The investor's primer

Front matter

Class Book ftfwz

Copyright N°_

COPYRIGHT DEPOSIT.

Preface

There has long been a demand for a concise handbook which would give, in simple, understandable language, definitions of all the important terms and phrases employed in the investment and banking business. This little book represents an effort to in some measure supply this demand.

The book is really in two parts, the first part covering the general definitions of finance; the second giving more specific information regarding investment securities and the manner in which they are distributed to the public.

Introduction

T^HE investment of money is a business, just as the manufacture of shoes and the selling of food are businesses. But modern investing is even more than a business; it is influenced by and covers all businesses, all enterprises, all industry. In the early days of the Republic, the situation was, of course, somewhat different. At that time there was but little wealth and therefore little capital. Population was sparse, privation was great, men were absorbed in holding body and soul together, in feeding and clothing themselves, rather than in seeking for luxuries. There was no leisure class in those days and, as a consequence, no investing class. For then, an investing class could only be drawn from a leisure class. Nowadays investors are made up from all classes, and a vast amount of money which is invested in stocks and bonds and other enterprises is the money of the poor, of the moderately-well-to-do and of the industrious, as well as of the merely rich and the non-industrious or idle. One hundred years 5 ago only a very few could spare anything beyond their daily needs for investment in outside things. If they accumulated any wealth at all above their cost of living, it was used to buy or build a home, raise and educate a family or develop a small undertaking of their own. And, indeed, even though they acquired or possessed surplus wealth, practically the only forms of investment accessible were government securities or loans upon realty. There were no railroads, no trolley companies, no manufacturing enterprises of large size, or other fields for the productive employment of surplus capital. Even savings banks were practically unknown, and mining or exploration enterprises were largely of that uncertain, speculative nature that only the boldest and least timorous would look favorably upon.

But to-day the field of investment covers enterprises of every conceivable nature. Manufacturing corporations covering every thinkable need or luxury of the human being, distributing concerns selling every kind and class of necessity and luxury in the line of food, clothing, or what not, are all embraced in the investment field. Transportation methods of every kind from the stage-coach to the powerful locomotive, from the coal cart to the automobile, are operated with the capi-

INTRODUCTION 7

tal of investors. Our department stores, our restaurants, our candy manufacturers, our theaters, our magazines and newspapers, the advertisements in the street cars, many of the metropolitan barber shops, the boot-black stands, and the news stands and book stores are operated by corporations, the capital in which is largely derived from investors. Not a large building is now put up in New York City but that an enormous corporation puts in the foundation; another corporation erects the superstructure and still others put on the finishing touches, all being concerns whose shares or bonds are owned by investors in all parts of the country. The hats we wear, the umbrellas we carry, the suit of clothes, the shoes, the socks, the shave we had this morning, or the ham we ate this noon — all these were shaped and produced to a large extent by the money of investors. When we realize that one corporation in this country boasts of over eighty thousand stockholders, and that many others are known to have over thirty thousand, we begin to get a slight idea of the magnitude of the investment field.

But this is not all. Not only is all modern business essentially the investors' field, but all the obligations of municipalities, of counties, cities and States are held by investors.

The governments themselves build up their navies and armies, carry on wars and develop public works with the money of investors. A case in point is our own Panama Canal. And not only do the investors of one country supply funds for their own activities, but they also supply much for the activities of other nations. Thus, when the American is investing money in a Mexican gold mine or in Japanese Government bonds, he is supplying investment funds to undertakings in those countries, and when the Englishman or Frenchman buys our railroad or industrial bonds or stocks, he is supplying investment capital for undertakings in our own country. The investors' field in this country would seem, therefore, to be limited only by the wealth of the country itself.

But what about the methods for investing money? Where does the money come from? Does it all come into Wall Street and the other financial centers, or does it flow directly from the pockets of the investors into the undertaking or enterprise itself?

Speaking broadly, there are two methods by which money is invested in any given enterprise. These are, direct and indirect. The person who places money directly, or through a broker or banker, in a specific enterprise or undertaking is a direct investor. He person-

INTRODUCTION 9

ally becomes the stock or bond-holder in a corporation of his own choosing. But the man who deposits his money in a savings bank, insurance, or trust company or State or National bank, is an indirect investor. His money goes into an investment of some sort where it earns the interest which he receives and possibly a little more. In the former case, he sees his money at work; it stays presumably in the place where he puts it. In the latter case, he delegates the matter of actual investment to another — to the bank — which acts in the capacity of a trustee, and invests his money for him. And in both cases, the money may easily be invested in the same enterprise. Thus, in the latter case, he may place his money in a savings bank, and the bank may then invest it in New York Central Railroad 3%% bonds. In the former case he may himself, through an investment banker, purchase New York Central Railroad 3^2% bonds. His money is in the same enterprise in both instances, the chief difference being that, in one case, he knows it; in the other, he does not.

