NEWSLETTER FOR INSTRUCTORS
2010
Dear Professor,
• VIDEOS
For this end-of-semester edition of the newsletter, we turn our eyes to finance.
While finance is an integral facet of the business world, introductory to business
students often have trouble grasping financial concepts when they are presented
with them for the first time. In order to help them understand some of the key
financial terms, we’ve provided links to two very elementary videos that
graphically describe key concepts. If you find these videos useful, you may want
to explore the other short videos in the Investopia series at
http://www.youtube.com/results?search_query=investopedia.com&aq=f.
As always, this issue contains abstracts of recent, relevant articles with
accompanying critical thinking questions. Of course, we also include a
PowerPoint file integrating these elements in an easy to use package.
In case you missed any of the previous newsletters, you can find them on the
text’s Web site at www.mhhe.com/ub9e. If you have suggestions for future
issues, please let us know by forwarding your comments to:
SarahSchuessler@mcgraw-hill.com. Remember, we always enjoy hearing
from you, so please let us know if there are any topics you would like for us to
include in future newsletters.
Bill Nickels
Jim McHugh
Susan McHugh
If you are interested in the textbook please visit: www.mhhe.com/
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De ce mb er
• AR T I C L E AB S T R AC T S
• CHAPTER CHART
• PPT PREVIEW
Videos
Initial Public Offering Explained
From Investopedia
The video can be seen here:
http://www.youtube.com/watch?v=S68uZqc6VD8
This companion to the newsletter’s piece on Asia’s IPO boom explains
the term succinctly with a light visual touch.
Questions:
1. How do IPOs help both business owners and individual investors?
As the video highlights, a business owner is able to generate capital to
expand the business without going into any significant debt. Individual
investors can share in the growth and potential future wealth of an
expanding business by purchasing shares in the company at the initial
public offering.
2. IPOs trade in the primary market. What does that mean?
Corporations make money only once on their sale of stock, when they sell
it in the primary market. After that the stock is traded on the secondary
market where stockholders exchange shares of stock among themselves.
Corporations receive nothing from sales in the secondary market.
Introduction to Dividend Yields
From Investopedia
The video can be seen here:
http://www.youtube.com/watch?v=uclXFdgPTGA
Focusing this time on dividend yields, Investopedia presents another
short, instructive video on a convoluted financial term.
Questions:
1. Why would an investor ever purchase a stock that offers no dividends?
As the video points out, there are many factors to consider when
purchasing a stock. Dividends are only one factor. Many investors, for
example, purchase shares of growth stocks that offer no dividends because
they believe the stock will grow and the stock’s price will go higher.
2. If an investor fails to receive a dividend when it’s due will they be paid at a later
date?
Only if the stock they own is a cumulative preferred stock that promises a
repayment of any dividends that are not paid when due. Other types of
preferred stock dividends or common stock dividends never have to be
repaid.
[Note: If you find these videos useful, you may want to explore the other short
videos in the Investopia series at
http://www.youtube.com/results?search_query=investopedia.com&aq=f.]
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Article Abstracts Index
Each abstract contains a concise summary of a relevant news article from
recent publications, followed by a set of critical-thinking questions and possible
answers. For more detail on any of these subjects, we’ve included a hyperlink
to the original article at the top of each abstract.

Asian IPOs Overtake the U.S. (Chapter 1, 3, 18, 19)

Google’s Tax Tricks (Chapter 4, 5, 7, 17, 18, Bonus A)

Lining Up For Free Apps (Chapter 13, 14, 16, Bonus B)

Mind-Reading Movies (Chapter 13, 14, Bonus B)

Innovating with Open Books and Shared Profits (Chapter 10,
11, 17)

Ivy League Endowment Difficulties (Chapter 2, 17, 18, 19)

Princeton University vs. Princeton Borough (Chapter 4, 17,
Bonus A)

Responsible Banking with CDFIs (Chapter 6, 18, 20)

Derivatives in Disguise (Chapter 4, 18, 19, 20)

The Dangers of ETFs (Chapter 1, 14, 18, 19)
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Asian IPOs Overtake the U.S.
