types of persons investing for steady income for a long time and who do not need much growth in their stock's value (though some growth does occur). In this sense, investors who choose them have something in common with bondholders. Income stocks can actually be more profitable than bonds. To maximize income, some investors will even seek out companies that frequently raise their dividends and are not saddled with debt. Value Stocks A value stock is a type of stock that is currently selling at a low price. Companies that have good earnings and growth potential but whose stock prices do not reflect this are considered value companies. Both the stock market and people investing in it are largely ignoring their stocks. Investors who buy value stocks believe that these stocks are only temporarily out of favor and will soon experience great growth. Any number of factors such as new management, a new product or operations that are more efficient may make a value stock grow quickly. Many companies alternate between value and growth types of classification. It is a normal aspect of the business cycle. Investing in value stocks is attractive for those who watch markets carefully for undervalued stocks they feel will move upward. OTHER TYPE OF STOCKS Defensive stocks are those whose prices stay stable when the market declines and are issued by industries that naturally do well during recessions. Food and utilities companies are defensive stocks. Debt collection companies also tend to perform well when the market turns sour. Cyclical stocks are a type of stocks that move up or down in sync with the business cycle. Examples include the housing industry and industrial equipment companies, because these companies serve the needs of growing economies. Investors who do not mind buying and selling as the market fluctuates tend to like cyclical stocks. Individuals who prefer to hold a stock for a long time may not like them unless they can weather ups and downs in the stock's value. Gold stocks are the stocks of gold-mining companies. Their value moves up or down with the price of gold. Treasury stock is a type of stock that has been bought back by the company that issued it. Companies may buy their stock back from investors when they believe it is underpriced on the market. The company can then set aside the stock for future uses such as debt payment or the awarding of stock options. STRATEGIES MARKET TIMING Perhaps the most well-known strategy in regards to investing in the stock market is “buy low, sell high”. Although it sounds simple enough, it is relatively a small number of people who have great success in stock market trading. Like sports, to be consistently successful in the stock market game requires a number of qualities. It requires a strategy, discipline, knowledge and tools. No matter what type of investor you are, you should know why you own a stock. A value investor's criteria will be different from that of a growth investor, which will be different still from an active trader. Any one strategy may work, but only if you stick to the strategy. The main point here is to be confident in your strategy and carry through with your plan. A good strategy can help us stay on track without clouding our judgment with emotion. One of the prominent strategies employed by the stock market investing “pros” is market timing. Market timing is an attempt to use past prices and other market data to predict future prices of stocks or indexes, whether long-term or intra-day. Forecasting stock prices is a problem that has fascinated investors since the very advent of financial markets. The time to buy or sell is founded on different economic and/or stock market indicators. Market timing methods include asset allocation, technical analysis, charting, momentum investing, and numerical analysis using all kinds of mathematical and computer-based algorithms. Because market pricing is a valuable indicator of information relevant to stock valuation, pricing serves as high quality input for construction of the market timing models. Very often market timing sounds fine in theory but it seldom works in practice, and it has shown itself to be a futile tool in conducted studies. DIVERSIFICATION Diversifying your investment portfolio by selecting a variety of securities is another frequently used strategy. Done properly, diversification can reduce about 70% of the total risk of investing. Portfolio diversification refers to mixing up your investments to offset some risk. With portfolio diversification, you get two main advantages: Portfolio diversification helps you minimize the potential of losing all your investment money if a stock, sector, or industry as a whole does poorly Portfolio diversification helps you maximize the potential of doing really well if a stock, sector, or industry as a whole does well One of the most effective ways to diversify an investment is with asset (stock) allocation, and it is a good way to help smooth out volatility in your portfolio. How does asset allocation work? Different asset classes (such as stocks and bonds) may respond differently to the same market conditions. This means if one part of a diversified portfolio does poorly it can be buffered by other investments that do relatively better. In other words, asset allocation helps spread the risk over several investments. The key to asset allocation is investing in assets with dissimilar performance. While the scientific and measurable investing principles of asset allocation are sound and are well proven, up until recently the process required some detailed mathematical calculations. Fortunately, the power of modern computers and specialized software make asset allocation much more accessible to a broader public. These computer-based programs store data about asset categories and class market histories, and then use the data to calculate optimal mixes of assets to meet the investor's personal risk tolerance and return requirements. A properly diversified portfolio should include investments in a variety of industries and asset classes such as small-company stocks, international government bonds, and fixed annuities. Short Selling A large number of investors make money on a decline in an individual stock or during a bear market, thanks to an advanced investing technique called “short selling.” In general, people think of investing as buying an asset, holding it while it appreciates in value, and then eventually selling to make a profit. Short selling is in fact the exact opposite of the normal process of investing by purchasing shares on margin (taking a long position) and selling them at a later time in the market. In case of short selling the investor first sells the security with the intent to later buy it back at a lower price. When an investor goes long on an investment, it means he has bought a stock believing its price will rise in the future. Conversely, when getting into the market by investing short, an investor is anticipating a decrease in share price. Shorting stocks allows you to enter the market as a seller and profit when a stock declines. Short selling is the selling of a stock that the seller doesn't own. Your broker "borrows" the stock from someone else's margin/short account and sells it in the market for you. As long as you buy back the shares at a lower price, you will profit. To short stocks you must first establish a margin/short account with your broker. Because you are buying on margin, you must pay interest and follow the rules of margin trading. The shorter is responsible for paying the lender any dividends or rights declared over the course of the loan. The stock you wish to short must be available to borrow and you must maintain at least 50 percent or more of the stock's value in your account. The primary reasons for shorting are to speculate and to hedge your investment. One danger of investing by short selling is the theoretical possibility of an unlimited loss. As opposed to a long or regular purchase of shares in the open market on which you can only lose the amount of money you originally invested, there is no maximum loss that a short seller can occur. This is, of course, due to a fact that there is no limit to how high a stock can go up in value. For instance, if you were to short a stock trading at $5.00 and, due to some unforeseen occurrence, the stock grows to the $100 level and keeps on climbing; you will at some point be forced to cover your short position by buying back the shares somewhere past the $100 level (costing you over 20 times the original short sale proceeds). Short selling contributes to the market by providing liquidity, efficiency, and acting as a voice of reason in bull markets. Fundamental Analysis - Analyzing Financial Statements Investing your money into the stock of the company that you know about only through the word of mouth is an ill-informed investing strategy. Maybe you've read about a company stock that interests you, or one of your friends is excited about a particular stock. Perhaps you keep seeing a stock on various "buy" lists and wonder what makes it so appealing. To make a well-informed, rational decision about your potential investment it would be beneficial to be able to judge whether circumstances, not just psychology, have changed. A strong fundamental analysis can become the most important key to making a good decision. Fundamental analysis means conducting basic research on a company. Fundamental market analysis examines of the underlying forces that affect the interests of the economy, industrial sectors and companies. As with most analysis, the goal is to derive a forecast for the future. A well conducted fundamental analysis focuses on creating a clear picture of a company, identifying the intrinsic or “fundamental” value of its stock shares, and assists in making wise investing decisions based on that information. When analyzing a company, there are several key features that one might want to consider. A competitive advantage of the company, such as patents, rate of growth of customer base and other relevant factors might need to be looked at. A record of consistently growing revenues could be a strong indicator of future growth. Examining the balance sheet, could reveal a great deal of information about the company such as debt standing and cash flow. Fundamental analysis is good as a long-term investing strategy. It will help identify companies that represent good value. Performing fundamental analysis can be a lot of hard work. But that is, arguably, the source of its appeal. By taking the time and making an effort to dig into a company's financial