This brief sketch of the investment field which obtains in this country to-day will give a rough idea of the breadth of the subject under discussion. And, in taking this broad view, we must bear the fact in mind that this is not a stationary condition, for the American investment field is broadening and intensifying every day. It is not only growing in size and volume, but also in density. We, even more, I think, than most other modern nations, are going through a quiet, steady, but most remarkable evolution in the methods of wealth production and distribution. Fifteen years ago we were called " a nation of investors," but this appellation is far more appropriate to-day than it was then. The changes during the past ten years in this respect are in no way better illustrated than in the remarkable expansion of Wall Street. The mere growth of stock exchange business, while great in itself, is not a complete guide in this matter. We must necessarily take into consideration the vast expansion of investment business outside of the stock exchange floor.

While there are no accurate figures for demonstration, the acknowledged fact that a hundred first-class investment houses exist in the Street to-day where ten existed in 1896 is evidence enough in itself that the expansion has been great. In 1896 or 1897, if an investment bond house bought or sold $500,000 or $1,000,000 of bonds in one block or at one time, the fact was heralded far and wide as a notable event; nowadays such transactions and much

INTRODUCTION 11

larger ones are constantly going through and create no comment whatever. In those days, if a bond or investment firm made half a million dollars in any one year, it was regarded as a most remarkable showing, but at the present time, dozens of houses can be pointed out in the Street which are making this or a better showing every year. To-day, single firms buy entire issues of bonds or stocks sometimes running into the tens of millions in amount; ten years ago this was unheard of, and usually a "million dollar loan" was regarded as of such magnitude that it required a syndicate of half a dozen or more concerns to underwrite it. In the field of stock speculation and trading, in those days, a business of 15,000 shares in one day was regarded as very large. To-day many firms do 50,000 to 100,000 shares per day right along in normal times. Then, a firm carrying on margin $5,000,000 worth of stock was a large firm; to-day many are constantly carrying from $30,000,000 to $40,000,000 worth. In the actual banking field the expansion has been equally great. Now many banks and trust companies in the city of New York can boast of deposits of $40,000,000 and over; in those days none could. And yet there are now several times the banking facilities in New York that there were in 1896.

While Wall Street is the main center of investment, it alone has not enjoyed all the expanding. Other cities, all over the land, can now boast of financial and investment centers of no mean extent. In most cases they have close alliances with the main center in New York, but they are all sharing in the general expansion of this particular phase of modern commercial advancement.

The fact should be consistently borne in mind that this great investment field is constantly being accelerated from several sources. Not only does it benefit by the steady growth of population and general development of the country, but it expands steadily because of the fact that it is becoming increasingly necessary to do things more and more on a large scale, and this tendency automatically involves the elimination of the smaller producer and competitor, and forces a steadily expanding element into the field of investment. Even the busy workers of to-day, as well as the leisure classes and those who pursue the professions, find it profitable to place their surplus funds more and more into enterprises outside of their chosen environment. It is this tendency of modern civilization which has much to do with making the investor class of greater importance in all parts of the country.

Part I

ACCOUNT AND RISK. The forms usually provided by brokers for the use of their customers when giving orders for purchases or sales of securities, bears the inscription, "Buy or sell for my account and risk." The meaning of this is that when an order as given is executed by the broker, it is done for the account and risk of the customer exclusively, and that the broker is simply acting as the agent in the matter and is therefore in no sense liable himself, but holds the customer wholly responsible for the transaction.

ACCRUED DIVIDEND. The amount or proportion of a regular dividend not yet payable that has accumulated at a given time after the date of payment of the preceding regular dividend. For instance, if a dividend on a stock at the rate of 6% per annum is payable semi-annually January and July ist, the amount of acrrued dividend on a given date, such as April ist, will be 1%%. Cumulative dividends which have not been paid when due, but which have accumulated, are sometimes called accrued dividends, but the correct term for such is "accumulated dividends." A cumulative dividend is an entirely different matter.