Use with Chapters 1, 3, 18 and 19
Michael Tsang and Lee Spears, “Asia Trounces the World in IPOS,” Bloomberg
BusinessWeek, November 4, 2010.
http://www.businessweek.com/magazine/content/10_46/b4203052848358.htm
As American and European entrepreneurs
continue to reel from the recession, Asia’s
business leaders soldiered on into an
unprecedented spurt of economic growth. This
year, Asia’s number of initial public offerings
decidedly eclipsed any competition. The continent
accounted for 66 percent of all money raised
globally with $134 billion. The U.S., meanwhile,
sunk to its lowest IPO share in history at 11
percent.
In 1999 the numbers told a similar story, only the
roles were reversed. The U.S enjoyed a whopping 75 percent share of all IPOs while Asia
languished at 12 percent. Times are different now, though, and not just because of the credit
crunch. After all, American outsourcing contributed directly to the burgeoning Asian markets that
are expanding with capital today. At the top of the heap is America’s economic rival China,
which attracted $76 billion in investment this year. Six Chinese companies’ offerings hit the
billion-dollar mark, with one IPO for the Agricultural Bank of China selling a world record of
$22.1 billion worth of shares. In the U.S., no company raised more than $700 million.
While India didn’t attain high numbers like China, the nation is nevertheless on pace to shatter its
previous annual IPO record of $8.2 billion. Central to India’s success was the government’s sale
of its 10 percent stake in Coal India, raking in a cool $3.4 billion on the deal. For investors,
Asia’s appeal lies in its strong growth. Indian and Chinese companies are tapping into relatively
untouched markets that could prove to be the most valuable consumer real estate in global
business. For the U.S., a portion of its future could be based on the success of these foreign
companies since six of the 10 biggest IPOs on U.S. exchanges hail from China or India.
Questions:
1. Why are IPOs important to companies?
As explained in Chapter 19 of your textbook, IPOs provide needed capital for businesses
to expand. It’s important to also remember that corporations make money only once on
their sale of stock that being when it’s sold on the primary market.
2. What does the lag in the number of U.S. IPOs imply?
The drop off in IPOs in the United States implies that our advantage in developing
innovative companies ready to lead the global market is eroding. It’s a tough pill to
swallow since we need future Microsofts and Apples to lead us out of the economic
situation we are facing.
Go to Abstract Contents
Google’s Tax Tactics
Use with Chapters 4, 5, 7, 17, 18 and Bonus A
Jesse Drucker, “The Tax Haven That’s Saving Google Billions,” Bloomberg BusinessWeek,
October 21, 2010. Photo courtesy of Thomas Sommeregger.
http://www.businessweek.com/magazine/content/10_44/b4201043146825.htm
Tax havens have long been used by multinationals to skirt the stringent
corporate tax laws of their home countries. But for many in and outside
the business world, the abundance of tax havens by no means justifies
the revenue they deprive deserving states. Unfortunately, not only is
tax sheltering common, in most cases it is legal. Google, for instance,
earned $12.5 billion overseas since 2007, only 2.4 percent of which
was taxed. Google’s clever, entirely legal money funneling saved the
company $3.1 billion and boosted last year’s earnings by 26 percent.
The system starts in Dublin at Google’s international headquarters. All
the money from ad sales outside the U.S. finds its way to Google
Ireland, where corporate profits are taxed at 12.5 percent. The
company’s ultimate goal is to send its earnings to Bermuda, where
there’s no corporate income tax at all. But sending the money directly
to the Caribbean would incur a large fee according to Irish law. To
circumvent this, the money is sent to Google Netherlands Holdings, a
shell company with no employees. Ireland doesn’t tax payments to
companies in other European Union states, ensuring that Google’s money can take advantage of
the Netherlands’ lax tax laws. From there, 99.8 percent of the money that hits Holland’s shores
goes off to Bermuda.
Google also eliminates a portion of its domestic taxes by licensing its search and advertising
technology through Google Ireland, even though most of the development is performed in the
U.S. In total, tax avoidance from corporations costs the U.S. government as much as $60 billion
annually. And though Google is certainly not alone in its tax control techniques, no other tech
company has managed to manipulate its overseas tax rate quite as low as the search giant. From a
legal standpoint, the company has done no wrong, but some believe Google has violated its
famous “Don’t be evil” motto. However, such a statement ignores the popular belief that
businesses have an obligation to its shareholders to minimize its taxes and other costs legally.