statements and assess its future prospects, investors can learn enough to know when the stock price is wrong. RISKS We understand that there are numerous risks associated with investing in the stock markets. We try to understand and then classify these risks based on the behavior of stock prices in the financial markets. Knowing that investing in stock carries a certain amount of risk is probably one of the first things you should be aware of. This is because the returns on stock are not guaranteed; not by the government, not by the company issuing the stock, and certainly not by your broker. That means that there is a chance that your actual revenue will be different than what you had expected. For instance, you might purchase stock under the expectation that its price will rise steadily over time and that it will pay you annual dividends. However, if the company experiences financial problems, you may not receive the price appreciation or the dividends that you expected. Moreover, the company could even go out of business, in which case you could lose your entire investment. Because there is uncertainty regarding which of the various possible outcomes will occur, you bear a certain amount of risk when purchasing the equity. How much of a risk does a stock carry in your overall portfolio? That depends upon what other investments are in your portfolio. In general, the risks associated with investing in stocks are greater than the risks associated with investing in bonds or money markets. At the same time, however, the risks associated with investing in stocks are less than the risks associated with investing in options or futures. Of course, not all stocks pose the same level of risk: some (such as internet stocks) are much higher risk than others (such as utilities), so it's important to understand the amount of risk you would be taking on with any given investment. The other variable that will influence the amount of risk in your stock portfolio is your time horizon. Over long term, history has shown time and again that stock prices outperform almost all other investing options. However, in the short run stock prices often go down (about half the time, if the time period is sufficiently short). That means that if you are at a point in your life when you may need to sell your stocks in the short run, then you may want to think twice about investing in stocks. There is a definite possibility that the stocks that you buy now may be worth significantly less one or two years in the future. Most likely, however, they will be worth significantly more ten or twenty years in the future. So before you investing in stocks, you should sit down and examine both your own time horizons and those of the market in order to see whether or not you can take the risks associated with short term stock investing. The most recognisable of all risks is the continual adjustment of a stock's price to new information entering the market. We recognize that there exists a strong relationship between new information and the price movements observed for a particular stock. People refer to this particular risk an investor faces from a potential movement in a stock's price, as 'idiosyncratic risk'. It is a risk that affects a very small number of assets, and can be almost eliminated with diversification On closer examination of the behavior of stock prices, we also notice that there are relationships between stock price movements indicating inter-dependence. This is because when information pertaining to one stock is released to the market, it affects other stocks. There exists a correlation between movements in the stock prices. As a consequence there exists correlation between stock returns. Let us assume that this risk is called 'correlation risk'. On a macro-level, we can also say that when information pertaining to all stocks is released to the market, certain stocks behave differently from others, and hence we can deduce that there must exist some relationship between stocks and the market as a whole. We refer to this risk as 'market risk or systematic risk'. Systematic risk cannot be diversified away, it can only be hedged, and is thus known as undiversifiable or market risk. This type of risk, associate with the market or market segments differs from the risk accompanying stocks in that systematic risk effects a broad range of securities whereas unsystematic risk affects a very specific group of securities or individual security. In order to manage the risks associated with investing in stocks, most investors turn to a practice diversification or numerous other risk reducing strategies. Once you've thought about the risks associated with stock investing and figured out your plans for diversification, the next issue to consider when adding stocks to your portfolio is which stocks to add. As an investor one must consider their risk tolerance. Risk tolerance is a person’s emotional and financial capacity to ride out the ups and downs of the investing market without panicking when the value of investments goes down. To do so you'll first want to take a look at your particular investing objectives. If you're looking for steady income with low risk, you may want to consider investing in income stocks. On the other hand, if you're looking for opportunities that may result in a big payoff and you're not too concerned about the risks involved, you might want to try investing in growth stocks BENEFITS The very thing that makes investing in stock a risky business also makes it a lucrative investment. It’s all about risk and return, and because your money is at more risk in the stock market than if you park it in a savings or CD (by the way, the money you invest in a CD is probably reinvested by the company offering the CD), the potential return is higher. It’s true that the gyrations in the stock market can cause both large losses and large gains, but if your investment time horizon is long enough, these short-term fluctuations will result in relatively high returns. It is generally accepted, that the average long term return from investing in stocks is 10-12%. Another latest trend that has added to the popularity of investing in stock market is the creation of IRA and 401K plans. Most people have by now set up a Roth IRA, 401(k), or other qualified retirement program. For some of them, it may be the only stock market investment they own. Regardless, they have made a wise move. These plans offer immediate or long-term tax advantages, and relieve the owners from depending on paltry Social Security payments for their retirement years. The money that you put into a 401k plan is not included in your taxable wages. So you pay less taxes on your income this year. Plus, no taxes are due on any interest or growth within the 401k until you take the money out of the account. Social Security, on the other hand, is a system which many economists have predicted to fail in the near future. Internet has made investing and participating in stock market an accessible affair for most at low costs. Trades can be placed almost instantaneously and your market standing can be assessed at any time. Before the Internet, stock investing meant phone calls or visits to brokers and evaluating their advice on the latest stock options. After the Internet, we now have direct access up-to-the-minute stock reports, investment research, and the ability to trade stocks on our own. This translates into more personal control over our financial future where we no longer need brokers to advise and monitor our accounts. It is a great way to own a piece and share in growth of a company whose concept or strong future you strongly believe in. Shareholders maintain an influence in the company's future growth and development through their right to vote. In addition to owning part of a company, you have the potential to receive monetary benefits when you own stock shares. A good example of that would be investing in income stocks. Owning stock may allows you the opportunity to earn money on money. PHILIPPINE STOCK EXCHANGE The Philippine Stock Exchange, Inc. ("PSE" or the "Exchange") is a private organization that provides and ensures a fair, efficient, transparent and orderly market for the buying and selling of securities. PSE traces its roots from the country's two former bourses: the Manila Stock Exchange ("MSE") and the Makati Stock Exchange ("MkSE"). Founded in March 1927, the MSE was the first stock exchange in the Philippines and one of the oldest in Asia. Originally housed in downtown Manila, the MSE moved to Pasig City in 1992. The MkSE, on the other hand, was established in May 1963 and became the second bourse to operate in the country. It was based in Makati City, a budding business district during those days. While trading the same listed issues, MSE and MkSE remained separate entities for almost thirty years. December 23, 1992 marked a milestone for the Philippine capital market when the MSE and MkSE were unified to become the PSE. At present, PSE maintains two trading floors -- one in Makati City and another in its head office in Pasig City. Even with two trading floors, PSE maintains a "one-price, one-market" Exchange through the MakTrade System. This is a single-order-book system that tallies all orders into one computer and ensures that these orders match with the best bid/best offer regardless of which floor the orders were placed. MakTrade likewise allows PSE to facilitate the trading of securities in a broker-to-broker market through automatic order and trade routing and confirmation. It also keeps an eye on any irregularity in the transactions with its market regulation and surveillance databases. In June 1998, the Securities and Exchange Commission conferred to the PSE the status of a Self-Regulatory Organization, which allows the PSE to implement its own rules and impose penalties on erring trading participants and listed companies. In 2001, or a year after the Securities Regulation Code of 2000 was enacted, the PSE was reorganized and transformed from a non-stock, member-governed organization into a shareholder-based, revenue-generating corporation. Along with this rebirth came the separation of the Exchange's ownership and trading rights, opening the doors for new market participants. On December 15, 2003, PSE shares were listed by way of introduction. The Philippine Central Depository, established in March 1995, provides the securities settlement system for both debt and equity instruments of the Exchange. Its computerized book-entry-settlement system paved the way for a safe and efficient scripless trading. Assuming the role of settlement coordinator and risk manager for broker transactions as well as administrator of the trade guaranty fund is the Securities Clearing Corporation of the Philippines ("SCCP"). SCCP is the clearing and settlement agency for depository eligible trades in the Exchange. Companies are listed in the PSE on the First Board, Second Board or the Small and Medium Enterprises Board. To help the investing public keep track faster of industry performance, listed companies are classified into the following sectors: Financial, Industrial, Holding Firms, Property, Services, and Mining and Oil. More importantly, PSE has adopted an online daily disclosure system to improve the transparency of listed companies and ensure full, fair, timely and accurate disclosure of material information from all listed companies. To address public demand for speedy access to information on the securities market, the PSE's website, www.pse.com.ph, provides comprehensive market data, stock quotations, dividend declarations, trading activities, and other pertinent information on the PSE, trading participants, listed companies and other institutions. WHAT ARE THE TYPES OF SECURITIES THAT I CAN BUY IN THE STOCK MARKET? Most of the issues listed in the PSE are common stocks. Other types of securities such as preferred stocks, warrants, PDRs and bonds are also traded. 