ACCRUED INTEREST. This is the amount of interest on a bond or debenture stock not yet payable, but which has accrued over a given period of time subsequent to the last regular payment. For instance, if the interest on a 4% bond is payable semi-annually January and July i, the amount of accrued interest on the bond on April ist would be exactly i%, which on a $1,000 bond would amount to $io. Many bonds are quoted "with accrued interest" and sold on this basis. This is particularly true of unlisted issues, municipal bonds, etc. Most of the issues quoted on the stock exchanges are sold "flat" ; that is, the accrued interest is not separately figured but is included in the price. To bring the distinction out concretely between a price quoted with accrued interest, and a price quoted "flat" the following illustration is submitted: If a 4% bond is selling at 90 and accrued interest on January ist, the total cost of the bond will be exactly $900 ; but if on April ist it is still quoted at go and accrued interest, the total cost of the bond will be not $900 but $910, the $10 representing the accrued interest over the preceding three months. If, however, the bond is quoted "flat" the price on April 1 st, other things being equal, would be given as 91. It will be seen, therefore, that the matter of accrued interest directly affects the "flat" price but does not affect the "and interest" price. As very large transactions are made daily in bonds on an accrued interest basis, it is necessary to do a great deal of figuring from day to day on the amounts of accrued interest when making purchases and sales. To facilitate this, most bankers and brokers make use of pocket bond interest tables, which contain the figures showing the amounts of accrued interest on $1,000 bonds for every day from one day to six months, at the various rates of interest from 2% up to 8%.

ACCUMULATED DIVIDENDS. This term is properly used to describe cumulative dividends which for one reason or another have not been paid as they fell due. For instance, in many corporations, particularly industrials, there are issues of preferred stocks on which the dividend charge is so heavy that the corporation is not able to earn and meet the payments. The amounts of dividends, therefore, have accumulated, and, theoretically at least, must be paid off some day. Usually when dividends of this kind or portions of dividends have accumulated over a series of years and it has been pretty well demonstrated that there is little prospect of the corporation being able ever to make good the back payments, some plan of compromise is then submitted to the stockholders whereby the accumulations are paid, possibly in securities of some kind, and then the rate of dividends is scaled down for the future. It is not always difficult for the corporation to make a readjustment of this kind, as the cumulative clause in a stock is really not of a great deal of value if the corporation cannot in some way earn sufficient money to pay the full dividend. In other words, the stockholder has no means of foreclosing on the property or bringing legal action if the past dividends are not paid.

ADJUSTMENT BOND. This term is used to describe a bond which has been issued for the purpose of in some way adjusting the finances of a company, usually at the time of a reorganization. For example, when the Atchison, Topeka & Santa Fe system was reorganized in 1897, some compromise had to be made with the old preferred stockholders and the. holders of the general mortgage bonds. It was necessary for the road to radically reduce its fixed charges, but at the same time the reorganization committee could not avoid giving the holders of a large proportion of the old securities something more tangible than a mere preferred stock. The holders were therefore given a second mortgage bond, which would be entitled to receive interest only in case the same had been earned, and in no case would the holders of the bond be able to foreclose before maturity in the event of the interest not being paid. The interest on this particular issue was to become accumulative after 5 years, but as far as any positive guarantee of interest being currently paid was concerned, the issue was simply in the same class as the ordinary accumulative preferred stock. It will thus be seen that this issue of bonds was in the nature of a compromise for the benefit of the holders of old securities, and it was therefore given the title of "adjustment bond." Several other large issues of adjustment bonds have since been created by other companies, but the Atchison "adjustments" are the most conspicuous example of this kind of security.

ALLOTMENT. A term used in connection with the amounts assigned to members or subscribers in underwriting syndicates. For example, it is generally understood when an underwriting syndicate is being formed and different concerns are subscribing for portions of the underwriting, that the managers of the syndicate have it in their power to allot to a given subscriber less than the amount applied for, provided the total subscription or underwriting exceeds the total amount offered for subscription. There have been many instances where an over-subscription of a stock or bond issue has been so great that the subscriber is finally allotted only a small proportion, sometimes only 10% of the amount for which he has subscribed. This fact of a tendency for over subscription has often, in the case of popular securities, had the result of inducing underwriters to sometimes subscribe for even greater amounts than they expected to get. In this way, they have been able to secure the amounts which they actually desired.

ARBITRAGE. The meaning of this expression is the buying and selling of the same thing in two different markets, as, for instance, New York and London, the purpose being to make a profit from the difference in the quotations between the two markets. The term is used chiefly in reference to dealings in stocks and bonds, but is also used in dealings in exchange and in other commodities.

