493. Consols and Rentes. - The debt of the British government (up to the time of the Great War) was represented by the so-called Consols (Consolidated Debts), bearing 21% interest and running indefinitely. That is, the consols differ from ordinary bonds in that they form a perpetual source of income, while bonds are payable at a fixed date. The bonds of the French government are called rentes, and bear interest at the rate of 3%.

494. Designation of Bonds. - Bonds are designated by the name of the issues, the date of maturity, and the rate of interest. Thus N. Y. City 4's 1956, means a bond issued by New York City bearing 4% interest and due in 1956. Similarly we have U. S. 4's 1925.

495. Common Stocks and Bonds Compared.

1. Dividend depends upon prosperity 1. Bear a definite rate of interest

term bond is very near the prevailing rates of income on safe investments the problems on bonds are like those on stocks.

Example 1. New York City 44's 1964 issued in 1914 are sold at an average of $101.45. Find the rate of income on the investment, allowing no brokerage.

Solution. This problem is exactly like that solved in § 484.

Example 2. Solve Example 1, allowing 3% for brokerage.

Solution. This is like the examples in § 487.

Example 3. What must a long term 44% bond be bought for to give an income of 4.49% on the investment? (a) allowing no brokerage, (b) allowing 3% brokerage.

Solution. (a) of this problem is just like that of § 486.

NOTE.

- On May 20, 1913, New York City issued 45,000,000 4 % bonds, which were sold on an income basis of 4.49 %.

497. Problems on Short Term Bonds. When the remaining term of the bond is short or when great accuracy is required, the problems on bonds are very different from those on stocks.

Example 1. A bond bearing 3% interest matures one year from date. At what price must it be bought to make an income of 41% on the investment?

Solution. Let the par value of the bond be $1000. Then at the end of the year it will be worth $1030.

Hence $1030 ÷ 1.045 = $985.65 is the present value of the bond. That is, the bond should be bought at 98.565.

When the bond is due in several years this process must be repeated once for each year.

Example 2. Find the present value of the above bond if it is due in 4 years from date.

Solution. By example 1, the bond will be worth $985.65 one year before maturity. Adding the $30 interest for the second year we have $1015.65. Then $1015.65 ÷ 1.045 = $971.914 = value 2 years before maturity. $971.914+$30 = $1001.914.

$1001.914 1.045 $958.77 = value 3 years before maturity.

$958.77 + $30 = $988.77. $988.77 ÷ 1.045 = $946.191 = value 4 years before maturity.

Hence if this bond is bought four years before maturity, it should be bought at the rate of 94.619.

A perfectly secure preferred stock bearing 3% dividend would have to be sold at 663 to make an income of 4%.

It is clear that if $946.191 is invested at 4%, the amount at the end of the year will be $988.77. Of this $30 is received in cash in the way of interest on the bond, the remaining $958.77 is the present worth of the bond and continues to draw interest for the following year. The amount at the end of the year is $1001.914, of which $30 is again received in cash. The remainder, $971.914, draws interest at the rate of 41⁄2%, amounting to $1015.65 at the end of the 3d year. $30 received in cash and the remainder, which is $985.65, draws interest at the rate of 4%. At the end of the year the amount is $1030, which is then received in full.

It will be noticed that part of the 41% on the investment is received in cash each year and part of it is received in increased value of the bond. If the cash received is invested promptly the total return will be 44% on the whole investment compounded annually.

The general theory of long and short term investments is beyond the scope of this book.

WRITTEN EXERCISES

Find the cost of the bonds in each of the following. The interest in each case is payable annually. Use the method of § 497.

Bankers and investment brokers use tables which give the present value for a variety of rates of dividend and rates on the investment and for any number of years, say up to twenty.

DRILL IN FUNDAMENTALS

Find out the net proceeds of the following bills and check results:

CHAPTER XXXIV

THE STOCK EXCHANGE

498. The Stock Exchanges are associations of brokers whose business it is to buy and sell stocks and bonds.

All cities of considerable size have stock exchanges, but that in New York City is by far the best known and most important.

499. Hall of Exchange. The business of the stock exchange is transacted in a large room called the hall of exchange. Brokers dealing in certain kinds of securities gather about certain posts in the room. These are designated as the "U. S. Steel Post," "R. R. Post," etc.

500. Strict Rules. The rules of the stock exchange are very strict, and a very high standard of commercial integrity is maintained. Transactions involving thousands, often hundreds of thousands, of dollars are made verbally. One broker shouts "1000 shares U. S. Steel at 851," another answers "Sold," and a transaction involving $85,250 is closed. Failure to live up to the terms of such transactions is severely punished. The number of memberships on the stock exchange is limited, that of the New York Exchange being 1000. Memberships, also called "seats," may be sold, but the new member is subject to election by the committee on memberships.

501. Rate of Brokerage. The broker usually charges % on the par value of securities for selling or buying in standard lots of 100 shares or more. On smaller lots and also on exceptionally large transactions the charge may be regulated by special agreement.

502. A Point.

When the price of a bond or stock changes, it must change by at least of one dollar. Thus if a bond is quoted at 86, the next higher quotation is 863 and the next 861, etc.

503. Kinds of Sales. A sale "buyers 3, 10, 20, 30, or 60 means that the buyer may demand the stock at any time within 3, 10, 20, 30, or 60 days as the case may be, but is not required to take it before the last day of the period. "Sellers 3, 10, 20, 30, 60" means that the seller may offer it before the last day of the period, but is not required to furnish it before that day.

For some days before and after interest day the books of a corporation are closed so that no transfers of registered bonds can be made. During this time securities are usually sold "Ex dividend," which means that the dividend just due is retained by the seller.

504. Wash Sales. - Sales arranged between different agents of the same party to influence the price of stocks are called wash sales.

505. Speculation. A large part of the buying and selling of securities is for speculative purposes. A man who believes that a stock is going up in value buys it in the hope of selling at a gain. If he believes the stock is going down, he sells for a future delivery.

506. Buying and Selling Futures. Stocks and bonds are frequently bought and sold to be delivered at a future date. If on the day of delivery the market value of the stock is higher than the contract price, the buyer gains, and if the price is lower than the contract price, the seller gains. In such transactions the stock is usually not delivered, but the "difference" between the contract price and the market value is paid over in cash. This sort of transaction amounts to little more than betting on a future price.

507. Bulls, Bears, Longs, Shorts. One who has bought stock for future delivery is said to be long on that stock and one who has sold stock for future delivery is said to be short on that stock. The shorts or bears try to force prices down and the longs or bulls try to force prices up.

508. Trading on Margins. A sends $1000 to a broker who buys. 100 shares of stock. The broker borrows money to pay the balance of the purchase price and uses the stock certificate as security. This is called trading on margins. A's margin is $10 a share.