1. Common Stocks - These are usually purchased for participation in the profits and control of ownership and management of the company. Holders of common stocks have voting rights. They are also entitled to an equal pro rata division of profits without preference or advantage over another stockholder. However, they have the last claim on dividends and are the last to collect in case of corporate liquidation. 2. Preferred Stocks - Its name is derived from preference given to the holders of these stocks over holders of common stocks. Holders of preferred stocks are entitled to receive dividends, to the extent agreed upon, before any dividends are paid to the holders of common stocks. However, preferred stocks usually have a specified limited rate of return or dividend and a specified limited redemption and liquidation price. 3. Warrants - A corporation can also raise additional capital by issuing warrants. A warrant, normally issued on a detachable basis, allows its holders the right, but not the obligation, to subscribe to new shares at a set price during a specified period of time. It is usually provided free of charge and traded separately in the securities market. 4. Philippine Deposit Receipts (PDRs) - A PDR is a security which grants the holder the right to the delivery or sale of the underlying share, and to certain other rights including additional PDR or adjustments to the terms or upon the occurrence of certain events in respect of rights issues, capital reorganizations, offers and analogous events or the distribution of cash in the event of a cash dividend on the shares. PDRs are evidences or statements nor certificates of ownership of a foreign/foreign-based corporation. For as long as the PDRs arenot exercised, the shares underlying the PDRs are and will continue to be registered in the name of and owned by and all rights pertaining to the shares shall be exercised by the issuer. Small-Demominated Treasury Bonds (SDT-Bonds) The SDT Bonds are long-term and relatively risk-free debt securities issued by the Bureau of Treasury (BTr) of the Republic of the Philippines. The bond is a certificate of indebtedness of the Republic of the Philippines to the owner of the SDT-Bonds. WHERE CAN I BUY OR SELL SHARES OF STOCKS AND/OR BONDS? In the Philippines, the only operating stock exchange is the Philippine Stock Exchange (PSE). Its main function is to facilitate the buying and selling of stocks and other securities through its accredited trading participants. The PSE has two trading floors - PSE Centre in Ortigas, Pasig City and PSE Plaza in Ayala, Makati City - where trading participants trade daily - from 9:30 a.m. to 12:10 p.m. except Saturdays, Sundays, legal holidays and days when the Central Bank Clearing Office is closed. HOW ARE SHARES AND SDT-BONDS BOUGHT OR SOLD? If you wish to buy shares of stocks or SDT-Bonds, you must have a stockbroker who will do this for you. A stockbroker is a person or a corporation authorized and licensed by the Securities and Exchange Commission (SEC) and PSE to trade securities. Investing Procedures: 1. Choose a stockbroker. The PSE has a complete list and information about all its trading participants who are authorized and qualified to trade either equity or debt securities for you. This list is also available on the Exchange's website and the PLDT directory's Government and Business listings yellow pages under the category of stock and bond brokers. 2. You shall be required to open an account and fill-out a Reference Card and to submit identification papers for verification. The stockbroker will then assign a trader or agent to assist you in either buying or selling any listed security. Discuss with the trader what stocks to buy or sell. 3. Give the order to your broker/trader, and then get the acknowledgement receipt. 4. For equity transactions: Deliver the Stock Certificate if you are selling or pay within the settlement date (3 days from date of transaction) if you are buying. Some brokers may require you to pay with post-dated checks upon ordering.
For SDT-Bonds transactions: Selling investors must open a RoSS account under his broker's sub-account and instruct his bank-underwriter to transfer the share to this account. Buying investors must also open an account with a BTr accredited bank and pay the appropriate amount of transaction to the settlement bank on the trade date. 5. You shall receive from your broker either the proceeds of sale your stocks (after 3 days for equities and on the date of trade for SDT-Bonds) or proof of ownership of stocks you bought (confirmation receipt and invoice). If you wish to have a physical certificate of the equities you bought, just give instructions to your broker and pay the required upliftment fee. Buyers of SDT-Bonds will only be given a confirmation slip in lieu of the bond certificates. You can purchase shares of stock either through IPO (Initial Public Offering) or through the open market. Shares sold through IPOs are offered for the first time to the public by the company(primary market) whereby proceeds of the sale go directly to the company. Shares of listed or publicly traded companies are bought during trading (open market). These shares have since been transferred from one owner to another (secondary market) and proceeds of the sales do not go directly to the company but to the owners of the shares. The Trading Cycle
All equity transactions, whether buying or selling has a settlement period of T+3 (trading day + 3 working days). This means that a seller should be able to deliver the stock certificate, if any, to his broker and the buyer must have paid the cost of transaction to his broker within 3 working days after the trade was done. Historically, settlement was done manually (27-day cycle). With the advent of scripless trading wherein settlement is done via the book-entry-system (thru Philippine Central Depository or PCD), transactions are settled on the third day after trade date. Under this system, the investor has the option to hold on to his certificate (uplift) or deposit (lodge) this certificate in PCD through his broker-participant account.
SDT-Bonds transactions, however, are settled on the same day when the trade is transacted (T+0). There shall be no physical transfer of bond certificates. The transfer of securities shall be conducted electronically by the BTr's Registry of Scripless Securities (RoSS). On the other hand, cash settlement will be coursed through the PSE's two settlement banks namely, Equitable-PCI Bank and Rizal Commercial Banking Corporation. WHAT IS THE MINIMUM AMOUNT NEEDED TO INVEST IN THE STOCK MARKET? Equity trading is done by board lot or round lot system. The Board Lot Table determines the minimum number of shares one can purchase or sell at a specific price range. Therefore, the minimum amount needed to invest in the stock market varies and will depend on the market price of the security as well as its corresponding board lot. Prices of stocks move through a scale of minimum price fluctuations.
On the other hand, the minimum amount of SDT-Bonds that an investor can buy if PhP 5,000.00. Board Lot Table: | | PRICE | MINIMUM FLUCTUATIONS</SPAN< td> | BOARD LOT | 0.001 to 0.0024 | 0.0002 | 1,000,000 | 0.0026 to 0.0050 | 0.0002 | 1,000,000 | 0.0055 to 0.0100 | 0.0005 | 1,000,000 | 0.0110 to 0.0250 | 0.001 | 100,000 | 0.0260 to 0.0500 | 0.001 | 100,000 | 0.0525 to 0.1000 | 0.0025 | 100,000 | 0.105 to 0.2500 | 0.005 | 10,000 | 0.2600 to 0.5000 | 0.01 | 10,000 | 0.5100 to 1.000 | 0.01 | 10,000 | 1.020 to 2.500 | 0.02 | 1,000 | 2.550 to 5.000 | 0.05 | 1,000 ** | 5.10 to 10.00 | 0.10 | 1,000 * | 10.25 to 25.00 | 0.25 | 100 | 25.50 to 50.00 | 0.50 | 100 | 50.50 to 100.00 | 0.50 | 100 | 101.00 to 250.00 | 1.00 | 10 | 252.50 to 500.00 | 2.50 | 10 | 505.00 and up | 5.00 | 10 |
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HOW CAN I PROFIT IN THE STOCK MARKET? Investors can profit in the stock market thru any or a combination of the following; A. Capital Gains - These are profits made due to an increase in the market price of a stock from the buying price. B. Cash Dividend - A dividend given to shareholders in the form of cash. It is computed by multiplying the number of shares held by the cash dividend rate declared. C. Stock Dividend - A dividend given to shareholders in the form of additional stocks. It is computed by multiplying the number of shares held by the percentage of the stock dividend declared. D. Stock Rights - Stock rights offering is the option given to the present shareholders to buy additional shares of stock at a price lower than its market price. IS THERE ANY RISK INVOLVED IN INVESTING? Yes, since risk is always a part of any investment. And because stock investment is the most volatile, a better attitude would be to limit and manage your risk. A maximum level of gain or loss should be set and calculated decisions should be made when this level is reached. DO I NEED TO KEEP TRACK OF MY INVESTMENT? Yes! Having placed some amount in stocks, you should spend some time and effort in studying your investment. You should keep track of the stock price and follow closely the developments of the company. This way, you are able to foresee possible gains or losses that will guide you in making sound and wise investment decisions.
