THE WILLIAM MARGRABE GROUP, INC., CONSULTING, PRESENTS
THE DERIVATIVES 'ZINE^TM     November 2001

Dr. Risk Gets Personal [about Personal Finance, etc.]  Last revised: March 02, 2002

• 7/28/00 Ask Dr. Risk!^TM: "What Does It Take ... To Mend a Broken Credit History?"
• 7/28/00 Dr. Risk's "Derivatives Dictionary^TM": Aftermarket, churning, ...
• 7/28/00 Dr. Risk's Links: muni bonds and mutual funds

On this page:

Ask Dr. Risk!^TM | Derivatives Dictionary^TM | Derivatives Digest^TM | Games | Have I Got a Deal for You! | Humor  | Links | Presentations 

Ask Dr. Risk!

Dr. Risk promises you at least a brief response to your important question, as soon as he has a free moment. A question of sufficiently general interest to make it into the 'Zine, tends to generate a more comprehensive response. All questions and answers become the property of The William Margrabe Group, Inc. 

7/28/00 What Does It Take ... To Mend a Broken Credit History? (728/00)

Dear Dr. Risk – For the past 18 months, I have been repairing my damaged credit which came about from four charge-offs showing on my credit report.  In this time, I have established six lines of unsecured credit and maintained my student loans and my car loan.  These lines of credit I speak of are merely hundreds of dollars and all second chance programs.

To reiterate, I have had an excellent credit rating for the past 18 months.  Additionally, I have had steady employment, have resided at the same place during this time and I have recently 'settled' all my charge-offs for 'nearly' the full amounts and have documented proof of such.  However rectified, these charge-offs place me in a high credit risk for almost any personal (small) bank loan and I am consistently told they can not help me.  

I have searched the internet high and low looking for that bank that would give a non-homeowner with no collateral a second chance at an unsecured persona loan.  The only thing I find are credit searches where these alleged companies search to find a loan suited to your needs if you pay a fee. 

The latter brings me to this subsequent question:  do you know of any banks who are willing to give a second chance personal loan?  Your assistance in this matter is so much appreciated.  I look forward to hearing of any resources you may have available. –) Corey

Dear Corey – Fortunately for you, Dr. Risk has recently tried to help a friend recover from a personal credit crisis. This friend's problem is much more extreme than yours -- we hope. He ran through about $500,000 of inherited property, ran up nearly $200,000 of credit debt, and bought a $400,000 house with no job. About three months after buying the house he stopped making payments on his mortgage loan. A few months after that, he stopped making payments on his credit cards.  

You haven't addressed what Dr. Risk thinks is the #1 issue: What have you done to make sure that your acute problem doesn't recur? Do you know how you got in your tight spot in the first place? Are you trying to spend your way into the heart or bed of a sexual partner? Do you have a problem with drugs or booze? Are you gambling? Are you a shopaholic? Dr. Risk's  friend is a shopaholic who was trying to buy his way to happiness and impress his wife, without holding a job. Dr. Risk has urged him to see a therapist about this. 

You have a plan for repairing your credit, which is good. You are settling your debts, holding a job, maintaining a permanent residence. Those are all positive factors in personal credit scoring. However, "'settling' all my charge-offs for 'nearly' the full amount" after 18 months suggests that the lender didn't get interest over that period, which is a significant loss that will haunt you for years. 

Dr. Risk suggests that you try to learn more about retail credit scoring at www.FairIsaac.com. Not to make light of your situation, but it reminds me of a joke that an economist-turned-comedian told: “Having an economics degree is great. It may not guarantee you a job, but at least you understand why you’re unemployed.” Most credit card companies use some form of credit scoring to decide whether to lend to you, or not. FairIsaac is in the credit scoring business, and their web site provides information about it. It may not help you get the credit you want, but at least it will help you understand why you can’t get it. 

Dr. Risk has no personal experience with companies that promise to either repair your credit or find  lenders with low standards. However, loan brokers who take their fees up front are notorious for taking advantage of desperate people in search of credit. They take the money, but deliver nothing.Dr. Risk would bet dollars to pennies that at least some of professionals  involved in credit search, credit repair, etc. run their businesses the same way. 

Nor does Dr. Risk know specifically who might lend give you a chance, beyond the chance that you say some lenders are already giving you. The only avenues that come to mind are not pretty ones.

• Some people with inadequate credit turn to friends and relatives to co-sign loans. Historically, this approach has a high incidence of default and lost friends. 
• Some desperate, would-be borrowers turn to loan sharks. The sharks are able to lend when others can’t, because they have more effective methods of collection. These borrowers must be desperate, because information of the way sharks collect from deadbeats is as widespread and depressing as information about the way cigarette smoke affects human lungs.
• Dr. Risk heard recently that “credit doctors” with access to your credit report may be able to expunge all the bad news. That is fraud, of course, with extremely negative and likely consequences.
• Pawn shops and other secured lenders accept collateral, which allows them to lend to borrowers with little regard for credit history. 
• Dr. Risk recommends against any of those ways to get a loan. 

Perhaps some of the lenders who turned you down have told you what they would need to lend you money. If so, that may be a road map for your credit future. – Dr. Risk

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$64 Question (6/28/00)

Dear Dr. Risk – I just went long on qualcomm today and bought a heckuva lot.  The price was 64.  Obviously I think that is a terrific price cause I sure bought a lot.  Now I need some protection.  What is a call option?  I am told july 70 calls are a good form of insurance.  what does this mean? – Van Doren

Dear Van – Not to wallow in self-pity, but a Risk Doctor sees a lot of personal financial tragedy. To make a medical analogy, a lot of patients walk into Dr. Risk's office with self-inflicted injuries and ask for treatment. Your situation is a little like the patient with a case of gonorrhea who walks in and says, "Doc, I think I need some protection." If the patient had come to the doctor in advance, the protection would have cost about 50 cents. Now the treatment will require expensive penicillin, with no guarantee of success.

<<What is a call option?>> A call option is an option to buy or "go long". Check out our "Derivatives Dictionary". You'll find the "C"s at http://www.margrabe.com/DictionaryAJ.html#sectC.