Arbitrage in stocks is based on the temporary differences in prices between the different markets for the same stock. For instance, when a stock is selling at a higher price in one market than in another, it is sold in the market where the higher price prevails and is bought in the market where the lower price prevails. The operator speculates on a return to the same price in both markets. When the equality in price has been restored he closes his transaction by buying where he sold and selling where he bought. The difference in price that existed, of course, represents his profit, unless the transaction has not been a successful one, in which case a loss may be reported.

To illustrate the method of arbitrage trading we will assume that a stock is selling in one market at ioo and in another at 98. It is then sold in the first market at 100 and bought on contract in the second market at 98. If the stock advances to 100 in the second market while it remains stationary in the first market a sale is then made in the second market and thus 2% is made on the transaction there. The same amount of stock is then bought back in the first market at ioo, and hence neither profit nor loss barring commissions, results in the transaction in the first market, the profit in the second market representing the entire net profit of the double transaction. Should the stock decline to 99 in the first market and advance to 99 in the second market the transaction can be closed up with a profit of 1% in each market or 2% in the two markets.

Because of the system of calculating values for American stocks on the London Stock Exchange, prices on the London Exchange are 2^8% higher than the prices for the same stocks on the New York Stock Exchange when they are actually the equivalent of the prices on the New York Exchange. Hence, in arbitrage dealings, allowance has to be made for this difference in prices between London and New York, which is merely apparent and not actual. The figure of 2^8% mentioned above is arrived at in the following manner : In dealings in American stocks on the London Stock Exchange four shillings is counted as one dollar. Four shillings being equal to 97 1-3 cents, the price of an American stock must be 2 2-3% (quotably 2$/£%) higher in London than in New York if the London price is to be equivalent to (or at a parity with) the New York price. Not 25/ s % of the par value is to be added arbitrarily to the New York price, but 2^8% of the New York price, whatever it may be, is to be added to the New York price to make an equivalent London price. Thus, for a stock selling at 50 in New York the equivalent price in London would be quotably 51%%. For a stock selling at 100 in New York the equivalent price in London would be 102^%. Conversely, for a stock selling at 100 in London the equivalent price in New York would be 97^6%, and for a stock selling at 50 in London the equivalent price in New York would be 4854%.

The difference in equivalent prices between New York and London permits two kinds of operations in stocks that are dealt in in both markets. One operation is called a "spread" and the other is called a "back spread." See also definition of "spread" as used locally under its own heading.

In the "spread" as employed in arbitrage dealings there must be more than a normal difference in prices between London and New York. The stock is sold in London where the higher price prevails, and bought in New York where a lower price prevails. Then, when the equality in price is restored the transaction is closed by buying in London and selling in New York. The difference in excess of the normal difference represents the profit in the transaction.

In the "back spread" there must be less than the normal difference in prices between New York and London. The stock is therefore bought in London where the nominal higher price prevails, and is sold in New York where the nominal lower price prevails. The transaction is finally closed when the equality in price has been restored by selling in London and buying in New York. The difference in price that existed less than the normal difference, represents the profit in the transaction.

A large arbitrage business in active stocks is carried on between London and New York by cable daily. By the clock London is five hours ahead of New York. At 10 a. m. in New York, when the New York Stock Exchange opens, it is 3 p. m. in London. The London Exchange opens at ii a. m. and closes at 4 p. m., except on the last day of accounting, when it closes at 4.30 p. m. After the closing of the London Exchange, American stocks are still traded in in the Street. A good part of this street market represents arbitrage business with New York. Very little business is transacted in New York before the opening of the New York Exchange, but orders are sent to London for execution. The London curb brokers remain active as long as there is business to keep them, continuing usually as late as 5.30 or 6 o'clock.

There is also a business in arbitrages carried on in grain, cotton, coffee and so forth, between different markets in one country or between different countries, just the same as in stocks between New York and London.

ASSENTED STOCKS OR BONDS. A

term which describes securities, deposited under an agreement by which the owners assent to some change in the status of the securities. Many reorganizations of properties are carried through without foreclosure or other legal process, the owners of the securities assenting to some change in the status of their stocks or bonds such as an exchange for new securities, with possibly less principal or interest. See also Reorganization.