Daily quotations of stock prices can be obtained from your stockbroker or from all leading newspapers. You may also get information from our official website: www.pse.com.ph or from the PSE-Public Information and Assistance Center (PIAC) at telephone numbers 688-7602 to 03.
GENERAL CRITERIA
BASIC GUIDELINES FIRST BOARD 1. A track record of profitable operations for three (3) full fiscal years; or 2. A market capitalization of P500 m, provided that it has a five-year operating history; or 3. Net tangible assets of P500 m, provided that it has a five-year operating history. SECOND BOARD - The applicant company must demonstrate its potential for superior growth to the Exchange;
- It must have an operating history of at least one (1) year prior to its listing; and
- At listing, the market capitalization of the company must be at least P250 m.
SME BOARD - The applicant company shall be evaluated based on the following:
- The integrity and capability of the company’s management and its controlling stockholders;
- The company’s prospects of further growth and profitability;
- The viability of the business and sustainability of the projected earning stream; and
- The company’s lack of existing material conflicts of interest.
TRACK RECORD REQUIREMENT FIRST BOARD A company must have a cumulative consolidated pre-tax profit of at least at least P50 Million and a minimum pre-tax profit of P10 Million for each of the three (3) full fiscal years immediately preceding the application for listing. For purposes of this rule, pre-tax profit shall not include non-recurring and extraordinary income, nor shall it be reduced by non-recurring and extraordinary loss. The applicant must further be engaged in materially the same businesses and must have a proven track record of management throughout the last three (3) years prior to the filing of the application. Exceptions to the 3 year track record rule: - The applicant company has been operating for at least Ten (10) years prior to the filing of the application. The applicant company shall have a cumulative pre-tax profit of at least P50 Million, excluding non-recurring and extraordinary income and/or loss, for the last Three (3) fiscal years immediately preceding the application for listing. No net operating loss must have been registered in the fiscal year immediately preceding the filing of the application;
- The applicant company is a newly formed holding company which uses the operational track record of its subsidiary(ies). The company, however, is prohibited from divesting its shareholdings in the said subsidiary(ies) for a period of three (3) years from the listing of its securities. The prohibition shall not apply if a divestment plan is approved by majority of the applicant company’s stockholders.
SECOND BOARD None, but must demonstrate a potential for superior growth, through the submission of Statement of Active Business Pursuits and Objectives SME BOARD The applicant company should have been operational for at least one (1) year with positive net operating income (income before interest, taxes, depreciation and amortization-EBITDA) during the last financial year. NUMERICAL CRITERIA FIRST BOARD Authorized Capital Stock- Minimum- P400,000,000.00
Subscription & Paid-up- Minimum- P100,000,000.00
Minimum Par Value- P 1.00 SECOND BOARD Authorized Capital Stock- Minimum- P 100,000,000.00
Subscription & Paid-up- Minimum- P 25,000,000.00
Condition on Paid-up: at least 75% of the paid-up must have already been disbursed to the project, venture or business referred to in the business plan
Minimum Par Value- P 1.00 SMB BOARD
Authorized Capital Stock- Minimum- P 20,000,000.00
Maximum- P 100,000,000.00
Subscription & Paid-up- Minimum- 25% of the ACS
* The applicant company should have net tangible assets of at least Five Million Pesos (P 5,000,000.00). The net tangible assets requirement is not applicable to information technology companies.
Minimum Par Value- P 1.00
OPERATING HISTORY FIRST BOARD
For a track record of profitable operations- At least three (3) full fiscal years prior to the filing of the listing application if with track record
For a market capitalization or net tangible assets of P500M - at least five (5) years. SECOND BOARD At least one (1) year prior to listing. SMB BOARD At least one (1) year from filing LISTINGS As of 01 May 2007, the Philippine Stock Exchange has a total of 241 listed companies. Stocks listed in the PSE are classified into six sectors, namely Financials, Industrial, Holding Firms, Property, Services, and Mining & Oil. Companies are classified according to the business that generates the bulk of their revenues.
Companies engaged in banking, investments, and finance are under the Financials sector. The Industrial sector includes companies active in electricity, energy, power & water; food, beverage & tobacco; construction, infrastructure & allied services; chemicals; and diversified industrials. Diversified companies engaged in three or more businesses classified in different industries, any of which does not dominate revenue, are classified under Holding Firms. Companies engaged in land and property development are classified under the Property sector. The Services sector includes companies involved in media, telecommunications, information technology, transportation services, hotel & leisure, education, and diversified services. The Mining & Oil sector includes companies engaged in mineral extraction and in oil exploration, extraction and production. MORTGAGE MARKET HISTORY OF THE MORTGAGE MARKET The early decades of the twentieth century are a good starting point for this review, as urbanization and the exceptionally rapid population growth of that period created a strong demand for new housing. Between 1890 and 1930, the number of housing units in the United States grew from about 10 million to about 30 million; the pace of homebuilding was particularly brisk during the economic boom of the 1920s. Remarkably, this rapid expansion of the housing stock took place despite limited sources of mortgage financing and typical lending terms that were far less attractive than those to which we are accustomed today. Required down payments, usually about half of the home's purchase price, excluded many households from the market. Also, by comparison with today's standards, the duration of mortgage loans was short, usually ten years or less. A "balloon" payment at the end of the loan often created problems for borrowers. High interest rates on loans reflected the illiquidity and the essentially unhedgeable interest rate risk and default risk associated with mortgages. Nationwide, the average spread between mortgage rates and high-grade corporate bond yields during the 1920s was about 200 basis points, compared with about 50 basis points on average since the mid-1980s. The absence of a national capital market also produced significant regional disparities in borrowing costs. Hard as it may be to conceive today, rates on mortgage loans before World War I were at times as much as 2 to 4 percentage points higher in some parts of the country than in others, and even in 1930, regional differences in rates could be more than a full percentage point. Despite the underdevelopment of the mortgage market, homeownership rates rose steadily after the turn of the century. As would often be the case in the future, government policy provided some inducement for homebuilding. When the federal income tax was introduced in 1913, it included an exemption for mortgage interest payments, a provision that is a powerful stimulus to housing demand even today. By 1930, about 46 percent of nonfarm households owned their own homes, up from about 37 percent in 1890. The New Deal and the Housing Market The housing sector, like the rest of the economy, was profoundly affected by the Great Depression. When Franklin Roosevelt took office in 1933, almost 10 percent of all homes were in foreclosure, construction employment had fallen by half from its late 1920s peak, and a banking system near collapse was providing little new credit. As in other sectors, New Deal reforms in housing and housing finance aimed to foster economic revival through government programs that either provided financing directly or strengthened the institutional and regulatory structure of private credit markets. Actually, one of the first steps in this direction was taken not by Roosevelt but by his predecessor, Herbert Hoover, who oversaw the creation of the Federal Home Loan Banking System in 1932. This measure reorganized the thrift industry (savings and loans and mutual savings banks) under federally chartered associations and established a credit reserve system modeled after the Federal Reserve. The Roosevelt administration pushed this and other programs affecting housing finance much further. In 1934, his administration oversaw the creation of the Federal Housing Administration (FHA). By providing a federally backed insurance system for mortgage lenders, the FHA was designed to encourage lenders to offer mortgages on more attractive terms?. by the 1950s, most new mortgages were for thirty years at fixed rates, and down payment requirements had fallen to about 20 percent. In 1938, the Congress chartered the Federal National Mortgage Association, or Fannie Mae, as it came to be known. The new institution was authorized to issue bonds and use the proceeds to purchase FHA mortgages from lenders, with the objectives of increasing the supply of mortgage credit and reducing variations in the terms and supply of credit across regions. Shaped to a considerable extent by New Deal reforms and regulations, the postwar mortgage market took on the form that would last for several decades. The market had two main sectors. One, the descendant of the pre-Depression market