<<I am told july 70 calls are a good form of insurance.  what does this mean?  thankkyou >> Assuming your question is serious, it means you're listening to the wrong person, possibly an option salesman! Ideally, insurance protection makes you whole after an insured loss. Of course, life insurance may not exactly make the beneficiaries whole after the insured's death. Some people may never recover from the loss, while others may be better off without the person - even without the insurance!

You said that you were long the stock. Dr. Risk can't think of any way to use a static position in July 70 calls to provide protection against a loss on a $64 stock. The standard protection against that loss would be a static hedge, an out-of-the-money put option on all the shares of stock, struck at 60 (say). The put option (also in the dictionary) gives you the right, but not the obligation to sell the stock at the strike price on or before expiration. For every dollar the stock price sank below 60 (say), the put option would provide one dollar more profit. The option gain would offset the stock loss. 

You could use those (short) calls as part of a dynamically changing portfolio that provided protection equivalent to the put. However, Dr. Risk wouldn't recommend it:

(a) That strategy is complicated to explain and you don't sound prepared for it until you do some more reading about options.
(b) That hedge would be what we call an "alligator hedge", because the transaction costs would eat you up. That's why Dr. Risk thought maybe an option salesman might have proposed it to you.
(c) July 70 calls would expire within about a month, and you would lose all the time value within that period. This accentuates point (b).

If you have enough money to buy "a lot" of a $64 stock, then you might consider investing some time reading some books about investing money. Then you won't have so much need for Dr. Risk's ... 

Best wishes – Dr. Risk

Dear Dr. Risk – thankyou very much for your well informed advice. (i didn't understand the thinking at all behind the call option strategy); I thought puts made sense also, but as you can see, I know nothing about options. Because of my heavy investment in qcom, now I must learn. (I do have one of mcmullin's books on options, but I am "sort of" already in Qualcomm pretty deep (ha!), a risky bet no doubt, but by the time I really understand option protection, (and read the book thoroughly) the stock might be a heckuva lot higher than my price of 64. I figured get the stock first at that price. One last question: I have 10K left in cash and you know my purchase price. I would spend it all on some downside option protection. Once we get to early november I think the odds are very good that qcom will go up with the rest of the tech/net sector. Therefore, should I be thinking about October puts on qcom, and if so, how much protection can I buy, and how? What are the costs, prices? I am only worried if the stock goes below 57. I can sweat bullets between my price of 64 and a retracement of 7 down point..........thankyou very very much. – Van Doren

Dear Van – You're welcome.

Dr. Risk can't respond directly to your current message.

1. You seem to be asking for specific investment advice, and we don't do that in this space. We try to use your specific situation as our motivation for presenting relevant, nonspecific information

2. The sort of specific information that you seeks is what a broker or dealer would step on his children to provide. Sounds like you've already figured out what you want to do and just need somebody to tell you how much of it you can do for $10,000.

Your situation suggest that it might make sense to reiterate a general point to our readers. In the options market, for every Rick Lazio who makes 600% on call options on stock in an associate's business, there are more than a few John Q. Publics who lose their entire investments. In the futures market, for every Hillary Clinton who turns a totally inadequate margin deposit of maybe one thousand dollars into $100,000, plus or minus change, there are probably millions of retail speculators who lose money – a little, everything they had, or everything and then some. The equity market is no more of a sure thing.

Best wishes – Dr. Risk

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Where's a Pied Piper of Hamlin when you need one? (6/28/00)

Dear Dr. Risk – I saw a cute little mouse, recently, near a pile of trash bags, outside a Manhattan restaurant that I frequent for lunch. I'd hate to run into one inside the establishment. What are the odds that mice are inside the restaurant? –  D. Oliphant

Dear Oliphant – When you start talking to Dr. Risk about health conditions in restaurants, you're opening up a can of worms, so to speak. For many years Dr. Risk's father inspected restaurants and dairy farms, and he was a treasury of fascinating stories that people with weak stomachs didn't seem to welcome at mealtime. He tried to spread the gospel of following best practices of restaurant sanitation, and found that he was sadly not preaching to the converted. Many restaurant workers were a recalcitrant and – in this metaphor – heathen lot, who obeyed public health regulations about as well as most Christians follow the custom of tithing. 

One morning a young, female food worker went into the kitchen restroom while Father was inspecting. After a while she flushed, exited the little room, and walked right past the sink without washing her hands. He said, "Excuse me, Miss ..." and proceeded to educate her about fecal-oral transmission of disease and related issues. Sullenly, she washed her hands. Around noon, she repeated the drill, except that as she walked by the sink without washing her hands, this time she smiled triumphantly at him and said, in explanation, "I'm going to lunch!"

However, you asked about mice. They created quite a stir, recently in Dr. Risk's town, where a large number of them infested one of the elementary schools. A full-page letter to the editor (paid advertising by the PTA!) contained abundant information about mouse infestation. Over spring break week, traps caught 70 mice in the school. After the break and the efforts of a professional exterminator, children were still seeing mice regularly in their classrooms, sometimes dying slowly in sticky traps. Since mice pee wherever they want, it dries up leaving an invisible residue, and that residue can contain salmonella bacteria, they can spread food poisoning. The symptoms of Salmonella food poisoning: (1) first you feel so sick you're afraid you're going to die, (2) then you get sicker and you're afraid you aren't. They can also spread the potentially fatal Hanta Virus. 

Dr. Risk can't tell you the odds of finding mice inside your restaurant, but if you really want to know, you can visit the New York City Department of Health Restaurant Inspection Information web site (http://www.nyclink.org/html/doh/html/rii/index.html)! There, you can search for a summary of findings of a recent restaurant inspection, which can be compelling reading. You can order up to five full restaurant inspection reports for free by calling (212) 442-9666 between 9 A.M. and 5 P.M. Monday through Friday. 