ASSESSMENT. An assessment on a security is a demand or call from a company or its management upon stockholders to pay into the treasury a specified sum of money on each share of the security which they may hold. There are many kinds of assessments, the most common in Wall Street being that which resuits as part of a plan of reorganization by* means of which funds are secured for the discharge of debts and for working capital. While most stocks of railroads and other large corporations are, in a legal sense, nonassessable yet in a reorganization where conditions have made it necessary for the different security-holders to make concessions and sacrifices, assessments are often paid. These assessments are, of course, in a sense voluntary, and are agreed to by the stockholder and paid in order to preserve the property with the hope that the reorganization will result in ultimately adding value enough to the securities to repay the stockholder for the expense of the assessment. Often the stockholder has no alternative except to pay the assessment. If he does not pay it, usually an underwriting syndicate stands ready to take his stock at a current market price (which is often a merely nominal one) and pay the assessment itself. This results in the former stockholder sacrificing practically his entire interest and he is then, in a sense, "frozen out." Any future benefit from the reorganization is, of course, derived by the payer of the assessment, who naturally takes the chance of the future success of the company and is therefore entitled to its future profits.

ASSIGNED IN BLANK. The ordinary stock certificate has on its back a printed form of assignment, whereby the owner of the certificate can endorse the same and thus make it a good delivery in selling it or passing it on to another party. By signing this form in blank he makes a legal and formal assignment of the stock to any purchaser who, of course, can fill in his own name in the blank provided for the purpose and then have it transferred on the books of the company in the usual way, receiving a new certificate in his own name. The New York Stock Exchange rules provide that any stock certificate assigned in blank by the owner must carry a witness to the signature, and also a formal guarantee of the signature by some stock exchange house in good standing. This, of course, is to guard against forgeries, errors, etc.

AVERAGING. This is a speculative term describing a method of purchases or sales of stock, which speculators often pursue in advancing or declining markets, for the purpose of improving their position regarding the average cost of certain purchases or sales of stock. For instance, should a man be dealing in New York Central stock on a speculative basis, he might begin by purchasing ioo shares at no.

Should the price then decline to 105, his transaction up to that date would show him a loss of $500. He might then purchase another 100 shares at 105, and he would thus be carrying 200 shares at an average cost of 107J4. Should the price then advance to above 10754 his entire account would show no loss, and he could close out the transaction 2y 2 points below the cost of the first hundred shares and yet not lose any money. The practice of averaging is carried on sometimes on a much larger scale. Investors or speculators will often put in orders to make purchases on a "scale down," buying at every point or two, and in a declining market where a given stock may drop 25 points, 100 shares may have been purchased at every point down. Each purchase naturally brings the average cost of the entire account down to a lower figure.

The method of averaging is also employed in the sales of stocks by investors and speculators in the same way, both in selling stocks for long account and for short account.

BALANCE OF TRADE. The difference in money value between sales and purchases. In foreign trade, the difference in money value between exports and imports. As commonly used the term signifies the balance or differ-

V ence in favor of a country ; as, for instance, the United States as against the rest of the world ; or in favor of the rest of the world and against that country. When exports exceed imports over a given period the balance of trade is said to be in favor of the country, and vice versa.

BANKING. The banking business is almost as old as civilization itself. Money lenders are mentioned many times in the Bible and in all other ancient literature, but banking in its modern sense as understood in the civilized countries of the world to-day is more of an evolution that has resulted as the natural outgrowth of modern industrial development and commercial conditions. Modern banking may be said to have begun, therefore, within the past three hundred years. Prior to that time each man was, in a large degree, the individual defender and protector of his own property. For instance, three centuries ago it was not safe to venture out after nightfall in the streets of London unless properly armed or in company, and the carrying of valuables of any kind was particularly hazardous. Goldsmiths, who in those days necessarily had to keep on hand large stocks of the precious metals, took great precautions for the safe keeping of property of this kind and people gradually acquired the habit of depositing money with them, paying something for the privilege in order to receive the accompanying protection. In the course of time the goldsmiths learned from experience that many people who had so deposited money did not require it at once, and they thus began to lend out a certain percentage of their surplus on their own authority. Furthermore, it was found that if a man had to discharge a debt it was often more convenient for him to give his creditor an order for the money on deposit with the goldsmith than to go in person and carry away the gold and deliver it, and thus impose upon the creditor the necessity of returning the gold for deposit in his own name, and many times in the same place. This situation developed the system of a transfer of credits by means of checks. This method was not only safer but much more convenient than the earlier method of delivering the actual coin or bullion. In making loans, likewise, the goldsmith now became the banker and learned to merely put the loan on his books as a credit to the borrower, against which the latter could draw his order or check precisely as if he had deposited the actual money; or the goldsmith issued his own note or promise to pay to the borrower, the latter passed it on in payment of debts and it became a circulating medium wherever the credit of the goldsmith was good.