sector, consisted of savings and loan associations, mutual savings banks, and, to a lesser extent, commercial banks?.Notably, federal and state regulations limited geographical diversification for these lenders, restricting interstate banking and obliging thrifts to make mortgage loans in small local areas - within 50 miles of the home office until 1964, and within 100 miles after that. In the other sector, the product of New Deal programs, private mortgage brokers and other lenders originated standardized loans backed by the FHA and the Veterans' Administration (VA). These guaranteed loans could be held in portfolio or sold to institutional investors through a nationwide secondary market. No discussion of the New Deal's effect on the housing market and the monetary transmission mechanism would be complete without reference to Regulation Q - which was eventually to exemplify the law of unintended consequences. The Banking Acts of 1933 and 1935 gave the Federal Reserve the authority to impose deposit-rate ceilings on banks, an authority that was later expanded to cover thrift institutions?. The original rationale for deposit ceilings was to reduce "excessive" competition for bank deposits, which some blamed as a cause of bank failures in the early 1930s. In retrospect, of course, this was a dubious bit of economic analysis. In any case, the principal effects of the ceilings were not on bank competition but on the supply of credit. With the ceilings in place, banks and thrifts experienced what came to be known as disintermediation - an outflow of funds from depositories that occurred whenever short-term money-market rates rose above the maximum that these institutions could pay. In the absence of alternative funding sources, the loss of deposits prevented banks and thrifts from extending mortgage credit to new customers. --- Under the New Deal system, housing construction soared after World War II, driven by the removal of wartime building restrictions, the need to replace an aging housing stock, rapid family formation that accompanied the beginning of the baby boom, and large-scale internal migration. The stock of housing units grew 20 percent between 1940 and 1950, with most of the new construction occurring after 1945. In 1951, the Treasury-Federal Reserve Accord freed the Fed from the obligation to support Treasury bond prices. Monetary policy began to focus on influencing short-term money markets as a means of affecting economic activity and inflation, foreshadowing the Federal Reserve's current use of the federal funds rate as a policy instrument. Over the next few decades, housing assumed a leading role in the monetary transmission mechanism, largely for two reasons: Reg Q and the advent of high inflation?. The impact of disintermediation on the housing market could be quite significant; for example, a moderate tightening of monetary policy in 1966 contributed to a 23 percent decline in residential construction between the first quarter of 1966 and the first quarter of 1967. State usury laws and branching restrictions worsened the episodes of disintermediation by placing ceilings on lending rates and limiting the flow of funds between local markets. --- The Emergence of Capital Markets as a Source of Housing Finance The manifest problems associated with relying on short-term deposits to fund long-term mortgage lending set in train major changes in financial markets and financial instruments, which collectively served to link mortgage lending more closely to the broader capital markets. The shift from reliance on specialized portfolio lenders financed by deposits to a greater use of capital markets represented the second great sea change in mortgage finance, equaled in importance only by the events of the New Deal. Government actions had considerable influence in shaping this second revolution. In 1968, Fannie Mae was split into two agencies: the Government National Mortgage Association (Ginnie Mae) and the re-chartered Fannie Mae, which became a privately owned government-sponsored enterprise (GSE), authorized to operate in the secondary market for conventional as well as guaranteed mortgage loans. In 1970, to compete with Fannie Mae in the secondary market, another GSE was created - the Federal Home Loan Mortgage Corporation, or Freddie Mac. Also in 1970, Ginnie Mae issued the first mortgage pass-through security, followed soon after by Freddie Mac. In the early 1980s, Freddie Mac introduced collateralized mortgage obligations (CMOs), which separated the payments from a pooled set of mortgages into "strips" carrying different effective maturities and credit risks. Since 1980, the outstanding volume of GSE mortgage-backed securities has risen from less than $200 billion to more than $4 trillion today. Alongside these developments came the establishment of private mortgage insurers, which competed with the FHA, and private mortgage pools, which bundled loans not handled by the GSEs, including loans that did not meet GSE eligibility criteria - so-called nonconforming loans. Today, these private pools account for around $2 trillion in residential mortgage debt. These developments did not occur in time to prevent a large fraction of the thrift industry from becoming effectively insolvent by the early 1980s in the wake of the late-1970s surge in inflation. In this instance, the government abandoned attempts to patch up the system and instead undertook sweeping deregulation. Req Q was phased out during the 1980s; state usury laws capping mortgage rates were abolished; restrictions on interstate banking were lifted by the mid-1990s; and lenders were permitted to offer adjustable-rate mortgages as well as mortgages that did not fully amortize and which therefore involved balloon payments at the end of the loan period. Critically, the savings and loan crisis of the late 1980s ended the dominance of deposit-taking portfolio lenders in the mortgage market. By the 1990s, increased reliance on securitization led to a greater separation between mortgage lending and mortgage investing even as the mortgage and capital markets became more closely integrated. About 56 percent of the home mortgage market is now securitized, compared with only 10 percent in 1980 and less than 1 percent in 1970. MORTGAGEA mortgage is a method of using property (real or personal) as security for the payment of a debt. The term mortgage (from Law French, lit. dead pledge) refers to the legal device used for this purpose, but it is also commonly used to refer to the debt secured by the mortgage, the mortgage loan. In most jurisdictions mortgages are strongly associated with loans secured on real estate rather than other property (such as ships) and in some cases only land may be mortgaged. Arranging a mortgage is seen as the standard method by which individuals and businesses can purchase residential and commercial real estate without the need to pay the full value immediately. See mortgage loan for residential mortgage lending, and commercial mortgage for lending against commercial property. In many countries it is normal for home purchases to be funded by a mortgage. In countries where the demand for home ownership is highest, strong domestic markets have developed, notably in Spain, the United Kingdom and the United States. MORTGAGE INTEREST RATES The interest rate borrowers pay on their mortgages if probably the most important factor in their decision of how much and from whom to borrow. The interest rate on the loan is determined by three factor: current long-term market rates, the life (term) of the mortgage and the number of discount points paid. - Market Rates- Long term market rates are determined by the supply of and demand for long-term funds, which are in turn influences by a number of global, national, and regional factors.
- Term- Long-term mortgages have higher interest rates then short-term mortgages. The usual mortgage lifetime is either 15-30 years. Lenders also offer 20-year loans, though they are not as popular. Because interest-rate risk falls as the term to maturity decreases, the interest rate on the 15-year loan will be substantially less than on the 30-year loan.
- Discount points- Discount points (or simply points) are interest payments made at the beginning of a loan. A loan with one discount point means that the borrower pay 1% of the loan at closing, the moment when the borrower signs the loan paper and receives the proceeds of the loan. In exchange for the points, the lender reduces the interest rate on the loan. In considering whether to pay points, borrowers must determine whether the reduced interest rate over the life of the loan fully compensates for the increased up-front expense. To make this determination, borrowers must take into account how long they will hold on to the loan.
GENERAL MORTGAGE TERMS ADJUSTABLE RATE MORTGAGE (ARM)
Is a mortgage in which the interest rate is adjusted periodically based on a preselected index. Also sometimes known as the re negotiable rate mortgage, the variable rate mortgage or the Canadian rollover mortgage.
AMORTIZATION
The periodic principal pay down of a loan.
ANNUAL PERCENTAGE RATE (A.P.R.)
Is a interest rate reflecting the cost of a mortgage as a yearly rate. This rate is likely to be higher than the stated note rate or advertised rate on the mortgage, because it takes into account point and other credit cost. the APR allows home buyers to compare different types of mortgages based on the annual cost for each loan.
ASSUMPTION
Taking over a loan and becoming personally liable for the repayment.
BALLOON (payment) MORTGAGE
Usually a short-term fixed-rate loan which involves small payments for a certain period of time and one large payment for the remaining amount of the principal at a time specified in the contract.