A trip to this site can raise some troubling questions. For example, on the evening of Friday, June 9, Dr. Risk took the family into Central Park for in-line skating. Afterward, Frau Dr. Risk thought it might be fun to take the kids to eat at Mickey Mantle's on Central Park South, so of course that's where we went. The food was delicious. Two days later, as Dr. Risk was writing this article, he decided on a whim to check out what the health department had to say about Mickey's. The inspection on 6/9/00 found "Vermin or other live animal present in food storage, preparation or service area." In case you are no more sure than Dr. Risk was, a hypertext link from the word, "vermin", provides a definition: "Insect or small animal that is destructive, annoying, or harmful to health. Includes cockroaches, flies, and rats." While Dr. Risk is curious about which vermin the inspectors found in Mickey's, he hasn't decided to ask for the full report. Next time he will, for sure ... in advance! – Dr. Risk

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When Free Isn't Free (5/28/00)

Dear Dr. Risk – Today there's no reason to pay more than $8 per trade and I've seen ads that indicate that you can sometimes trade for free. Doesn't that make day-trading a lot more sensible? – Otto Commissione

Dear On-Line –  Hardly! What you and the rest of the public that takes seriously all this talk about $8 trades fail to realize is that the brokerage commission is only part of the cost of trading – ordinarily, a relatively small part. More important is the bid-ask spread. Let's say you take a quick round trip (either buy, then sell, or sell, then buy) with 100 shares of Microsoft (MSFT). The cost of that trip will be $16 commission, plus the bid-ask spread. If you had tried to do that on 5/8/00 at 12:50:26, using Island ECN (http://www.island.com), you would have seen the following in the limit order book:

The best bid was for 435 shares at 70 7/8 and the best offer for 420 at 70 255/256. That indicates that a quick round trip (e.g., buy, then sell) in 100 shares of that stock would have cost you 100 x $31/256 = $12.109365, and the brokerage commission would have been $16. However, for a round trip in 1000 shares you would have had to sell 435 shares at 70 7/8, 100 at 70 13/16, and 465 at 70 5/8, for a round trip cost of about $243.60 from bid-ask and $16 from brokerage commissions.

By the way, if you want the current Island ECN market for MSFT, click on the "Request" button, above. If you want the market for a different stock, replace "MSFT" with a different ticker symbol. Caveat: Island doesn't always have the tightest market in every stock. For example, I just looked up FNM (Fannie Mae) and saw only an asking price for 200 shares. – Dr. Risk

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How to Deal with a Traveler (4/28/00)

Dear Dr. Risk – A nice man with a lovely  Irish accent came to my door and offered to repair my driveway. He pointed out the poor drainage, root damage, and normal cracks and other deterioration. His first offer was to pour asphalt for $2500. I told him that I didn't have that kind of money. Then he suggested sealing the surface. I declined the offer. He asked me me what the job would be worth to me, so he could tell me if he could do it for that. I said that I wasn't picky, that the driveway was going downhill extremely slowly, and that repairs today weren't worth but about $50 to me. Finally, he said that if I wouldn't tell anybody else the price, he would do the whole thing for $2000, and I wouldn't have to put any money down, and wouldn't pay until the job was perfect. I said no. After he left, I had second thoughts. The price might have been good. – Vic Timm

Dear Vic – The first sign of spring is often the crocus, but sometimes it's the driveway repair hustler. Of course, until you're been hustled, you can't be sure that you're dealing with a hustler. For all you know, maybe the tooth fairy's branching out. Some people don't even know they've been hustled, even after they're been hustled. If you saw The Sting, you know that that sort of confusion about the outcome is the goal and result of the consummate con man. If you don't mention the price of driveway repairs to anyone, you might go to your grave still wondering if you got a good deal. Others realize that they're the victims of a hustle and refuse to speak, because they feel foolish.

This could have been your lucky day, but maybe you blew it. Dr. Risk has a woman friend who had a 1970s Cadillac in her driveway in the middle 1990s. You may be amazed to learn that this ancient vehicle could be a powerful magnet for a certain element of the population, and she received numerous visitors and notes with offers to buy the car from her, even though it had sat for two years, immobile with four flat tires, and it displayed no "for sale" sign. Dr. Risk had to marvel at the number of blue-collar men who were driving on side streets in upscale neighborhoods. Finally, she struck a deal with one of the men – he promised to do some wall and walk work to pay for the car. When Dr. Risk heard about it, he thought she was playing with fire, and recommended against it. However, the man did repairs worth one or two thousand dollars, and he hauled away the car and its flat tires. For her, it was an arb, because she would have paid to have someone remove the car. So, it's possible to deal with strangers and come out okay.

However, Dr. Risk thinks it's more likely that you dodged a bullet. In 1996, Dateline broadcast a series of television shows about Irish Travelers. Dr. Risk's knowledge about Travelers comes from two of these shows, the Internet, and personal experience. For centuries in the UK roving families of “Travelers” have ripped off homeowners. 

About 150 years ago some of those families came to the U.S. Today, there are three clans of these Travelers: English, Irish, and Scottish. About 3000 Irish Travelers live in or around Murphy Village, near Aiken, South Carolina. They have a lot of fancy new homes. They’re doing well, while doing bad. The women and children stay in town, while the men roam the country, stealing. Their M.O.  is to pass through town, approach homeowners about home repairs, collect cash, and do either no work or shoddy work. Sometimes they commit petty thefts, as well. 

According to Dateline, in the middle 1990s, Travelers often drove around in pairs, in pickup trucks with camper covers ("turtle tops") over the back bed. They displayed no telephone numbers or company addresses on the exteriors of their trucks. The camper covers had the ordinary lock in the back, plus a lock on either side window. Apparently, this configuration for the truck is a "marker" or "uniform". 

They would pick a neighborhood, identify homes with elderly persons, and go right up to the door and knock to gain entry. They would tell the victims that they (Travelers) would do repairs for a good price. But, the Travelers did shoddy work. At least, that's what Dateline said.

Eerily, one or two weekends after seeing Dateline's show about Travelers, Dr. Risk and his son were visiting Grandma Risk. While they were there, a man knocked on the front door. He said that the paint was coming off the aluminum siding, and held up his finger with white residue on it. He said that he would wash the siding and repaint it for a small sum of money. He had a vaguely Irish accent. His pickup truck had no name or telephone number on the side. He had no business card, but a local telephone number and an 800 number where Dr. Risk could leave a message. The man said he would never be there to receive the call, because he was always out working.  A boy sat in the truck, which had a camp cover on back and three locks, just as Dateline had described.