Whether ethically or unethically, Google has certainly accomplished that task.
Questions:
1. How is Google able to legally take advantage of such tax breaks?
As noted in Chapter 3 and Bonus Chapter A, there is no global system of laws; laws are
different country-by-country. Google is only making use of this diversity of tax laws to
enhance its profits and expand stockholder value.
2. Is Google acting ethically in using different tax laws to its benefit?
Probably there are a good many points of view among you as there are among your
textbook author team. Legally Google is doing nothing wrong and their lawyers and
accountants should be applauded. Ethically the shifting of funds is a bit cloudier.
Go to Abstract Contents
Lining Up for Free Apps
Use with Chapters 13, 14, 16 and Bonus B
Joel Howard, “Your Wait Is Over,” Entrepreneur, November 2010.
http://www.entrepreneur.com/article/217451
In this digital age of free information, it can be a chore to
convince consumers, especially young ones, to purchase some
products. After all, for every web app or program that isn’t
already distributed freely, there are about a dozen other ways to
obtain it through easy but extralegal means. Nevertheless,
information and the ways in which it is transmitted will become
no more restrained in five years than they are now. Rather than
react with higher prices and stringent policies, entrepreneurs must
adapt and find ways to integrate the free flow of information into
their moneymaking schemes.
For instance, in 2006 Eric Alder and Julien Chabbott graduated
from college with an idea for a smartphone app that would
provide regular updates on the wait times of lines around town.
The app was to be driven by social media with individual users providing the app with the
estimated length of the lines they were standing in. But the pair of young entrepreneurs faced a
quandary. Without accurate line times built in, nobody would use the app. And if nobody used the
app, there wouldn’t be enough reliable data to formulate accurate line times.
In order to get the app off the ground, Alder and Chabbott first distributed Line Snob for free on
the iPhone marketplace. Then the pair rewarded users who reported wait times with points that
could be redeemed for coupons. And rather than rely solely on word of mouth, Line Snob
ingratiated itself with popular venues that uploaded data on their own lines and posted fliers about
the app around their queues. Once Chabbott and Alder established their user base, they began
making money by charging companies a monthly fee for using the app. Line Snob is especially
popular in Las Vegas, where hotels use it to announce which buffet or club lines are the shortest.
The app remains free for regular users, and the company hopes to unveil soon a new feature that
can predict line waits before they occur.
Questions:
1. What key entrepreneurial characteristics seemed to drive Alder & Chabbott?
As described in Chapter 6, both entrepreneurs seemed to be self-nurturing and actionoriented. They continued to believe strongly in their product even though it faced many
ups-and-downs. They had the burning desire to build their dream into a reality.
2. What’s the major challenge for Line Snob going forward?
The flow of information continues to move unrestrained at a fast pace with competition
forever on the horizon. Line Snob needs to continuously add new features and services
that reach their target customers and tops competitors. No small task for a company in
this market.
Go to Abstract Contents
Mind-Reading Movies
Use with Chapters 13, 14 and Bonus B
Michael White, “Concentrate, and You Too Can Be Spielberg,” Bloomberg BusinessWeek,
September 30, 2010. Photo courtesy of Cory Doctorow.
http://www.businessweek.com/magazine/content/10_41/b4198039823799.htm
For many Americans, even the shortest trip
around the World Wide Web can feel like a
relentless information assault. Free media sites
like YouTube and news aggregators like Reddit
generate so much content that it would take a
person hours to slog through just one minute’s
worth of uploaded material. As a result, the
intrepid Internet users of today look to various
outlets for control and customizability. RSS
feeds allow users to control the content they see,
while social networks like Facebook and Twitter
let them customize how they receive and
transmit that information.
As our technological might has grown, consumers have come to expect the same level of control
and customizability they find on the Internet to translate to other products as well. Perhaps the
best expression of this new consumer desire for product customization is the MindWave headset.
The brainwave-reading technology first hit consumer shelves in the form of Mattel’s Mindflex, a
toy that allows children to manipulate a small, floating ball with their thoughts. As if that wasn’t
futuristic enough, developer NeuroSky combined MindWave technology with movies for a new
product that allows the wearer to alter the outcome of a film using their own brainwaves.