BANKRUPTCY
A provision of Federal Law whereby a debtor surrenders his assets to the Bankruptcy Court and is relieved of the future obligation to repay his unsecured debts. Secured creditors, those holding deeds of trust or judgment liens, continue to be secured by the property but they may not take other action to collect from the debtor. There are different types of bankruptcy chapters, the above is very general.
BENEFICIARY
A person named to receive a benefit from a trust. A contingent beneficiary has conditions attached to his rights, usually someone else must die first.
BROKER
An individual in the business of assisting in arranging funding or negotiating contracts for a client buy who does not loan the money himself. BUY-DOWN
When the lender and/or the home builder subsidized the mortgage by lowering the interest rate during the first few years of the loan. While the payments are initially low, they will increase when the subsidy expires.
CAPS (interest)
Consumer safeguards which limit the amount the interest rate on an adjustable rate mortgage may change per year and/or the life of the loan. (floor or ceiling)
CAPS (payment)
Consumer safeguards which limit the amount of monthly payments on an adjustable rate mortgage the lender may change. CERTIFICATE OF ELIGIBILITY
The document given to qualified veterans which entitles them to VA guaranteed loans for homes, business, and mobile homes. Certificates of eligibility may be obtained by sending DD-214 (Separation Paper) to the local VA office with VA form 1880 (request for Certificate of Eligibility)
CERTIFICATE OF REASONABLE VALUE (CRV)
An appraisal issued by the Veterans Administration showing the property's current market value
CERTIFICATE OF TITLE
A written opinion by an attorney or title company setting forth the status of title to the property as shown on the public records. The certificate does not certify as to matters not of record and affords no protection unless the author was negligent.
CLOSINGS The meeting between the buyer, seller and lender or their agents where the property and funds legally change hands. Also called settlement. Closing costs usually include an origination fee, discount points, appraisal fee, title search and insurance, survey, taxes, deed recording fee, credit report charge and other costs assessed at settlement. The cost of closing usually are about 3 percent to 6 percent of the mortgage amount. commitment an agreement, often in writing, between a lender and a borrower to loan money at a future date subject to the completion of paperwork or compliance with stated conditions.
COLLATERAL
Property pledged to secure a loan. COMMITMENT
A contract issued by a lender to make a loan on specific terms or conditions to a borrower or builder.
CONSTRUCTION LOAN (interim loan):
A loan to provide the funds necessary to pay for the construction of buildings or homes. These are usually designed to provide periodic disbursements to the builder as he progresses. contract sale or deed: A contract between purchaser and a seller of real estate to convey title after certain conditions have been met. It is a form of installment sale.
CONDOMINIUM
A system of individual fee simple ownership of portions (units) in a multi-unit structure, combined with joint ownership of common areas. Each individual may sell or encumber his own unit.
CONSTRUCTION LOAN
A short term interim loan for financing the cost of construction. The lender advance funds to the builder at periodic intervals as the work progresses. .
COVENANT
A written agreement or restriction on the use of land or promising certain acts. Homeowner Associations often enforce restrictive covenants governing architectural controls and maintenance responsibilities. However, land could be subject to restrictive covenants even if there is no homeowner's association.
CONVENTIONAL LOAN
A mortgage not insured by FHA or guaranteed by the VA or deferred interest: When a mortgage is written with a monthly payment that is less than required to satisfy the note rate, the unpaid interest is deferred by adding it to the loan balance.
CREDIT REPORT
A report documenting the credit history and current status of a borrower's credit standing.
DEBT-TO-INCOME RATIO
The ratio, expressed as a percentage, which results when a borrower's monthly payment obligation on long-term debts is divided by his or her net effective income (FHA/VA loans) or gross monthly income (conventional loans).
DEED The written document conveying real property. Once recorded at the Courthouse, the original piece of paper is not needed to convey title in the future.
DEED OF TRUST
A voluntary lien to secure a debt deeding the property to Trustees who foreclose, sell the property at public auction, in the event of default on the Note the Deed of Trust secures. In many states, this document is used in place of a mortgage to secure the payment of a note.
DEFAULT
Failure to meet legal obligations in a contract, specifically, failure to make the monthly payments on a mortgage.
DELINQUENCY
Failure to make payments on time. this can lead to foreclosure.
DELIVERY
The final, unconditional and absolute transfer of a deed to the Grantee so that the Grantor may not revoke it. A Deed, signed but held by the Grantor, does not pass title.
DEPARTMENT OF VETERANS AFFAIRS An independent agency of the federal government which guarantees long-term, low-or no-down payment mortgages to eligible veterans.
DOWN PAYMENT
Money paid to make up the difference between the purchase price and the mortgage amount. Down payments usually are 10 percent to 20 percent of the sales price on conventional.
DUE-ON-SALES CLAUSE A provision in a mortgage or deed of trust that allows the lender to demand immediate payment of the balance of the mortgage if the mortgage holder sells the home.
ERNEST MONEY
Money given by a buyer to a seller as part of the purchase price to bind a transaction or assure payment.
EASEMENT The right to use the land of another for a specific limited purpose.
EMINENT DOMAIN
The power of the state to take private property for public use upon payment of just compensation.
ENCROACHMENT
The physical intrusion of a structure or improvement on the land of another. Examples include a fence or driveway over the property line.
ENTITLEMENT
The VA home loan benefit is called entitlement. Entitlement for a VA guaranteed home loan. This is also known as eligibility.
EQUAL CREDIT OPPORTUNITY ACT (ECOA)
Is a federal law that requires lenders and other creditors to make credit equally available without discrimination based on race, color, religion, national origin, age, sex, marital status or receipt of income from public assistance programs
EQUITY
The value an owner has in real estate over and above the obligation against the property.
EQUITY SHARING A form of joint ownership between an owner/occupant and an owner/investor. The investor takes depreciation deductions for his share of the ownership. The occupant receives a portion of the tax write-offs for interest and taxes and a part of his monthly payment is treated as rent. The co-owners divide the profit upon sale of the property.
ESCROW
Funds that are set aside and held in trust, usually for payment of taxes and insurance on real property. Also earnest deposits held pending loan closing.
FARMERS HOME ADMINISTRATION (FMHA) Provides financing to farmers and other qualified borrowers who are unable to obtain loans elsewhere.
FEDERAL HOME LOAN BANK BOARD (FHLBB)
A regulatory and supervisory agency for federally chartered savings institutions.
FEDERAL HOME LOAN MORTGAGE CORPORATION (FHLMC)
The Federal Home Loan Mortgage Corporation provides a secondary market for saving and loans by purchasing their conventional loans. Also known as "Freddie Mac."
FEDERAL HOUSING ADMINISTRATION (FHA)
A division of the Department of Housing and Urban Development. Its main activity is the insuring of residential mortgage loans made by private lenders. FHA also sets standards for underwriting mortgages.
FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA) Secondary mortgage institution which is the largest single holder of home mortgages in the United States. FNMA buys VA, FHA, and conventional mortgages from primary lenders. Also known as "Fannie Mae."
FHA LOAN
A loan insured by the Federal Housing Administration open to all qualified home purchasers. While there are limits to the size of FHA loans.
FHA MORTGAGE INSURANCE
Requires a small fee (up to 3.8 percent of the loan amount) paid at closing or a portion of this fee added to each monthly payment of an FHA loan to insure the loan with FHA. On a 9.5 percent $75,000 30-year fixed rate FHA loan, this fee would amount to either $2,850 at closing or an extra $31 a month for the life of the loan. In addition, FHA mortgage insurance requires an annual fee of 0.5 percent of the current loan amount, paid in monthly installments. The lower the down payment, the more years the fee must be paid. FIXED RATE MORTGAGE
The mortgage interest rate will remain the same on these mortgages throughout the term of the mortgage for the original borrower.
FORECLOSURE
A legal process by which the lender or the seller forces a sale of a mortgaged property because the borrower has not met the terms of the mortgage. Also known as a repossession of property.