Needless to say, Dr. Risk thanked the gentleman for his offer, but declined politely to accept it. Dr. Risk thinks you did the right thing by declining the offer that he made you. 

Dr. Risk favors dealing with tradesmen and tradeswomen with fixed address and roots in the community. They are more likely to be accountable for their actions. Consequently, they are more likely to deliver good value for money, and less likely to cheat you or steal from you. Friends and neighbors are probably your most reliable source of such works. After that, you might try the yellow pages. – Dr. Risk

P.S. [more about Travelers]

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Travelers' Update (5/28/00)

Dear Vic – More on the Travelers. Stone Phillips hosted a TV show about Travelers that appeared on The Discovery Channel during May 2000. It was probably a repeat of a Dateline show from 1996. According to that show, Wanda Mary Mary Normile, a young, female traveler, and one male and one female cohort had conspired to sting Disney World for three million dollars by staging her rape in a Disney hotel. She had intercourse with a male acquaintance to plant semen. She had another her male conspirator beat the crap out of her face. This was going to be a legendary Traveler scam, one that Travelers would talk about for years. Disney was ready to pay, when Wanda Mary's female conspirator turned her in after a squabble over who was going to hold the money. The court sentenced Wanda Mary to 18 months for grand theft.  – Dr. Risk

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A publisher offers Dr. Risk a chance at two million dollars! (4/28/00)

Dear Dr. & Mrs. Risk – There's a very real chance that Reader's Digest may owe you a good deal of money. ... According to statistical estimates, by returning your Computer Cards IMMEDIATELY, no other entry will have a better chance of claiming that TWO MILLION DOLLARS. ...  – Ronald J. Leslie, Sweepstakes Director

Dear R.L.J. – Dr. Risk was so excited at the "very real chance" of "claiming that TWO MILLION DOLLARS," that he decided to run the numbers  and figure out the value of the opportunity with which you presented him, so he could prefer an offering statement for a private placement, in order to realize immediately the liquid value. 

According to documents in Dr. Risk's possession, if your winner decides to take his money up front in a lump sum, your "TWO MILLION DOLLARS" prize becomes a one million dollars prize. Dr. Risk will use that figure for the prize's cash value. The document says that printed lists of prize winners will be available on or about 9/29/00, so we'll use that as the date on which the prize is worth the $1,000,000. Your disclosure statement says that the odds of winning the "TWO MILLION DOLLARS" prize are about one in 145,000,000. 

That tells me that your prize is worth, gross, ... 
NOT the time it takes to read your confusing sales literature and documentation ... 
NOT the 33¢ first class postage required to send the computer cards to Reader's Digest in Marion, OH ...
NOT one U.S. penny, 1/10 of a penny, or even 1/100 of a penny ....
the princely sum of  $0.006897 = $1/145 = $1,000,000 x 1/145,000,000 + $0 x 144,999,999/145,000,000.  – Dr. Risk

P.S. The negative outcome was obvious from the start, but Dr. Risk had to work out the numbers for his readers. 

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Those Who Can, Do. Those Who Can't, Manage Money? (11/28/99)

Dear Dr. Risk – I would judge a good money manager by whether he's wealthy. Wouldn't that make sense? – Liza

Dear Liza – It certainly would make sense, if all the following myths were true: 
1. If a money manager is "good", then he will increase your wealth.
2. If a money manager is "bad", he will decrease your wealth.
3. A good money manager manages your money the way he manages his own.
4. The only way for a money manager to become wealthy is by managing his own money well. 
However, none of those myths is correct, and the connection between the the manager's wealth and what he does for you is tenuous. The hallmarks of a good manager

Let's consider those myths, one at a time. First myth: "If a manager is 'good', then he will increase your wealth." It's equivalent, contrapositive proposition is, "If a manager doesn't increase your wealth, he isn't good." Suppose your managed portfolio lost ten percent of its value in a single day. Does that mean your manager isn't good? What if that day were "Black Monday", October 19, 1987, when the Dow-Jones Industrial Average dropped 22.6% in one day? Suppose your portfolio value hasn't increased in months? Time to fire your manager? What if the market has been trending down that entire time, as during the early years of the Great Depression? 

Myth #2: "If a manager is 'bad', he will decrease your wealth." Contrapositive: "If the manager doesn't decrease your wealth, he isn't bad. Suppose your manager has increased your portfolio value a steady five percent a year for three years. Do you give him a bonus? What if the market has achieved double digit returns each year over that period? 

Myth #3: "A good money manager manages your money the way he manages his own." Consider a hypothetical, forty-year-old divorcee with three young children, little market expertise, and fears about being employable. Her hot-shot, thirty-something, bachelor male money manager has her investing in the same Internet stocks that made him a million dollars in less time than it takes to make a baby. Good idea? Hardly! If your manager's demographic and personal characteristics differ from yours, then it would be irresponsible for the manager to invest your money the same way that he invests his own. 

Myth #4: "The only way for a money manager to become wealthy is by managing his own money well." The first problem is that you probably don't know whether the manager is wealthy, or not. You can't conclude that he's wealthy, just because he dresses well and lives large. Maybe he's putting up a front to attract impressionable customers. Even if he has millions, you must consider the source:
1. A money manager can inherit wealth, marry wealth, save it from income, steal it from his customers, or just get lucky. None of those sources of money prove that he's a good manager of your money. Remember the saying, "The easiest way to make a small fortune is to start with a large one." 
2. A manager's wealth depends on the length of time he has invested it, by the power of compound interest. An older manager has likely grown his wealth over more years than a younger manager. The sheer power of compound interest tends to make older managers wealthier than younger ones. Does that make older managers better?
3. A manager's wealth depends on luck. The manager who happened to put his money in a little software company, called Microsoft, in 1985 seems prescient, in hindsight. Clearly, the rate of return depends on the manager's "style", i.e., whether he invests in bonds or stocks, growth or value stocks, U.S. or foreign stocks, European or Southeast Asian stocks, airline or computer stocks, etc. 

