Index Arbitrage
The prices of commodities or financial assets in the futures market do not stand apart from the prices of the underlying commodity. If the value of a futures contract rises sufficiently above the price of the commodity that can be purchased for immediate delivery in the open market often called the cash or spot market , traders can buy the commodity, store it, and then deliver it at a profit against the higher-priced futures contract on the settlement date. If the price of a future contract...
Spread between SP Futures and SP Index
FIGURE 15-2 Trading Bands and Futures Trading, July 18, 1997 FIGURE 15-2 Trading Bands and Futures Trading, July 18, 1997 Stock index futures were launched in February 1982 by the Kansas City Board of Trade using the Value Line Index of about 1,700 stocks. But two months later in Chicago, at the Chicago Mercantile Exchange, the world's most successful stock index future based on the S amp P 500 Index was introduced. Only two years after its introduction, the value of the contracts traded on...
Risk and Holding Period
For many investors, the most meaningful way to describe risk is by portraying a worst case scenario. Figure 2-1 displays the best and worst real returns for stocks, bonds, and bills from 1802 over holding periods ranging from 1 to 30 years. Note how dramatically the height of the bars, which measures the difference between best and worst returns, declines so rapidly for equities compared to fixed-income securities when the holding period increases. Stocks are unquestionably riskier than bonds...
The Nifty Fifty Revisited
It was so easy to forget that probably no sizable company could possibly be worth over 50 times normal earnings. As the late Burton Crane once observed about Xerox, its multiple discounted not only the future but also the hereafter. Forbes, 19771 This chapter examines a group of high-flying growth stocks that soared in the early 1970s, only to come crashing to earth in the vicious 1973-74 bear market. These stocks were often held up as examples of speculation based on unwarranted optimism about...
Early Views of Stock Investing
Throughout the nineteenth century, stocks were deemed the province of speculators and insiders, but certainly not conservative investors. It was not until the early twentieth century that researchers came to realize that stocks, as a class, might be suitable investments under certain economic conditions. At that time, Irving Fisher himself maintained that stocks would indeed be superior to bonds during inflationary times, but that common shares would likely underperform bonds during periods of...
The Benefits of Deferring Capital Gains Taxes
Many investors assume that capital gains are beneficial solely because of the favorable rates at which such gains have been taxed. But lower capital gains tax rates are not the only advantage of investing in appreciating assets. Taxes on capital gains are paid only when the asset is sold, not as the gain is accrued. The advantage of this tax deferral is that assets accumulate at the higher before-tax rates, rather than after-tax rates of return. Table 8-2 documents the increase in the effective...
Appendix 1 Stocks from 1802 to 1871
The first actively traded U.S. stocks, floated in 1791, were two banks The Bank of New York and the Bank of the United States. Both offerings were enormously successful and were quickly bid to a premium. But they collapsed the following year when Alexander Hamilton's assistant The oldest continuously operating firm is Dexter Corp., founded in 1767, a Connecticut maker of special materials the second is Bowne amp Co. 1775 , which specializes in printing the third is CoreStates Financial Corp.,...
Appendix A What Happened to the Original 12 Dow Industrials
Two stocks General Electric and Laclede retained their original name and industry five American Cotton, American Tobacco, Chicago Gas, National Lead, and North American became large public companies in their original industries one Tennessee Coal and Iron was merged into the giant U.S. Steel and two American Sugar and U.S. Rubber went private both in the 1980s. Surprisingly, only one Distilling and Cattle Feeding changed its product line from alcoholic beverages to petrochemicals, although it...
Appendix 2 Arithmetic and Geometric Returns
The average arithmetic return, rA, is the average of each yearly return. If r to rn are the n yearly returns, rA r r2 rn n. The average geometric, or compound return, re, is the nth root of the product of one-year total returns minus one. Mathematically this is expressed as re 1 n 1 r2 1 rn 1 n -1. An asset that achieves a geometric return of re will accumulate to 1 re n times the initial investment over n years. The geometric return is approximately equal to the arithmetic return minus...
The Price Level and Gold
Figure 1-3 depicts consumer prices in the U.S. and the United Kingdom over the past 200 years. In each country, the price level was essentially the same at the end of World War II as it was 150 years earlier. But since World War II, the nature of inflation has changed dramatically. The price level has risen almost continuously over the past 50 years, often gradually, but sometimes at double-digit rates as in the 1970s. Excluding wartime, the 1970s witnessed the first rapid and sustained...