Table of Contents

How are stocks traded?

Generally, stocks are traded in blocks or multiples of 100 shares, which are called round lots. An amount of stock consisting of fewer than 100 shares is said to be an odd lot.

On an exchange, an order that involves both a round lot and an odd lotósay 175 sharesówill be treated as two different trades and may be executed at different prices.

Your broker will charge you a different commission on each trade, and will confirm each of them separately.

These distinctions do not generally apply to trades executed in the OTC market.

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What are the differences between over-the-counter trades and stock-exchange trades?

To be traded on an exchange such as the New York Stock Exchange or the American Stock Exchange, the issuing company must meet the exchange's listing standards; these may include requirements on the company's assets, number of shares publicly held, and number of stockholders. Organized markets for other instruments, including standardized options, impose similar restrictions.

Many securities are not traded on an exchange but are said to be traded over the counter (OTC) through a large network of securities brokers and dealers. In the National Association of Securities Dealers' Automated Quotation System (NASDAQ), operated by the National Association of Securities Dealers (NASD), trading in OTC stocks is accomplished through on-line computer listings of bid and asked prices and completed transactions.

Like the exchanges, NASDAQ has certain listing standards which must be met for securities to be traded in that market.

Investors who buy or sell securities on an exchange or over the counter usually will do so with the aid of a broker-dealer firm. The registered representative is the link between the investor and the traders and dealers who actually buy and sell securities on the floor of the exchange or elsewhere.

Market prices for stocks traded over the counter and for those traded on exchanges are established in somewhat different ways. The exchanges centralize trading in each security at one locationóthe floor of the exchange. There, auction principles of trading establish the market price of a security according to the current buying and selling interests. If such interests do not balance, designated floor members known as specialists are expected to step in to buy or sell for their own account, to a reasonable degree, as necessary to maintain an orderly market.

In the OTC market, brokers acting on behalf of their customers (the investors) contact a brokerage firm which holds itself out as a market-maker in the specific security, and negotiate the most favorable purchase or sale price. Commissions received by brokers are then added to the purchase price or deducted from the sale price to arrive at the net price to the customer.

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Are my mutual fund investments protected by insurance?

There are no guarantees for investors. No matter how you buy a fundóthrough a brokerage firm, a bank, an insurance agency, a financial planning firm, or directly through the mail, bond funds, unlike bank deposits, are not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Nor are they guaranteed by the bank or other financial institution through which you make your investment. Mutual funds involve investment risk, including the possible loss of principal. Of course, investment risk always includes the potential for greater reward.

Even though mutual funds are not insured, there are some protections. Mutual funds are highly regulated by both the federal governmentóprimarily through the Securities and Exchange Commissionóand each of the state governments.

For example, all funds must meet certain operating standards, observe strict antifraud rules, and disclose specific information to potential investors. After you invest, funds must provide you with reports at least twice a year that describe how the fund fared during the period covered.

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Should I hold my securities in certificate or electronic form and in my own name or in street name?

Today, many debt securities are in electronic book-entry form. Ownership is transferred via computer rather than via actual transfer of paper certificates, reducing the possibility of loss, theft, or mutilation of the certificates. In the future, more and more securities certificates will be in this electronic form.

There are still, however, many securities that are in certificate form. Certificates representing your ownership of stocks or bonds are valuable documents and should be kept in a safe place. If a certificate is lost or destroyed, it may prove time-consuming and costly to obtain a replacement. Furthermore, some securities certificates may not be replaceable at all.

If you buy stock through a brokerage, youíll usually have several choices as to how your stock will be handled:

  1. Certificates may be made out in your name, and kept in your possession. When you sell the stock, the certificates must be endorsed and delivered to the selling broker.

  2. Certificates may also be held by the brokerage firm in what is known as "street name." In this case, the brokerage firm is recorded on the list of shareholders of the corporation even though the customer is the actual owner. Thus, any communication from the company to its shareholdersósuch as annual reports and proxy materialsówould be sent to the broker, not to the customer. The broker then must forward the material to each owner, unless shareholders have given permission for issuers of shares to communicate with them directly.

Most investors have the broker hold stock in street name. The advantages of doing so:

  • If the broker takes responsibility for safeguarding the certificate, your account is protected by SIPC, and the transfer process is facilitated should the stock be sold.

  • If you own more than a few stocks, having the stocks in street name cuts down on record-keeping chores.

  • Trades are accomplished more easilyóespecially now that trades must be settled in three days.

  • Some brokerages are now charging a fee if investors want to keep certificates.

On the other hand, you may not receive shareholder information as quickly because it is sent first to the broker; in addition, if an account is not actively traded, the broker may impose a custodial fee.

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What are the differences between preferred stock and common stock?

Stocks may be designated as commonóthe most widely known formóor as preferred. With preferred shares, holders have some priority over owners of common stock regarding dividends (and also in the distribution of assets if the company is liquidated or reorganized in bankruptcy).

Preferred stocks generally do not have the voting rights that common shares do. Preferred shares generally have a stated dividend, while common stock dividend are based upon company performance.

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What are restricted securities?

Some stocks are "restricted" or "unregistered"óso designated because they were originally issued in a private sale or other transaction where they were not registered with the SEC. Restricted or unregistered securities may not be freely resold unless a registration statement is filed with the SEC or unless an exemption under the law permits resale.