So how could you evaluate your money manager's performance? Pretty much the same way you could evaluate your plumber, doctor, auto mechanic, or lawyer. The required data are 

• the problem he faced and how he assessed it 

• the available solutions and the solution he chose

• what he said he was going to do and what he actually did

In short, you would need a lot of information and a lot of expertise, which you don't have, unless you're about as qualified as the professional that you're trying to evaluate. Then you evaluate the data, point by point, in light of professional standards. The more points to the evaluation, the better the potential evaluation. 

A lot of people will say that they don't have what it takes to perform such an evaluation, and a lot of people will be right. Evaluating a money manager is probably at least as difficult as evaluating plumbers, auto mechanics, attorneys, and surgeons. Most people are in the dark about these professionals. Consequently, people can't do a good evaluation of money managers, for whom luck is a major factor that muddies the waters. 

Unless you're a professional manager, yourself, you'll just have to trust someone else's evaluation of the manager, base your evaluation on past performance (and hope it's accurate and not due to good luck), take the money manager at his word, or rely on his reputation. In any event, you increase your odds of success by increasing your knowledge. – Dr. Risk

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The Death Tax Break (11/28/99)

Dear Dr. Risk – What is a Spyder Buy & Hold account?????? – Al

Dear Al – I'm not familiar with that precise term of art in investment. A buy and hold account sounds like an account where you buy something, then hold it. Spyder (also, Spider) is a name for the American Stock Exchange product, Standard & Poor’s Depositary Receipts (SPDRs), with ticker symbol SPY. Spyders are Units of Undivided Beneficial Interest in a trust that contains the right proportions of the shares in the S&P 500 index. (You can read more about Spyders at http://options.nasdaq-amex.com/indexshares/index_shares_spdrs.stm.) 

Put together the two concepts together, and what do you get? You buy the Spyder and hold it for a long, long time. If there's more to it than that, I don't know what, but I asked an expert, Gary Gastineau, Sr. V.P. , New Product Development, at the American Stock Exchange. Here's his response: 

"Your guess is as good as Mike Babel, who heads our telephone inquiry group, or I can make. To extend your guess a bit, it might be the account of someone who wants to take full advantage of the legendary tax efficiency of Spyders by holding them for the rest of his or her life, giving the investor's heirs a capital gains taxfree stepup of basis. 
"There are about 90,000 Spyders shareholders now. We believe that many of them are longterm holders." 

Let me illustrate Gary's excellent point about the stepup of tax basis. Let’s say that Grandma and Grandpa sell the family home, invest all their worldly wealth ($300,000) in Spyders, and move into an assisted living unit with rent that approximately equals the monthly payments from social security and Grandpa’s pension. The stock market zooms for a few years and the value of their Spyders grows to $650,000. Now, consider three scenarios: 

1. The elderly couple lives happily another three years in their paid up assisted living unit, then requires a move to an expensive nursing facility at $8,000 per month for each. They live there for another four years, exhausting their assets, then die penniless. 

2. The couple sells their assets, pays $70,000 in capital gains taxes (at 20%) to Uncle Sam, and writes a $580,000 check to their children. They live happily another three years in their paid up assisted living unit, then require a move to an expensive nursing facility, for which Medicaid pays everything above their social security and pension income. 

3. A truck driver – with an enormous sleep deficit that overwhelms the wake-up drive from the bennies he’s taking – falls asleep and crushes the couple inside their automobile, as they are driving home from an Elderhostel program on ancient Greek architecture. Their children inherit the Spyders TAX FREE with a tax basis of $650,000. They could sell the Spyders as soon as they receive them and pay no capital gains tax. 

Also, Spiders reduce the cost of diversification. You pay the commission and a small bid-ask spread on one stock issue, rather than commissions on the 500 components of the S&P 500 index.  – Dr. Risk

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EE-gad! The Virtue of Patience (11/28/99)

Dear Dr. Risk – I'm thinking about cashing in a EE bond that my mother bought for my daughter. Nothing could be simpler, right? Except I don't know where to go and how much I'm supposed to get. Can you help? – Leeza 

Dear Leeza – The process is fairly simple, but it's possible to be smarter about it, and it's possible to make an expensive mistake.

Probably the most convenient place to redeem the Series EE bond is at your local bank. The banker will look up the amount due in a book that has a page for each redemption year and month, e.g., September 1999.  The amount you get depends on the denomination, the issue year and month, and the year and month when you redeem it. The denomination would be something like $50, $100, $500, $1000, $5000, or $10,000. The initial purchase price was half the denomination. Each denomination has two columns – interest earned and redemption value (which equals initial purchase price plus interest earned). That page will have a row for the issue year and month, e.g., 1992 April thru September or 1992 October thru December. Then, on the right page and at the intersection of the right row and column you will find the redemption value for your bond. 

Let's take a concrete example. On October 1, 1992 Grandma paid $5000 for a $10,000 Series EE bond. You could cash it in on September 30, 1999 for $7,344. If, instead, you cashed it in on October 1, 1999, you would get $7564. Thus, by waiting one extra day you would earn an extra $220 on $10,000, about three percent of the principal amount. At the average yield of six percent over that period, that is equivalent to getting about four months interest. 

So you may not want to take casually this simple process. – Dr. Risk

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What is a straw mortgage? (11/28/99)

Dear Dr. Risk – We are looking at getting a loan on a house and they are talking about a 2nd mortgage by the place we are getting the house from and saying that it will be a straw mortgage and what they are saying it means is that the dealer will forgive the 2nd mortgage once we get all the papers signed and that is why it is called a straw mortgage our problem is that everyone that we ask about if they know anything about it or what it means they say they have never heard of it and i cant seem to find any where that has information on it so i wanted to know if you knew what it means of if by chance there is also another name for this. – Patti 

Dear Patti  – In real estate, the adjective, "straw", sometimes means temporary, as was the straw house in the fable of the three pigs. For example, general partner Smith might file partnership papers, listing instead Jones as the (straw) general partner, who just holds Smith's place. After the papers are filed, Jones steps aside and Smith asserts ownership. The purpose of this straw ownership is to hide Smith's real ownership from someone. 