NeuroSky tested the product with a reedited version of Rocky IV in which users could change the
outcome of the movie’s climactic fight. To some, altering the course of a film based solely on
cranial impulses is akin to cinematic sacrilege. But like many aging media empires, the film
industry is ailing and gimmicks such as 3D and IMAX bring in big crowds. Although NeuroSky’s
goal is to produce original films that operate based on the collective thoughts of an audience,
movie studios and theaters aren’t equipped for such a radical venture just yet. In the meantime,
NeuroSky has teamed up with the London studio Treite to develop a series of alterable short films
that consumers can watch at home.
Questions:
1. Why would the film industry experiment with product customization?
Like other industries facing multiple challenges to its core product, the film business must be
continuously changing to meet customer expectations. Though products such as NeuroSky are
still in the introductory stage of its life cycle, market researchers will keep a close watch on
such innovations and their impact on the market.
2. How long will a product like NeruoSky be in the introductory stage?
This is very difficult to estimate so we will not try to be exact. Suffice it to say that such a
product would involve a great deal of expense to film producers, distributors and theatres
which means they will want definite and concrete proof the product is technically sound, has
firm consumer support, and will pay off to them in the long term before investing enough to
push the product beyond the introductory stage.
Go to Abstract Contents
Innovating with Open Books and Shared Profits
Use with Chapters 10, 11 and 17
Jody Heymann, “Bootstrapping Profits By Opening the Books,” Bloomberg BusinessWeek,
September 23, 2010.
http://www.businessweek.com/smallbiz/content/sep2010/sb20100922_650970.htm
During a recessionary economy, cutting costs becomes the
primary focus of most companies. Anything that detracts from a
business’ bottom line is excised and nothing that could burden the
books is added. But with all their penny-pinching, many
managers fail to heed one of the simplest maxims in business: you
have to spend money to make money. In most cases, a little
investment in a company’s employees through open accounting
and profit sharing can go a long way towards improving
efficiency and, ultimately, profit margins.
By opening the books to employees and cutting them in on
profits, staffers become more motivated to do a good job since
they can see how their salary is tied to their performance. But
most importantly, open-book management spurs innovation in
every level of the company. For instance, at the small packaging business Great Little Box,
employees equally split 15 percent of the company’s pretax earnings. Thanks to the staff’s level
playing field, a maintenance worker suggested to upper management that they trim a quarter-inch
of cardboard off some boxes. The employee’s recommendation resulted in thousands of dollars in
savings each month for Great Little Box. Also, each employee acts as a sort of mini-manager by
keeping tabs on their colleagues’ productivity, since any amount of slacking could result in less
money for everybody.
A recent study by the Institute for Health and Social Policy at McGill University found
comprehensive employee empowerment to be a common thread in successful companies both big
and small. In fact, a survey by Inc. magazine revealed that 40 percent of the 500 fastest growing
companies in the U.S. use open-book management. Nevertheless, only 1 percent of American
companies grant employees’ access to accounting records. And those few that employ profit
sharing usually reserve it only for managers. In the end, most companies feel they can’t afford to
include their staff in on their already slim profit margins. But as the recession wears on,
businesses could find that short-term cost-cutting measures could come back to bite them in the
long term.
Questions:
1. Why do employees react so favorably to open-book management?
Open-book management says to employees they are valued and a respected part of the
organization. The video about New Belgium Brewery that accompanies the textbook
shows a strong example of how sharing profits and open accounting build employee trust
and innovation.
2. Why do companies restrict employee access to accounting records and profit sharing?
While both are excellent motivators that help build employee trust and motivation, many
companies could be concerned about financial information being leaked outside the
company – especially if that financial information is less than positive.
Go to Abstract Contents
Ivy League Endowment Difficulties
Use with Chapters 2, 17, 18 and 19
Michael McDonald, “Paying the Price for Following Yale,” Bloomberg BusinessWeek,
September 30, 2010. Photo courtesy of John Terhorst.
http://www.businessweek.com/magazine/content/10_41/b4198047665503.htm
From countless investment magazines to television personalities like Mad Money’s Jim Cramer,
Americans have plenty of places to turn for financial advice. But just because financial “experts”
are respected enough to be given a voice in journals or television shows, they aren’t infallible.
The business world is a volatile and ever-changing entity that defies the expectations of even the
industry’s brightest minds. So when it comes to investing, seeking expert advice is a must, but
potential investors also have to be careful not to follow their financial advisors blindly.
