Thursday, May 28, 2009

Economic Indicators

The Series 65 will almost certainly ask 2 or 3 questions about economic indicators. You'll need to memorize which are leading, which are coincident, and which are considered lagging indicators. And, you'll need to recognize the significance of rising claims for unemployment insurance, increased or decreased inventories, etc. Remember that a leading indicator shows up before it plays out in the economy, including: # of new claims for unemployment insurance, # of manufacturing workers, and the stock market. Coincident indicators indicate where the economy is right about now, including: GDP, CPI, personal income, unemployment rate, manufacturing and trade sales. Lagging indicators point backwards, including: inventory, duration of unemployment, and corporate profits.

This morning I see headlines that the number of initial claims for unemployment insurance dropped last week. Of course, millions of people will probably interpret that as good news and rush off to throw their hard-earned cash into "the market," but if you read more closely, you see that this so-called "good news" must be taken with a grain of salt. First, the number fell from 636,000 to 623,000, which is a lot of unemployed people and about twice as high as what we'd see in a healthy economy. Second, although the leading indicator--initial claims for unemployment--improved, the coincident indicator--unemployment rate--worsened. How bad is the unemployment rate? About 9%, with economists expecting it to hit 10% soon. There are approximately 6.78 million people receiving unemployment benefits now, which is the largest number ever recorded since they started keeping track in 1967, and is the 17th week in a row that we've set a record!

Hmm, what else does this economy have going for it?

The only "good news" I've seen lately is that consumer confidence is rising and that durable goods (washers & dryers, refrigerators, etc.) orders are rising. I would sure hate to miss out on the next bull market for stocks, but something tells me that party won't even get started until this time next year. Of course, as Warren and Charlie said in Omaha a few weeks ago, the economy will almost certainly be miserable for all of 2009 and most of 2010 . . . but that doesn't mean they can predict where the stock market will be over the next year or so. They don't try to time the market or play the "top-down" game of looking at economic indicators and "determining" which companies will benefit from economic trends. They just buy good companies and hold them as long as possible.

Do some web research on economic indicators. is a good site for that.

Tuesday, May 26, 2009

IAR's working for federal covered IAs

Here is a good practice question that is very similar to something I saw last time I took the Series 65:

Jessica Stevens works for a federal covered adviser with an office in State A. Only once per month Jessica meets with a few clients at a diner in State B. Therefore:
A. Jessica is exempt from registration requirements in State B because she works for a federal covered adviser
B. Jessica must register in State B because she has a place of business there
C. Jessica must register in State B because she has clients in that state
D. Because the diner is not an actual office, Jessica need not register in State B

EXPLANATION: there is no such thing as "an actual office," so eliminate Choice D. An IAR has to register in any state where she has a place of business, so Choice A is eliminated. Choice C is tempting, but we don't know if the clients are residents of State B or if they just find it easier to meet Jessica there. Yes, anyplace where you conduct business is a "place of business." In fact, if you just let it be known that you can meet clients at a diner in State B, you have a place of business there.

Thursday, May 21, 2009

Constant Change

What I love about the investment industry is that things constantly change. Just when I had woven Oracle into the fabric of several textbooks based on its stubborn anti-dividend policy, I open up my account this morning and see that I've received a darned cash dividend from Oracle! Don't get me wrong--I'll gladly cash the check. It's just that nothing stays the same for very long in this industry. When we get comfortable quoting FDIC coverage at $100,000, the industry raises it to $250,000, but maybe only temporarily. One year the lifetime gift credit is $1 million, next year maybe it's $1.5 million. What does this mean for your exam? Probably nothing. Your exam stays out of the fray by focusing on the concepts that remain the same year after year. Rather than asking you to recite the current lifetime gift credit amount, the exam prefers to see if you understand the concept. Rather than asking if qualified dividends are taxed at 15%, the exam would likely make up its own tax rate and ask you to figure somebody's after-tax return.
So, don't sweat the ever-changing facts connected to the industry yet. You can just study for your exam and worry about staying on top of all the changing rules and realities over the span of your career. And, we publish updates at and if we think it's necessary.

Tuesday, May 19, 2009

Types of Orders

Let's look at a question on stop, limit, and market orders. Try to use process of elimination until you find a strategy that works for the following customer:

Your customer purchased shares of XYZ for $40 last year. Currently, with the stock trading for$65, your customer is concerned that the stock could drop sharply from its current price, although long-term, she wants to hold this investment if possible. You would recommend that she place
A. a market order to sell
B. a buy-stop order @66
C. a sell-stop order @67
D. a sell-stop order @64

EXPLANATION: the customer does not need to buy any more stock, so you can eliminate choice B. You can eliminate choice A since the customer thinks the stock may be worth holding long-term. A sell-stop order at $67 would be executed as soon as the stock traded at $67 or lower--since the stock is already there, the order would effectively be a market order to sell that might even cost the customer more $ to place than a market order to sell. You can eliminate choice, C, then, too.


Wednesday, May 13, 2009

UGMA Accounts and Gift Taxes

For Tax Year 2009 the maximum gift that a donor can make to a non-related minor child in an UGMA account is
A. $11,000
B. $12,000
C. $13,000
D. None of these choices

EXPLANATION: don't jump to conclusions! Sometimes test questions try to mislead you. You're supposed to start thinking about the annual gift tax exclusion amount, which was $12,000 for 2008 and is $13,000 for 2009. That only has to do with gift taxes. If you give someone more than $13,000 this year, you pay gift taxes on the excess above $13,000, which has absolutely nothing to do with this question. There is no such thing as a "maximum gift" for an UGMA account.