However, "straw mortgage" is a new one on Dr. Risk. He has shown your question to an expert, Lester Kravitz  (kravitz@realtor.com), an attorney who owns a residential real estate brokerage and has a Real Estate Q & A Web page ( http://www.westchesterweb.com/realestate/quest.html). Here's his response:

"Straw mortgage" is not part of the every-day practice of residential real estate transactions. Perhaps Patti should ask the person who is proposing the "straw mortgage" to explain in writing exactly what is being proposed. Why do you need a "straw"? There are hundreds of mortgage sources all over the Internet which can provide an almost unlimited variety of more conventional financing. It's generally a better practice to shop for your financing from an independent source. While it is possible that the mortgage being offered by the dealer is a better deal than you could find yourself, it's usually not the case.

"Patti, are you buying a newly-built home? If that's what's involved, perhaps the seller is interested in establishing a high price for your sale so that other homes will be expected to sell for higher prices. For example, if you are buying a home that is actually going to cost you $400,000, but it would be advantageous for the seller to record the sale as a $500,000 sale, I could understand the reasoning behind getting Mortgage #1 from a lender for almost $400,000 and "straw" mortgage #2 from the developer for $100,000 (with the developer "tearing up" your $100,000 I.O.U.).

"You must discuss this with your lawyer before you agree to anything or you may be asking for serious trouble. It's probably a good policy not to get involved in any financial transaction where the party you are dealing with is unable or unwilling to take the time to explain to you all of the details in order for you to have a thorough understanding of what you are getting into."

Dr. Risk reiterates Mr. Kravitz's good advice: 

• get the proposed deal in writing 

• ask your attorney the legal implications 

• decide, yourself, what's best for you.  

– Dr. Risk

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Derivatives Dictionary^TM  Terms and definitions relating to personal finance are below. The main Derivatives Dictionary^TM is here. 

affinity fraud

Definition: Fraud, "in which the victims tend to belong to a particular ethnic group."  (Karen Jacobs, "SEC Accuses Brooklyn Lawyer of Fraud Related to Investments in 'Melchizedek', Wall Street Journal, 11/24/99.)

Example: "Victor M. Wilson ... raised money from about 480 investors in the U.S. and ... Dominica ... The money was to be invested in a program sponsored by Credit Bank International Co., which was said to have its charter in Melchizedek. But the SEC alleges that Credit Bank isn't a bank and Melchizedek doesn't exist." Nor did the promised 300% per annum returns materialize.

affluenza

A formerly rare disease of the rich that is now epidemic in Silicon Valley, Silicon Alley, and other spawning grounds for Internet businesses. The symptoms include lethary, ennui, and feelings of worthlessness and self-loathing. If untreated, affluenza leads to atrophy of one's ability to experience reality, think clearly, and act decisively  – particularly as related to work. The effects are much worse on children than on adults, who created the wealth, at least in some legal sense. Treatment is still a matter of opinion. The opinion of Merrill Lynch is that they can help private banking customers with counseling and other services: "Scott Cooper, a Merrill relationship manager whose office group serves families worth $100m or more, said Merrill was also helping with 'financial parenting' because its newly wealthy clients 'are concerned about affluenza' in their children but are unsure how to respond." (http://www.ft.com/nbearchive/email-ftibwcq31d2da.htm)
Affluenza is strikingly similar to a disease that is now endemic in impoverished ghettos of the U.S. However, in the poorer areas, government payments destroy the incentives to work and create wealth, whereas in richer areas the affluent people do it to themselves and their children with private money.  

aftermarket

The free market, after the end of the IPO, for the recently issued shares. The first days of the secondary market. 

8/28/00 annual percentage rate (APR)

Definition: The simple interest payment at the end of one year for the use of the money for that year. If at the start of the year you borrow $P and at the end of the year you repay the P dollars and pay $r×P interest, then the APR is r, or 100×r%. For example, if you borrow $1000 for one year, then repay it plus $120 interest, your APR is 0.12 or 12%.
Application: The APR is a standard way of stating the the interest on a loan that permits easy comparison of the cost of two loans. For example, two loans might have a stated rate of 12% and (a) monthly and (b) quarterly payments. The APRs are (a) 1.01¹²-1 = 12.6825% and (b) 1.03⁴-1 = 12.5509%.
Comment: Sometimes lenders have a legal obligation to state the APR for a loan or lease, but sometimes they don't. For example, automobile lessors are not obligated to disclose APR.

8/28/00 APR

Annual percentage rate (q.v.).

cash balance pension plan

Definition: A pension plan that operates a lot like a 401(K) plan money market fund with (a) a contribution each year that is a percentage of the worker's pay, (b) a guaranteed rate of growth (perhaps the U.S. Treasury bill rate) on the balance, and (c) a lump-sum or life-annuity payout. The Pension Benefit Guaranty Corporation's insurance program covers cash balance plans, but not 401(K)s. 

Example: The plan might call for a contribution each year of five percent of the employee's gross wages, plus a rate of interest equal to the U.S. Treasury bill rate on the previous account balance.

Application: The cash balance plan could allow the worker to move the plan to a new employer. 

churning

1. Trading assets in a client's portfolio much faster than makes sense, ordinarily done to generate excessive brokerage commissions.  
2. The feeling you should have in your stomach when your money manager turns over your portfolio faster than a stunt airplane doing barrel rolls. 

Cubes

An exchange-traded fund (ETF, q.v.) that tracks the NASDAQ 100 and trades on the American Stock Exchange with ticker symbol QQQ. 

Diamonds

An exchange-traded fund (ETF, q.v.) that tracks the Dow-Jones Industrial Average and trades on the American Stock Exchange.

ETF

The acronym for an exchange-traded fund. A fractional interest in a basket of shares, it trades on an exchange, just as common shares in a public corporation might trade. Examples include Cubes, Diamonds, HOLDRs, SPDRS, and WEBS, all of which, q.v.