For instance, from the mid-80s up until the eve
of the financial crisis, Yale’s endowment
manager David Swensen was the Ivy League’s
investment guru. Over the course of more than
two decades, Swensen poured billions into real
estate, private equity, hedge funds, and other
non-traditional assets. Swensen’s clever
investing yielded substantial returns, expanding
Yale’s endowment at an average annual rate of
16.3 percent in the decade preceding the credit
crunch. Dozens of other wealthy universities
copied Swensen’s investment strategy,
especially Ivy rival Harvard, which boasted a
$36.6 billion endowment at the end of fiscal
2008.
But the other shoe dropped with a resounding thud in October 2008. The stock market meltdown
left investment-centric colleges with billions tied up in various failing ventures but with little cash
on hand to actually run their schools. As a result, 15 wealthy colleges, Harvard and Yale among
them, borrowed $7.2 billion between 2008 and 2009. Harvard now spends $87.5 million a year on
interest payments to debtors alone. As a result of Harvard’s 27.3 percent endowment nosedive,
university officials cut costs at the student level. School administrators nixed hot breakfasts from
student dining halls, reduced shuttle bus service and offered buyouts to professors in an effort to
close budget gaps.
Questions:
1. What lesson does this story teach us?
It teaches us a lesson that is repeated time and time again. The investment business is a risky
venture that can cost investors dearly. If you remember nothing else from Chapters 18 and
19, remember these two words: risk and return. The pursuit of high returns entails high risk.
As the Ivy Leagues found out these investment principles spare no one.
2. What other important financial principle comes to mind from the abstract?
Hopefully some of you spotted the need for careful cash-flow analysis. Harvard, for example,
tied up too much of its money in its endowment that could not be accessed when needed.
Luckily it had the reputation and resources to borrow funds for operations. Many businesses
that neglect cash flow are not quite as fortunate.
Go to Abstract Contents
Princeton University vs. Princeton Burrough
Use with Chapters 4, 17 and Bonus A
Moira Herbst, “Princeton and Princeton Face Off Over Taxes,” Bloomberg Businesseek, July
1, 2010. Photo courtesy of Doug Kerr.
http://www.businessweek.com/magazine/content/10_28/b4186028429115.htm
In the previous abstract, we profiled the rise and fall of Harvard, Yale
and other elite schools’ multi-billion dollar endowments. Not to be
outdone by its fellow Ivys, Princeton University hitched its wagon to
Yale’s Swensen system and, for a time, prospered. Princeton’s
endowment peaked at $16.3 billion in June 2008, but soon plummeted
by $3.74 billion the year following the start of the financial crisis. To
university officials, a 24 percent drop in its investments is a
catastrophe. But to Princeton Borough and adjoining Princeton
Township where the university is located, $12.5 billion is still a
princely sum that could do a great deal of good in their communities, if
taxed properly.
Like many colleges, Princeton University’s land holdings are taxexempt. Last year it paid just $8.2 million in property taxes even
though it occupies 43 percent of the land in Princeton Borough and 13
percent of Princeton Township. Local government officials estimate
that if the university paid its property taxes in full, it could contribute an additional $28 million.
That money could go a long way in the cash-strapped municipalities, both of which made
sweeping budget cuts since 2008.
University representatives cite that the school is the largest taxpayer in both Princeton Borough
and Township and that it voluntarily paid $1.2 million to the community in lieu of other taxes.
Princeton also employs 5,300 people and generates more than $1 billion in economic activity.
Still, that $12.5 billion endowment looms large in the minds of many local officials, leading some
to speculate if Princeton really is an institution of learning or “a hedge fund…promoting an
educational arm on the side." But as we saw with Harvard and Yale, Princeton doesn’t actually
have billions of dollars lying around; that money is tied up in complicated investments. And
much like its governing bodies, Princeton has had to make substantial cuts as well, slashing $170
million from its budget and eliminating 43 positions.
Questions:
1. Should wealthy universities like Princeton be exempt from local taxes?
Obviously this is a very good discussion question that many strongly support on one side
or the other. Our opinion is that Princeton is first and foremost an institution of higher
learning. If additional taxes were imposed on it, a precedent could be set that could harm
other, less affluent, institutions.