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) also known as Ginnie Mae, provides sources of funds for residential mortgage, insured or guaranteed by FHA or VA.
GRADUATED PAYMENT MORTGAGE (GPM)
A type of flexible-payment mortgage where the payments increase for a specified period of time and then level off. This type of mortgage has negative amortization built into it.
GUARANTY A promise by one party to pay a debt or perform an obligation contracted by another if the original party fails to pay or perform according to a contract.
HAZARD INSURANCE
A form of insurance in which the insurance company protects the insured from specified losses, such as fire, windstorm and the like.
HOUSING EXPENSES-TO-INCOME RATIO
The ratio, expressed as a percentage, which results when a borrower's housing expenses are divided by his/her net effective income (FHA/VA loans) or gross monthly income. IMPOUND
That portion of a borrower's monthly payments held by the lender or servicer to pay for taxes, hazard insurance, mortgage insurance, lease payments, and other items as they become due. Also known as reserves.
INDEX
A published interest rate against which lenders measure the difference between the current interest rate on an adjustable rate mortgage and that earned by other investments (such as one- three-, and five-year U.S. Treasury security yields, the monthly average interest rate on loans closed by savings and loan institutions, and the monthly average costs-of-funds incurred by savings and loans), which is then used to adjust the interest rate on an adjustable mortgage up or down.
INVESTOR
A money source for a lender.
INTERIM FINANCING
A construction loan made during completion of a building or a project. A permanent loan usually replaces this loan after completion JOINT OWNERSHIP AGREEMENT
An agreement between owners defining their rights, ownership, monetary obligations and responsibilities. This could be between and investor and an occupant or the occupants. If an investor is involved, the investor does not take depreciation deductions and none of the occupant's payment is deemed rent for tax purposes.
JOINT TENANCY
Two or more persons own a property. Joint tenants with the common law right of survivorship means the survivor inherits the property without reference to the decedent's will. Creditors may sue to have the property divided to settle claims against one of the owners.
LIEN
A claim or charge against property. Property is said to be encumbered by a lien and the lien must be removed to clear title
LOAN-TO-VALUE RATIO
The relationship between the amount of the mortgage loan and the appraised value of the property expressed as a percentage.
MARGIN
The amount a lender adds to the index on an adjustable rate mortgage to establish the adjusted interest rate.
MARKET VALUE
The highest price that a buyer would pay and the lowest price a seller would accept on a property. Market value may be different from the price a property could actually be sold for at a given time. .
MORTGAGE
A voluntary lien filed against property to secure a debt, usually a loan. To foreclose, the lender must often institute a court action and the borrower may have the right to reclaim the property after foreclosure.
ORTGAGE INSURANCE Money paid to insure the mortgage when the down payment is less than 20 percent.
MORTGAGE INSURANCE PREMIUM (MIP)
One-half percent borrowers pay each month on FHA insured mortgage loans. It is insurance from FHA to the lender against incurring a loss on account of the borrower's default. On September 1, 1983, the MIP was changed to a one-time charge to the borrowers.
MORTGAGEE
The lender
MORTGAGOR
The borrower or homeowner
NEGATIVE AMORTIZATION Occurs when your monthly payments are not large enough to pay all the interest due on the loan. This unpaid interest is added to the unpaid balance of the loan. the danger of negative amortization is that the home buyer ends up owing more than the original amount of the loan.
NEGOTIABLE RATE MORTGAGE Loan in which the interest rate is adjusted periodically.
NET EFFECTIVE INCOME
The borrower's gross income minus federal income tax.
NON ASSUMPTION CLAUSE
A statement in a mortgage contract forbidding the assumption of the mortgage without the prior approval of the lender. Note: The signed obligation to pay a debt, as a mortgage note.
NOTE
A written promise to pay a certain sum of money at a certain time. A negotiable note starts "Pay to the order of" and is transferable by endorsement similar to a check.
ORIGINATION FEE
The fee charged by a lender to prepare loan documents, perform credit checks, inspect and sometimes appraise a property; usually computed as a percentage of the face value of the loan.
PERMANENT LOAN A long term mortgage, usually ten years or more. Also called an "end loan."
PITI
Principal, Interest, Taxes and Insurance. Also called monthly housing expense.
PLEDGED ACCOUNT MORTGAGE
Money is placed in a pledged savings account and this fund plus earned interest is gradually used to reduce mortgage payments.
POINTS
Prepaid interest assessed at closing by the lender. Each point is equal to 1 percent of the loan amount (e.g., two points on a $100,000 mortgage would cost $2,000).
POWER OF ATTORNEY A written document authorizing another to act on his behalf as an Attorney in Fact. One does not need to be a licensed attorney to act as an attorney in fact but, power of attorney forms are powerful legal documents that should be used only under advice of a licensed attorney at law.
PREPAID EXPENSES
Necessary to create an escrow account or to adjust the seller's existing escrow account. Can include taxes, hazard insurance, private mortgage insurance and special assessments.
PREPAYMENT A privilege in a mortgage permitting the borrower to make payments in advance of their due date.
REPAYMENT PENALTY
An additional charge imposed by the lender for paying off a loan before the due date.
PRIMARY MORTGAGE MARKET
Lenders making mortgage loans directly to borrower's such as savings and loan association, commercial banks, and mortgage companies. These lenders sometimes sell their mortgages into the secondary mortgage markets.
PRIVATE MORTGAGE INSURANCE (PMI)
In the event that you do not have a 20 percent down payment, lenders will allow a smaller down payment as low as 5 percent in some cases. With the smaller down payment loans, however, borrowers are usually required to carry private mortgage insurance. Private mortgage insurance will require an initial premium payment of 1.0 percent to 5.0 percent of your mortgage amount and may require an additional monthly fee depending on you loan's structure. PRINCIPAL
The amount of debt, not counting interest, left on a loan. QUITCLAIM DEED
A deed releasing whatever interest you may hold in a property but making no warranty whatsoever.
REAL ESTATE SETTLEMENT PROCEDURES ACT (RESPA)
RESPA is a federal law that allows consumers to review information on known or estimated settlement cost once after application and once prior to or at a settlement. The law requires lenders to furnish the information after application only.
REALTOR®
A real estate broker or an associate holding active membership in a local real estate board affiliated with the National Association of Realtors.
RECESSION
The cancellation of a contract. With respect to mortgage refinancing, the law that gives the homeowner three days to cancel a contract in some cases once it is signed if the transaction uses equity in the home as security.
RECORDING FEES
Money paid to the lender for recording a home sale with the local authorities, thereby making it part of the public records.
REFINANCE
Obtaining a new mortgage loan on a property already owned. Often to replace existing loans on the property
REVERSE ANNUITY MORTGAGE
Form of mortgage in which the lender makes periodic payments to the borrower using the borrower's equity in the home as Satisfaction of Mortgage: The document issued by the mortgagee when the mortgage loam is paid in full. Also called a "release of mortgage."
SECOND MORTGAGE
A mortgage made subsequent to another mortgage and subordinate to the first one.
SECONDARY MORTGAGE MARKET
The place where primary mortgage lenders sell the mortgages they make to obtain more funds to originate more new loans. It provides liquidity for the lenders.
SERVICING all the steps and operations a lender performs to keep a loan in good standing, such as collection of payments, payment of taxes, insurance, property inspections and the like.
SHARED APPRECIATION MORTGAGE
Mortgage in which a borrower receives a below-market interest rate in return for which the lender (or another investor such as a family member or other partner) receives a portion of the future appreciation in the value of the property. May also apply to mortgage where the borrowers shares the monthly principal and interest payments with another party in exchange for part of the appreciation.
SIMPLE INTEREST
Interest which is computed only on the principle balance.
SURVEY A measurement of land, prepared by a registered land surveyor, showing the location of the land with reference to know points, its dimensions, and the location and dimensions of any buildings.
SWEAT EQUITY Equity created by a purchaser performing work on a property being purchased.
TENANTS BY THE ENTIRETY
A husband and wife own the property with the common law right of survivorship so, if one dies, the other automatically inherits.