8/28/00 float-down rate

Definition: A rate of interest on a fixed-rate residential mortgage loan that is contingent on conditions in the loan market at the closing. Namely, the lender promises a coupon on the mortgage note that is no higher than an agree level, but ratchets down if market interest rates fall. 
Application: If a prospective buyer thinks that rates may decline before closing, this offers the possibility of a lower morgage loan rate. 
Comment: Of course, a professional lender will charge for this contingency, and the borrower may not be in a position to understand the the value of the feature. 

HOLDRs

Merrill Lynch's equity basket product that has traded since 9/99 only in round lots of 100 shares on the American Stock Exchange. As of 3/15/00, six types of HOLDRs trade: Biotech, B2B, Internet Architecture, Internet Infrastructure, Pharmaceuticals, and Telecom. Most have increased sharply in value and may be disproportionately large in an investor's portfolio. The ticker symbol is HHH.  (Cf. ETF.) 

longevity risk

The risk of running out of money before you die. (Cf. mortality risk.) 

the Martin Act

Definition: The New York State Securities Law, which regulates sales of investment securities in New York and requires brokers, dealers, salesmen and investment advisors to register with the Attorney General's Office. The Investor Protection and Securities Bureau (the Bureau) enforces the Martin Act. Under the right circumstances, the Bureau investigates possible crimes, prosecutes criminals, and conducts civil lawsuits, all on behalf of the investing public. The Bureau also enforces laws that regulate the financing of theatrical ventures, the sale of franchises, and corporate takeovers in New York State.
Source: http://www.oag.state.ny.us/investors/investors.html

Martini banking

Definition: Online banking that is available 24/7, via PC, mobile telephone, PDA, tv, and your child's computer game console. Huw van Steenis (J.P. Morgan) coined the term to describe banking that you can enjoy "any time, any place, anywhere" as the old advertisement said you could enjoy a Martini. ("Online Finance; The virtual threat," The Economist, 5/20/00.) 

money market

The market for short term financial instruments, such as bankers acceptances, commercial paper, negotiable certificates of deposit, U.S. Treasury bills, and short-term agency issues. 

money market account

A deposit account with a floating rate of interest that a bank, credit union, or thrift can offer. It has check writing privileges and some sort of federal deposit insurance. 

money market fund

A mutual fund that invests in money market instruments, pays a variable dividend that depends on money market interest rates, and lacks federal deposit insurance. 

mortality risk

The risk of dying before you run out of money. (Cf. longevity risk.) 

"pay to play"

The practice of bribing brokers to talk their clients into paying far too much for certain shares. 

primary market

The IPO market. The market for new shares, where the underwriter is the seller and investors are buyers. 

8/28/00 Regulation S

The SEC regulation that allows a U.S. corporation to sell unregistered shares abroad, to foreigners, who may trade them, but may not sell them to U.S. investors for one year. 

secondary market

The market for "used" shares, where investors or speculators are both the buyers and sellers. 

Spider, SPDR, Spyder

Names for the American Stock Exchange product, Standard & Poor’s Depositary Receipts (SPDRs), with ticker symbol SPY. Spyders are Units of Undivided Beneficial Interest in a trust that contains the right proportions of the shares in the S&P 500 index. (You can read more about Spyders at http://options.nasdaq-amex.com/indexshares/index_shares_spdrs.stm.) 

torpedo effect

The tendency for a small earnings disappointment to lead to a large decline in stock price.
Example: For 1998 Q2, analysts forecasted Oracle's EPS to be $0.23. Oracle reported $0.19, 17% shy of the consensus forecast. Oracle's share price dropped 29%.
Source: Skinner and Sloan (1999), as reported in Patricia M. Dechow, Scott A. Richardson, and A. Irem Tuna, "Are benchmark beaters doing anything wrong?" 'Ann Arbor: University of Michigan Business School, 4/10/2000. 

Travelers

Itinerant con men of British Isles origins, who drive around in pickup trucks with "turtle tops", and specialize in ripping off the elderly via home repair scams. 
Source: Dateline, 1996. 

unauthorized trading

1. Securities transactions that you didn't order, but happened anyway, according to confirms and your monthly statement.  
2. A stockbroker's unfaithful act, analogous to your spouse swapping bodily fluids with someone besides you. 

unsuitable investments

Shares, bonds, options, partnerships, annuities, etc. that don't belong in a client's portfolio, because of a poor match between the client's characteristics (age, family situation, health, wealth, financial sophistication, and attitude toward risk) and the investment's (excessive risk, inadequate disclosure, known but hidden defects, undesirable tax implications, etc.) 

variable annuity

A personal retirement account into which a person can pour an unlimited number of after-tax dollars, defer tax on investment income until withdrawal, and use the balance to buy a life annuity. This allows the individual to manage longevity risk (q.v.). 

viatical settlement

The exchange of a life insurance policy for immediate cash, typically in excess of the cash surrender value. Also known as a lifetime settlement.  

WEBS

The acronym for World Equity Benchmark Shares. A WEBS issue is an exchange-traded fund (ETF, q.v.) that tracks one stock-market sector or stocks of one specific country. 

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Derivatives Digest^TM

8/28/00 "Hot for U.S. Stocks, Foreigners Get Burned In Regulatory Limbo." Wall Street Journal (2000 August 16) By John R. Emshwiller and Christopher Cooper.

A broker who went by the name of Steve Young, with an American accent, called from Brussels to Adrian Lawlor, a computer salesman in Dublin. Young had "just the ticket for entering the red-0hot U.S. stock market," and Lawlor was "absolutely green", so Lawlor sent the broker the best part of $17,000 in spare cash. The broker moved to Barcelona. Lawlor tried to sell some shares. The broker said he would -- if Lawlor reinvested the money plus $10,000 in share of ZiaSun Technologies Inc. Lawlor went to Spanish regulators, who said that they had no jurisdiction, because the brokerage firm apparently didn't sell to Spanish investors. Somehow, it's comforting that Americans are not the only people who will write checks for thousands of dollars to complete strangers who happen to want to keep it all for themselves and give the investors nothing but the runaround. 