2. Are business practices different at private universities than at private sector businesses?
Remember as explained in Chapter 1, businesses come in a great many sizes and shapes.
Hospitals, churches, and schools are businesses that use business practices like
budgeting, managing, and investing just like their counterparts in private sector business.
Go to Abstract Contents
Responsible Banking with CDFIs
Use with Chapters 6, 18 and 20
Mark Pinsky, “Help for Small Businesses: Loans Are Just the Start,” Bloomberg
BusinessWeek, October 21, 2010.
http://www.businessweek.com/smallbiz/content/oct2010/sb20101020_757603.htm
A common complaint among small business owners
these days is that banks have been too reluctant to
lend since the financial meltdown. As a result, some
companies seek assistance from local sources like
community development financial institutions
(CDFIs). Originally founded by socially motivated
investors and faith based groups, CDFIs provide
loans and financial education to small businesses in
impoverished areas. And ironically enough, most
new capital for CDFIs comes from large commercial
banks, with over $1 billion in investment over the
past year coming from Citi, Goldman Sachs and
others.
So why fund CDFIs while remaining stingy lending through traditional banks? For one, CDFIs
operate in a far more disciplined fashion than most commercial banks. If borrowers fail to pay
back loans, the CDFI itself takes the financial hit, not the investors. To combat delinquency,
CDFIs take an active interest in securing their loans, going so far as to knock on a borrower’s
door even if a payment is one day late. Most importantly, though, CDFIs offer their clients a
wealth of educational services. After all, keeping the borrower’s business alive is a sure way to
sustain their loan payments, so CDFIs help businesses with everything from bookkeeping to
business strategy.
Large commercial banks focused on maximizing profit simply can’t afford to tend to their clients
so closely. Nor can they match CDFIs’ abilities to substantially impact depressed communities in
a positive way. CDFIs are unique in that when the economy contracts, their market expands. And
in the wake of a banking crisis coupled with a decades-long exodus of industrial interests, CDFIs
like local credit unions and loan and equity funds can be the sole financial lifeline for otherwise
isolated communities. All told, CDFIs manage a staggering $30 billion in assets, and their
methods are attracting attention from high places. First Lady Michelle Obama, for instance, based
the Obama Administration’s Healthy Food Financing Initiative on a Pennsylvania CDFI that has
financed more than 85 health food stores across the state.
Questions:
1. What seems to be the winning formula for CDFIs success?
Since CDFIs clearly impact distressed communities, they take a very personal interest in
their loans and do everything possible to see that a funded business succeeds. Also, by
following the client firm closely, progress can be evaluated promptly and assistance can
be provided when needed.
2. As the economy improves, will CDFIs be able to survive?
With $30 billion in assets and a formidable track record of success, it’s likely that CDFIs
will be a fixture in small business for some time to come.
Go to Abstract Contents
Derivatives in Disguise
Use with Chapters 4, 18, 19 and 20
Zeke Faux, “Individual Investors Duped by Derivatives,” Bloomberg BusinessWeek,
September 30, 2010.
http://www.businessweek.com/magazine/content/10_41/b4198043663903.htm
Many complicated Wall Street deals contributed to the 2008
financial crisis, but custom derivatives have shouldered much of
the blame. Bought and traded en masse by the nation’s biggest
banks, derivatives like the infamous credit default swap tangled
the marketplace, creating a web of debt and losses that was nearly
impossible to unravel. The Dodd-Frank financial regulation bill
attempts to rein in many destructive derivatives, but the bill stops
short of protecting investors at the consumer level. As a result,
brokers are pushing confusing securities to investors that are
actually derivatives in disguise.
For instance, retired beautician Leona Miller bought what she
thought were standard bonds on the recommendation of her
broker. In reality, she purchased a structured note, a bond
combined with a derivative that carries an appealingly low interest
rate but also significant risk. Her structured-note had been bundled with a stake in Merck along
with a put-option that would convert her entire investment into Merck shares should the
company’s trading price fall lower than her original purchase price. After the retiree lost 30
percent of her $20,000 investment, the put-option triggered and Miller was left with Merck stock
whose value was dropping by the day.
