Work on subject Stock market

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New issues are different. You have probably noticed the advertisements in the newspaper financial pages for new issues of stocks or bonds–large advertising which, because of the very tight restrictions on advertising new issues, state virtually nothing except the name of the security, the quantity being offered, and the names of the firms which are “underwriting” the security or bringing it to market.

Sometimes there is only a single underwriter; more often, especially if the offering is a large one, many firms participate in the underwriting group. The underwriters plan and manage the offering. They negotiate with the offering company to arrive at a price arrangement which will be high enough to satisfy the company but low enough to bring in buyers. In the case of untested companies, the underwriters may work for a prearranged fee. In the case of established companies, the underwriters usually take on a risk function by actually buying the securities from the company at a certain price and reoffering them to the public at a slightly higher price; the difference, which is usually between 1% and 7%, is the underwriters’ profit. Usually the underwriters have very carefully sounded out the demand is disappointing–or if the general market takes a turn for the worse while the offering is under way–the underwriters may be left with securities that can’t be sold at the scheduled offering price. In this case the underwriting “syndicate” is dissolved and the underwriters sell the securities for whatever they can get, occasionally at a substantial loss.

The new issue process is critical for the economy. It’s important that both old and new companies have the ability to raise additional capital to meet expanding business needs. For you, the individual investor, the area may be a dangerous one. If a privately owned company is “going public” for the fist time by offering securities in the public market, it is usually does so at a time when its earnings have been rising and everything looks particularly rosy. The offering also may come at a time when the general market is optimistic and prices are relatively high. Even experienced investors can have great difficulty in assessing the real value of a new offering under these conditions.

Also, it may be hard for your broker to give you impartial advice. If the brokerage firm is in the underwriting group, or in the “selling group” of dealers that supplements the underwriting group, it has a vested interest in seeing the securities sold. Also, the commissions are likely to be substantially higher than on an ordinary stock. On the other hand, if the stock is a “hot issue” in great demand, it may be sold only through small individual allocations to favored customers (who will benefit if the stock then trades in the open market at a price well above the fixed offering price)

If you are considering buying a new issue, one protective step you can take is to read the prospectus The prospectus is a legal document describing the company and offering the securities to the public. Unless the offering is a very small one, it can't be made without passing through a registration process with the SEC. The SEC can't vouch for the value of the offering, but it does act to make sure that essential facts about the company and the offering are disclosed in the prospectus.

This requirement of full disclosure was part of the securities laws of the 1930s and has been a great boon to investors and to the securities markets. It works because both the underwriters and the offering companies know that if any material information is omitted or misstated in the prospectus, the way is open to lawsuits from investors who have bought the securities.

In a typical new offering, the final prospectus isn't ready until the day the securities are offered. But before that date you can get a "preliminary prospectus" or "red herring"—so na­med because it carries red lettering warning that the prospectus hasn't yet been cleared by the SEC as meeting disclosure require­ments

The red herring will not contain the offering price or the final underwriting arrangements But it will give you a description of the company's business, and financial statements showing just what the company's growth and profitability have been over the last several years It will also tell you something about the management. If the management group is taking the occasion to sell any large percentage of its stock to the public, be particularly wary.

It is a very different case when an established public company is selling additional stock to raise new capital. Here the company and the stock have track records that you can study, and it's not so difficult to make an estimate of what might be a reasonable price for the stock The offering price has to be close to the current market price, and the underwriters' profit margin will generally be smaller But you still need to be careful. While the SEC has strict rules against promoting any new offering, the securities industry often manages to create an aura of enthusiasm about a company when an offering is on the way On the other hand, the knowledge that a large offering is coming may depress the market price of a stock, and there are times when the offering price turns out to have been a bargain

New bond offerings are a different animal altogether. The bond markets are highly professional, and there is nothing glamorous about a new bond offering. Everyone knows that a new A-rated corporate

bond will be very similar to all the old A-rated bonds. In fact, to sell the new issue effectively, it is usually priced at a slightly higher "effective yield" than the current market for comparable older bonds—either at a slightly higher interest rate, or a slightly lower dollar price, or both. So for a bond buyer, new issues often offer a slight price advantage.

What is true of corporate bonds applies also to U.S. government and municipal issues. When the Treasury comes to market with a new issue of bonds or notes (a very frequent occurrence), the new issue is priced very close to the market for outstanding (existing) Treasury securities, but the new issue usually carries a slight price concession that makes it a good buy. The same is true of bonds and notes brought to market by state and local governments; if you are a buyer of municipals, these new offerings may provide you with modest price concessions. If the quality is what you want, there's no reason you shouldn't buy them—even if your broker makes a little extra money on the deal.

8. MUTUAL FUNDS. A DIFFERENT APPROACH

Up until now, we have described the ways in which securities are bought directly, and we have discussed how you can make such investments through a brokerage account.

But a brokerage account is not the only way to invest. For many investors, a brokerage has disadvantages–the difficulty of selecting an individual broker, the commission costs (especially on small transactions), and the need to be involved in decisions that many would prefer to leave to professionals. For people who feel this way, there is an excellent alternative available—mutual funds.

It isn't easy to manage a small investment account effectively. A mutual fund gets around this problem by pooling the money of many investors so that it can be managed efficiently and economically as a single large unit. The best-known type of mutual fund is probably the money market fund, where the pool is invested for complete safety in the shortest-term income-producing investments. Another large group of mutual funds invest in common stocks, and still others invest in long-term bonds, tax-exempt securities, and more specialized types of investments.

The mutual fund principle has been so successful that the funds now manage over $400 billion of investors' money—not including over $250 billion in the money market funds.

8.1 Advantages of Mutual Funds