Regulation S shares are a favorite vehicle for fleecing investors outside the U.S. Here's how it works: Regulation S allows the U.S. corporation to sell the shares to a promoter -- a foreigner, outside the U.S. -- without registering them. The shares are restricted, which means in this case that no one can legally resell the shares to a U.S. investor for one year. However, foreigners may buy and sell the shares. The promoter marks up the shares beyond all reason and sells them to foreign neophytes.  

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Games

Money Magic (5/28/00)

The Amazing Moola has proposed a formula for computing your daily interest on a large sum of money invested at 7.30% per annum.

1. Write down the principal amount, say $1,000,000.
2. Knock off the last four digits, arriving at $100.
3. Double that, arriving at $200. 

So if you have a million dollars, you'll have $200 a day to spend, including spending on taxes!

Is the Amazing Moola right? If not, why not? If so, why?

Money Magic – Solution (6/28/00)

David Wilson replies, "Yes it is correct because .073 (interest rate) divided [by] 365 (number of days in a year) equals .0002." 

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Have I Got a Deal for You!

How to Collect on Your Insurance Policy Without Dying!

Dear Dr. Risk – I have a five-million dollar "key man" policy on me, with my partner as beneficiary. Recently, he bought me out and I'm outta there, so I'm no longer a "key man". Consequently, I don't want him to have a big insurance policy on my life. My theory is that it's always better to be worth more alive than dead to someone. I don't need five million dollars in insurance, either, so I figured I'd let the policy lapse. 

Then a guy called me up and arranged a meeting. He said that he would pay me immediate, cash money to be the beneficiary on my policy. All I had to do was take a physical examination and name his company as beneficiary. He said that he'd pay me $20,000 to $55,000, depending on my medical report. I'm really healthy, so I'm looking at half a hundred thou! What do you think? – Methuselah

Dear Methuselah – Life insurance ordinarily starts out as a bad bet for the customer, much as playing roulette is an unfair gamble. In both insurance and roulette – the house needs to cover overhead, as well as its "gambling" losses, or it couldn't stay in business. However, working against this are some tax advantages of some insurance products. The insurance business is more complicated than the casino business, because the insurance company ordinarily gets to use the premiums for a while before it has to pay claims.  

Of course, people don't ordinarily take out a life insurance policy because they think the odds of a favorable payoff are in their favor. Instead, they are trying to prevent financial disaster for their beneficiaries, people who would lose significant  income and/or services in case the insured died. 

However, some people try to get insurance, despite a pre-existing condition that puts the odds in their favor. Others contemplate suicide, which can make an insurance policy a truly incredible investment – unless the policy doesn't pay off in the event of suicide. 

In some rare cases, it may be possible to buy insurance that is attractive on purely actuarial terms. Back in the 1970s, the late Fischer Black, one of the inventors of option pricing, wrote a paper, "How I got Free Life Insurance from TIAA-CREF." In it, he described a plan for taking out a whole life insurance policy (roughly equivalent to term insurance plus a savings account), then systematically borrowing its cash value. By his calculations, under reasonable assumptions at the time, the anticipated dividends plus the benefit of borrowing at (say) five percent when interest rates were in double digits covered the premiums on the policy. Dr. Risk ran the numbers, found them compelling, and took out a $100,000 policy. Was the policy "free"? Dr. Risk hasn't done a "post mortem", but his gut feeling is that the numbers are favorable for him.

You should know that a good medical report and a long life expectancy reduce the market value of your policy to a third party. Your policy would have the greatest value if you were clearly at death's door, and would likely die only moments after signing over your rights. Then, the buyer would promptly get the face amount of the policy, perhaps without even paying a single premium. This explains the greatly increased number of "viatical settlements" for AIDS patients in past years. Recent, successful treatments of the disease have greatly reduced that formerly booming industry. If your health were perfect, and you wouldn't die until the policy's cash value equaled its face value, then the value would be at a minimum. After all, the buyer would receive the face amount only after the maximum delay, and would need to make regular premium payments, until that time. 

While you show good judgment in wanting to remove from your partner the temptation to kill you for the insurance money, you sound eager to put some anonymous investors in the same position. That may not be the best idea. Anyone who saw the classic comedy film, The Wrong Box, the only film explore the human aspects of a "tontine" pool of money, would be sure not to make that rooky mistake with the wrong buyer. Of course, the market and murder laws protect you. The bad publicity surrounding the murder of a client wouldn't be good for business, and might lead to a civil suit or criminal charges. Common and statutory law also prohibit a murderer from benefiting from his murder, as by slaying his parents to inherit their property.  – Dr. Risk

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Humor

What price honor? 

Q: What's the difference between an eccentric, elderly gentleman and a silly, old fart? 
A: About $2,000,000 (in 1999 dollars).

Q: What's the difference between an eccentric, elderly matron and a crazy, old bat? 
A: About $2,000,000 (in 1999 dollars).

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Links Links related to personal finance are below. Links related to other financial topics are here.

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Presentations

Love to eat? Have to invest big bucks? Hate to get ripped off? Ask Dr. Risk over dinner about the dark side of finance.

Enjoy breakfast, lunch or dinner at your favorite Manhattan restaurant, as Dr. Risk personally unlocks the secrets of the financial underworld that you occasionally stumble into. 

• Find out how the SEC has proclaimed "open season" on you and other "accredited  investors". What are the amazing rules? Who has the hunting license? 
• What are the most common ways to turn a large fortune into a small fortune?
• What are the top scams used to fleece wealthy investors?
• What can "The Sting" teach us about managing our personal finances. 
• How do tell if your financial advisor is as qualified as he seems?
• Financial advisors: What's cheaper? Paying by the hour or getting them free?
• How does your mutual fund salesmen get paid when you specify no front end load? 
• Why does your life insurance salesman spend so much time selling you that whole life policy?
• Who are your broker and his industry analysts working for? You, the underwriter, or the issuer? 
• Submit additional, written questions in advance for Dr. Risk to research before we meet. 

 Bring your family, friends, and lots of questions. (Price: only $250 per hour, 90 minutes minimum. Food, drink, and service extra. Call Dr. Risk at area code 914, telephone number 738-3309.)

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