If that explanation sounds confusing, it’s because it is. Nevertheless, securities laws allow the sale
of derivatives to individuals as long as they’re bound with bonds. According to one expert,
individual investors are incapable of distinguishing the value of structured notes due to their sheer
complexity. Most consumers ignore all the red tape and focus instead on the notes’ near 0 percent
interest rates. But doing so ignores the inherent risk of convoluted securities with misleading
names like S&P 500 Index Linked Callable notes. Despite their ignorance, investors are snatching
up structured notes, with sales of the securities jumping 58 percent to $31.9 billion through
August.
Questions:
1. Should investors be told of all risks of investments sold by brokers?
That certainly seems more than fair to us. As the abstract points out, often investors put
their money in products that have hidden features they are completely unaware of or
uninformed about. Because of the lack of Congressional action, we could realize another
derivatives debacle.
2. What lesson do investors need to remember from the financial crisis of 2008?
Warren Buffett, the textbook’s featured profile in Chapter 19, says he never invests in
companies or products that he doesn’t understand. Investors should take heed in what he
says and remember if something sounds too good to be true, it probably isn’t. It also
helps to ask your broker questions about the underlying risks of investments. If you don’t
understand it, don’t buy it.
Go to Abstract Contents
The Dangers of ETFs
Use with Chapters 1, 14, 18 and 19
J. Alex Tarquinio, “The New ETF Pitfalls,” SmartMoney, October 10, 2010.
http://www.smartmoney.com/investing/etfs/the-new-etf-pitfalls/
It’s no secret that the stock market is an unpredictable entity.
Nevertheless, every day savvy investors the world over try to find a
way to consistently and safely earn money through clever investing.
But on the New York Stock Exchange, nothing is assured and even
the safest bets have their dark sides. For instance, exchange-traded
funds (ETFs) are bundles of stocks, bonds or other investments that
trade like a single stock. Many different companies and funds
comprise an ETF, but normally they all fall under one central industry
or commodity, such as oil or gold. In this way, ETFs ideally provide
an easy and profitable way to diversify a portfolio.
ETFs have been a hot item on the stock market for the past few years,
growing at rate of $1.5 billion a week and totaling to an estimated
$838 billion overall. But as their popularity grows, Wall Street is
increasingly issuing misleading ETFs that contradict the funds’ safe
reputation. For one, ETFs are closing at an alarming rate, with 140
shutting down since 2008. In the 15 years before then, only 10 had
closed. An ETF needs at least $50 million to generate a profit and
many disappear due to a lack of investor interest. Although investors don’t lose their money once
a fund closes, those looking for ETFs as a solid diversification tool instead find themselves
saddled with commissions and transfer fees for a new investment.
Sometimes ETFs fail to perform the same way as the indices or products they track. For example,
an ETF called the PowerShares FTSE RAFI Emerging Markets Portfolio rose 67 percent last
year. A solid return to be sure, except that the collection of stocks it tracked rose 78 percent.
While such tracking errors can occur in some funds from time to time, they’re becoming
especially common in ETFs, which differ from their indices by an average of 1.25 percent. So
although ETFs are still about as safe a bet as one can make on Wall Street, their reputation is
being polluted by the day thanks to miscalculations and increasingly convoluted bundles of
securities.
Questions:
1. What’s the best advice for investors wanting to invest in ETFs?
The best advice for investors looking at ETFs is the same for investors looking at private
companies; do your homework. Make sure the ETF has solid management and a
noteworthy track record. It’s also advisable to look at Chapter 19 which offer
information on choosing the best investment strategy that fits the investor’s needs.
2. Do ETFs look like a fad investment?
Hardly! As the abstract states they have been a hot item on the stock market for the past
few years and no one expects their popularity to decrease in the near future. The
expanding number of ETFs is one reason why some analysts are voicing their concerns to
potential investors.
Go to Abstract Contents
Article / Chapter Index
Article
1
Asian IPOs
Overtake the
U.S.
X
Google’s Tax
Tricks
Lining Up for
Free Apps
Mind
Reading
Movies
Innovating
with Open
Books and
Shared
Profits
Ivy League
Endowment
Difficulties
Princeton
University
vs. Princeton
Borough
Responsible
Banking with
CDFIs
Derivatives
in Disguise
The Dangers
of ETFs
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
X
X X
X
X
X
X
X
X
X
X
X
X
20
X
A
X
X
X
X
X
X
X
X
X
X
X
B
X
X
X
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19
X
X
X
18
X
X
X
X
X
X
C
D
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