Saturday, May 9, 2009

Practice Question, Bonds

Which of the following corporate debt instruments issued by the same corporation would tend to offer the highest yield?
A. 10-year convertible bond
B. 10-year non-convertible bond
C. 15-year subordinated debenture
D. 15-year collateral trust certificate

EXPLANATION: bonds with longer terms pay higher interest rates to investors, just as you would expect to pay a higher rate on a 30-year vs. a 15-year mortgage. So, you can eliminate choice A and B. Now that you're left with two 15-year bonds, ask yourself which one is more secure? Choice D has collateral behind it (a portfolio of securities). So, eliminate D, and you're left with C. Subordinated debenture holders are the lowest creditors in the pecking order

Monday, May 4, 2009

The Series 65 and Warren Buffett

Many exam candidates believe that what they're learning for the test "has nothing to do with the real world," but if they had sat last Saturday listening to Warren Buffett and Charlie Munger pontificate for some 5 hours, they would be forced to admit how wrong that notion is. The first slide Buffett showed was of a big trade ticket indicating that back when the credit markets truly seized up, Berskhire was able to sell $5 million par value of T-bills for $5 million plus $90 due to a sudden need for traders to post collateral. In other words, the buyer of those T-bills was accepting a negative yield because getting his hands on cash equivalents was that dire. Both Warren and Charlie predicted that we will never see negative yields on government securities again in our lifetimes and both wanted us to know how truly unsual our recent economic turmoil is. Any Series 65/66 candidate struggling to understand the value of modern portfolio theory, beta, standard deviation, etc. would have enjoyed hearing both Warren and Charlie, two of the most successful investors of all time, express their contempt for half of what you're learning under "quantitative methods to evaluate investments." Charlie said that only high-IQ investors fall for the dangerous and false certainty that their equations produce. When a shareholder asked Warren whether discounted cash flow models should use 10 years or should be taken out indefinitely, Buffett basically ridiculed the guy's premise that such certainty could actually exist when trying to buy a business. Warren said something like, "If you need a computer, if you need the difference of a few tenths of a percent--don't do the deal. It should be so apparently obvious to you what the future cash flows are going to be; otherwise, don't buy it." They both talked about the hubris of the high-IQ investors, who consistently lead us to the brink of financial disaster. Warren said, "If you're in the investment business and have an IQ of 180, sell 30 points to somebody else." Charlie said, "Your computer models and calculations can't account for once-in-a-generation occurences. We can't take outsized risks based on some consultant talking about a 2 or a 3-standard deviation event." They both said it doesn't take a genius to run a business or to pick good investments. In fact, Buffett used one of his favorite lines to make the point, which is, "Buy a business so simple it can be run by a fool, because eventually it will be."
In order to explain the crisis caused by financial derivatives, Warren brought up some information tested on the fringes of the Series 65/66. He mentioned that those unregulated, non-standardized markets led to disaster and then mentioned that the Federal Reserve Board still has Reg T, which requires parties to settle generally in 3 business days--the weird derivatives apparently allowed settlements that were very vague and very long-term, allowing the other side of the contract to hem and haw until finally it becomes apparent that the dude, like, can't pay you. He brought up the liquidiation priority of a deadbeat company, how preferred stock is worthless if the company has no equity (like FNMA and FHLMC) but how a company like Goldman Sachs or Wells Fargo actually has all kinds of equity in spite of their financial challenges.
What really struck me had little to do with the exam, or with investing for that matter. What I really noticed was how much fun these two guys in their late 70's are having running arguably the greatest company ever assembled, and how laid back they are about everything. For five hours or so, they just sat there sucking down Coca-Cola and munching on See's candies like they were friggin' vitamins as they casually explained high finance to inferior minds with the humility and folksy charm of two midwestern farmers at the local diner. Do they know what the heck they're doing? Since 1965, the book value of their stock has risen more than 300,000 percent! And it's not because of genius, sophisticated computer models, or ball-busting business tactics. It's because those two geezers in off-the-rack business suits munching on junk food and cracking jokes all day know that being the second or the tenth richest person in the world is nice, but is not to be confused with genius, which has no place in the investment game, anyway.

Saturday, May 2, 2009

Berkshire Hathaway annual meeting

It's a little after 6 AM in Lincoln, Nebraska. Looking out my 8th-floor hotel room window, I'm amazed that there are already people walking, biking, and driving all over the place. We're a busy, busy culture, and our energy is reflected in every company that Berkshire Hathaway owns. When Buffett talks about the wonders of Geico, he speaks mostly about the amazing CEO, Tony Nicely, and his 40+ years of experience. When he talks about his Wells Fargo holdings, he talks at length about the amazing management team. I wish I had the energy and dedication of these captains of industry, these entrepreneurs who work 17-hour days, 7 days a week for decades. I mean, Buffett is in his late 70's, and I know damned well he's already up, probably in a business suit, reviewing some notes or financial statements, as excited as a kid about to go on summer vacation . . . even though he's worth about $20-30 billion and has been doing these annual meetings since 1965. I am often struck at the massive difference in drive between a guy like me, who makes a decent living and enjoys a nice lifestyle, and a true entrepreneur who starts a business like FedEx, Coca-Cola, or Berkshire Hathaway. I used to get down on myself for lacking their drive, but then I realized that I can do exactly what the Howey Case says: I can profit solely through the efforts of others by investing in a common enterprise. Think about the beauty of that phrase: to profit solely through the efforts of others.
Talk about the American dream, right? So, while I'll keep running Pass the Test a few years, I'm going to start focusing much harder on figuring out who the true fire-in-the-belly entrepreneurs are and simply investing in their stock. It might sound lazy or even parasitic, but it has to be better than working for a living.