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How can foreign stocks be bought?

Foreign corporations wishing to sell securities in the United States must register those securities with the SEC. They are generally subject to the same rules and regulations that apply to securities of U.S. companies, although the nature of information foreign companies make available to investors may be somewhat different.

U.S. investors who are interested in foreign securities may also purchase American Depositary Receipts (ADRs). These are negotiable receipts, registered in the name of a U.S. citizen, which represent a specific number of shares of a foreign corporation.

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What are dividend reinvestment plans and should I invest in them?

With a dividend reinvestment plan, you can make small, regular cash investments in participating companies without paying prohibitive transaction fees. Further, all or a part of your dividends can be reinvested and used to purchase more shares. Some plans permit optional periodic cash purchases of securities.

For additional information see:

  • How do I acquire initial shares of stock to enter a dividend reinvestment plan?
  • How do I enroll in a dividend reinvestment plan?
  • Can I use dividend reinvestment plans in my IRA?
  • Must I pay taxes on reinvested dividends?
  • What are "Super DRPs"? Should I use them to invest?

Q: How to I acquire initial shares of stock to enter a dividend reinvestment plan?

A. Some companies allow you to invest directly, providing what are called "Super DRP" plans. (Others allow only residents of certain states to do so.) However, most companies that offer DRPs require you to already own stockóusually as little as one share, but sometimes moreóbefore you can participate.

You must hold the stock in your own name, not in "street name." If you own shares of a company in street name, just ask your broker to have the shares reissued in your own name.

If you do not own stock, buy the required number of shares through a broker.

An alternative to using a broker is to use an enrollment service. Two enrollment services are Temperís and the National Association of Investment Clubs. Temperís can be used for most companies, while the NAIC serves a more limited group of companies.

Temper of the Times Communications, Inc.
P.O. Box 558
Mamaroneck, NY 10543
Tel. 914-381-4500

Some DRPs send you a certificate, and then enroll you in the plan. Others use book entry ownership of the share to enroll you, and keep your one share in the plan. It is more convenient to be enrolled on a book entry basis.

Example Tip: Treat your decision to enroll in a DRP just as seriously as you would a decision to invest in a company. Before investing, subject the company to your usual research and analysis.

Q: How do I enroll in a dividend reinvestment plan?

A. To enroll in the DRP, contact the transfer agent or the companyís shareholder relations department, and ask for an enrollment form. Then return the form, usually along with your first optional cash investment, to the company.

Once you are enrolled, you can invest more money directly through the companyís transfer agent. Many companies offer an automatic investment serviceóthey will automatically withdraw a pre-set amount from your bank account to make optional cash investments. Some charge a fee for this service.

Q: Can I use dividend reinvestment plans in my IRA

A. A small number of companies will open IRAs through their plans. Otherwise, if you wish to invest IRA funds through DRPs, you will have to have a bank act as custodian of your IRA.

Q: Must I pay taxes on reinvested dividends?

A. The dividends are taxable income even though you reinvest them.

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What are super DRPs and should I invest in them?

There are now about 100 U.S. companies with direct stock-purchase programsóprograms that allow investors to buy a company's shares directly from the company in stead of using a broker. Direct stock purchase programs are sometimes called "Super DRPs." Like DRPs, direct-purchase plans cost an investor less, since there is no broker commission to pay, and often no fee.

A Super DRP program makes buying shares easy. Some programs have automatic-investment options, which will debit a set amount each month from an investorís bank account.

Super-DRPs are less trouble to invest in than regular DRPs, which are offered by about 1,000 companies. With a regular DRIP, investors must (in most cases) buy at least one share of stock through a broker or an investment club such as National Association of Investors Corp. in Madison Heights, Michigan. Further, although most DRPs allow participants to buy additional shares directly, most allow purchases only once a month or once a quarter.

Super DRPs are easier to use and allow investors more flexibility. Investors can buy shares weekly or bi-monthly, and shares can be sold with a telephone redemption service. With regular DRPs, requests to sell must usually be sent by mail.

As with regular DRPs, dividend reinvestment isn't mandatory. Investors can receive dividend payments, and they can be automatically deposited in a bank account. Some companies that offer direct-purchase programs do not pay dividends.

Now that weíve seen the benefits of Super DRPsóconvenience, investment flexibility, and low costóhere are some of the negatives.

First, investors may prefer the convenience of having all of their holdings in one brokerage account. Many brokerage firms provide free dividend reinvestment for some or all clients.

Investors should also be aware that many direct-purchase programs charge fees ranging from $1 to $15 when investors buy or sell shares, and a few also impose set-up fees of $5 to $8.50, or similar small annual fees.

Another possible negative for Super DRPs (and DRPs as well) is that calculation of capital-gains taxes becomes complex when dividends have been reinvested over the years, and lots have been bought at varying prices. This can be remedied by carefully keeping track of the cost basis of shares when dividends are reinvested. Further, investors who invest through an IRA, need not deal with the problem of calculating capital gains taxes at all. Not all of the Super DRP programs offer tax-deferred individual retirement accounts.

If you like the independence and money-saving aspects of direct investment, Super DRPs may be for you. Perhaps you would like to supplement a diversified mutual-fund portfolio with some individual holdings. Super DRPs, like no-load mutual funds, are inexpensive and convenient.

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