TENANT IN COMMON
Two or more persons own the property with no right of survivorship. If one dies, his interest passes to his heirs, not necessarily the co-owner. Either party, or a creditor of one, may sue to partition the property.
TITLE
Document that gives evidence of an individual's ownership of property
TITLE INSURANCE Insurance that provides an indemnity against loss or damage as a result of defect in title ownership to a particular piece of property. Title insurance covers mistakes made during a Title Search as well as matters which could not be found or discovered in the public records such as missing heirs, mistakes, fraud and forgery.
TITLE SEARCH An examination of municipal records to determine the legal ownership of property. Usually is performed by a title company.
TRUTH-IN-LENDING
Federal law requiring disclosure of the Annual Percentage Rate to home buyers shortly after they apply for the loan.
TWO-STEP MORTGAGE
Mortgage in which the borrower receives a below-market interest rate for a specified number of years (most often seven or 10), and then receives a new interest rate adjusted (within certain limits) to market conditions at that time. the lender sometimes has the option to call the loan due with 30 days notice at the end of seven or 10 years. also called "Super Seven" or "Premier" mortgage.
UNDERWRITING
The decision whether to make a loan to a potential home buyer based on credit, employment, assets, and other factors and the matching of this risk to an appropriate rate and term or loan amount.
USURY
Interest charged in excess of the legal rate established by law.
VA LOANS
Long-term, low-or no-down payment loan guaranteed by the Department of Veterans Affairs. Restricted to individuals qualified by military service or other entitlements.
VA MORTGAGE FUNDING FEE Premium of up to 1-7/8 percent (depending on the size of the down payment) paid on a VA-backed loan. On a $75,000 fixed-rate mortgage with no down payment, this would amount to $1,406 either paid at closing or added to the amount financed.
VERIFICATION OF DEPOSITS Document signed by the borrower's financial institution verifying the status and balance of his/her financial accounts.
VERIFICATION OF EMPLOYMENT
Document signed by the borrower's employer verifying his/her position and salary.
WAREHOUSE FEE
Many mortgage firms must borrow funds on a short term basis in order to originate loans which are to be sold later in the secondary mortgage market (or to investors). When the prime rate of interest is higher on short term loans than on mortgage loans, the mortgage firm has an economic loss which is offset by charging a warehouse fee.
WRAPAROUND wraparound results when an existing assumable loan is combined with a new loan, resulting in an interest rate somewhere between the old rate and the current market rate. The payments are made to a second lender or the previous homeowner, who then forwards the payments to the first lender after taking the additional amount off the top.The debt secured includes an existing debt already on the property. The payments made to the holder of the wraparound include payments due on the existing loan and the holder must forward the appropriate portion of each payment to the existing note holder. TYPES OF MORTGAGE LOANS Major types of mortgage loans include: - Fixed-rate loans. Because they offer a monthly payment that is known and does not change, fixed-rate mortgage loans remain the most popular type.
Most fixed-rate mortgages are for loan terms of 15 or 30-years. A 30-year loan has lower payments but a slightly higher interest rate. For all of 2005, the average mortgage rate on a 30-year fixed-rate loan was 5.87%, according to data from Freddie Mac. For 15-year mortgages, the average rate was 5.42%.
To pay off a fixed-rate loan sooner, check with your lender to make sure you can make prepayments. You should be allowed to make these anytime and for any amount, and at no penalty.
- Adjustable-rate loans. After an initial term, the interest rate on an adjustable-rate mortgage (ARM) loan is re-set periodically. This is to keep the rate in line with current market interest rates. For example, a 3/1 ARM loan offers a fixed rate for the first three years, adjusting once a year thereafter. A 5/1 ARM loan offers a fixed rate for the first five years, adjusting yearly thereafter. The lender sets the interest rate by adding a margin to an index rate. Common indexes include:
- Cost of Funds Index. The Eleventh District of the Federal Home Loan Bank Board, which covers California, Nevada and Arizona, publishes the Cost of Funds Index. For more information on the index, visit the Web site of the Federal Home Loan Bank of San Francisco.
- Treasury bill yields. The yield on the 1-year T-bill, adjusted for a constant-maturity security, is widely used.
Most ARM loans have a periodic rate cap and lifetime cap to limit the amount the interest rate can increase each adjustment period and over the term of the loan, respectively.
If you have a payment cap in your loan agreement, you may face negative amortization of your loan. This has the effect of increasing the amount you owe.
- Convertible mortgage loans. These are ARM loans that allow you to convert to a fixed-rate loan at or before a specified time. The conversion privilege lets you start off with a low variable rate, then lock in when fixed rates drop low enough.
- Balloon mortgage loans. These loans often have interest-only payments. In this case, you don't amortize any loan principal and the entire loan amount is due at the end of the loan term. A balloon mortgage allows you to minimize your monthly payments until you refinance the loan. Another advantage is that a larger share of your payment may be eligible for the mortgage interest tax deduction.
OTHER TYPES OF MORTGAGES Graduated payment mortgage loan Often referred to as GPM, is a mortgage with low initial monthly payments which gradually increase over a specified time frame. These plans are mostly geared towards young men and women who cannot afford large payments now, but can realistically expect to do better financially in the future. For instance a medical student who is just about to finish medical school might not have the financial capability to pay for a mortgage loan, but once he graduates, it is more than probable that he will be earning a high income. It is a form of negative amortization loan. Growing equity mortgage Mortgage which has a fixed interest rate and increasing monthly payments.Shared appreciation mortgage or SAM Is a mortgage in which the lender agrees as part of the loan to accept some or all payment in the form of a share of the increase in value (the appreciation) of the property. Second mortgage Typically refers to a secured loan (or mortgage) that is subordinate to another loan against the same property. In real estate, a property can have multiple loans or liens against it. The loan which is registered with county or city registry first is called the first mortgage or first position trust deed. The lien registered second is called the second mortgage. A property can have a third or even fourth mortgage, but those are rarer. Second mortgages are called subordinate because, if the loan goes into default, the first mortgage gets paid off first before the second mortgage gets any money. Thus, second mortgages are riskier for the lender, who generally charges a higher interest rate. In most cases, a second mortgage takes the form of a home equity loan and the two are synonymous, from a financial standpoint. The difference in terminology is that a mortgage traditionally refers to the legal lien instrument, rather than the debt itself. REVERSE ANNUITY MOTGAGE A reverse annuity mortgage (RAM) is a loan aimed at senior citizens who have paid off their houses but cannot afford to stay there or need extra money for such things as home repair, long-term care, or other purposes. The loans are usually paid out to the borrower monthly, instead of in a lump sum, and repaid when the borrower sells the home, moves out, or dies. DERIVATIVES MARKET The derivatives markets are the financial markets for derivatives. The market can be divided into two, that for exchange traded derivatives and that for over-the-counter derivatives. The legal nature of these products is very different as well as the way they are traded, though many market participants are active in both. Futures marketsMain article: Futures exchange Futures exchanges, such as Euronext.liffe and the Chicago Mercantile Exchange, trade in standardized derivative contracts. These are options contracts and futures contracts on a whole range of underlying products. The members of the exchange hold positions in these contracts with the exchange, who acts as central counterparty. When one party goes long (buys) a futures contract, another goes short. When a new contract is introduced, the total position in the contract is zero. Therefore, the sum of all the long positions must be equal to the sum of all the short positions. In other words, risk is transferred from one party to another. The total notional amount of all the outstanding positions at the end of June 2004 stood at $53 trillion. (source: Bank for International Settlements (BIS): [1]) Over-the-counter marketsTailor-made derivatives traded on a futures exchange, are traded on over-the-counter markets, also known as the OTC market. These consist of investment banks who have traders who make markets in these derivatives, and clients such as hedge funds, commercial banks, government sponsored enterprises, etc. Products that are always traded over-the-counter are swaps, forward rate agreements, forward contracts, credit derivatives, etc. The total notional amount of all the outstanding positions at the end of June 2004 stood at $220 trillion. (source: BIS: [2]) | 