Money 101: Terms of Enrichment

everything you need to know to be a financial adult

A Couple of Playboy editors were sitting around j------o-- (can we talk?) and they suddenly realized:

Here you all are, just out of school, preparing to take your places in the Real World, and you are ready for it, sexwise, having had four years of Playboy, and you know how to mix all the right drinks and assemble the right stereo components and dress for success, but what do you know about money? How are you going to make it Out There if you don't know about money? In Bulgaria, you don't need money, but Out There, you do.

"How about an article telling readers everything they need to know about money?" the editors suggested.

"A whole article?" I asked.

"And could you have it ready for July?" they replied.

"Your mother," I said.

And so, alphalogibetically:

Annual reports. Like parents' day at camp. Everything is made to look as appealing as possible, but the counselors know different.

If you are going to read them, start at the back. Read the auditor's opinion first (beware the words except for and subject to), footnotes second (beware the words buxom and buttocks), financial statements third (beware parentheses; they indicate losses) and only then the illustrated narrative in the front.

But as you won't be able to analyze the report any better than a pro--who got all this info months ago--why bother? Go out and play, like the other kids.

Bonds. When you borrow money, it's called an auto loan. When G.M. borrows money, it's called a bond issue. Bonds are nothing more than I.O.U.'s. They are issued with "face values" of $1000. Their "coupon rates" are the annual interest they pay (through it is paid semiannually). If a $1000 G.M. bond with an 8 percent coupon is "76-1/4 bid," that means (A) it pays $40 every six months and (B) even though it will be redeemed for $1000 at maturity, all you can get for it today is 76-1/4 cents on the dollar ($762.50).

Bearer bonds. Bearer bonds are not issued in your name--they are unregistered--so any one who shows up bearing them (as in "Damn, dese bonds is heavy!") is presumed to own them. However, rather than make you show up with the bonds every six months, bond issuers append coupons to the certificate--40 of them in the case of a 20-year bond--so that you can just clip the proper coupon and deposit it with your bank. Some people still clip coupons, but most entrust their holdings to their brokers and leave the coupon clipping to a computer.

Borrowing. The only way you can make money borrowing at 14 percent is if you have a way to invest that money at 15 percent. This is a notion few seem to grasp. True, interest is tax deductible and capital appreciation is partially tax-free. And a lot of money has been made--or at least spared from tax--on the difference. But borrowing at 14 percent (pretax) in hope of, say, 11 percent (after tax) is a risky way to get rich.

Bankruptcy. A way to steal from society without serious penalty. Lots of people now advertise how painless and advantageous it is (it's advantageous for them: They get a fee).

Bankruptcy resulting from catastrophic illness or some similar calamity is a different matter, morally valid. But that's not what the ads are about.

Bucket shops. In Colonial days, these were located mostly in suburban shopping malls and sold nothing but buckets, barrels and--in the larger malls--vats. Nowadays, bucket shops are located in large rooms on low floors of Florida and Oklahoma office buildings and sell, by phone, commodity options, oil-lease lottery tickets and penny mining shares that will soon be worthless, or already are. If a guy calls you on the phone and offers to send an illustrated brochure promising Great Wealth, by all means accept! And then send him your $5000, even though he's a total stranger who's reading his sales pitch from a script, because this could be your lucky day. This could be the one such offer in all of recorded time that works out just the way the salesman says it will.

Big board. Not to be confused with Big Bird or bedboard: the august New York Stock Exchange.

The Amex. Should by rights be known as the Little Board but is actually known as the Curb: the American Stock Exchange. (Not to be confused with AMEX, short for Shearson-Hayden-Stone-IDS-Fireman's Fund-Boston Company -- Balcor -- Safra -- Robinson -- Humphrey/American Express.)

O.T.C. Over the Counter. Stocks not traded on one of the major exchanges (or the Pacific, Boston, Philadelphia or Midwest exchangelets) are traded by "market makers," linked by phones and computers, "over the counter." Not to be confused with G.T.C., which stands for "good till canceled" (as when your broker asks, "Is this order to buy 1000 Orfo at 2-1/2 for the day only or good till canceled?").

NASDAQ. The National Association of Securities Dealers Automated Quotations system. Over-the-counter stocks aren't traded on an exchange, but thousands of them--including plenty of small, thinly capitalized outfits--are "on NASDAQ," meaning that your broker can punch their symbols into the terminal on his desk and tell you, "It's one and an eighth bid, but our people are confident it'll come back."

Capital gains. You buy something, then sell it for more. The difference is a capital gain (unless you are in business to buy and sell it; then the difference, net of expenses, is called income). There are short-term gains and long-term gains, depending on whether you owned the stock or bond or horse or house more than a year. Currently, 60 percent of a long-term gain is exempt from tax. (See also illgotten gains.)

Capital losses. You buy something, then sell it for less. The difference should teach you a lesson but probably won't. Up to $3000 of short-term losses may be deducted, dollar for dollar, from your ordinary income, with the remainder carried forward to future years. But only half your long-term losses are deductible.

Basis. The amount on which your gain or loss is figured. Ordinarily, it is your purchase price. But what if you inherited the asset? (These days, your basis would be its appraised value as of the date of death.) Or depreciated it? (Your basis is lowered by the amount of depreciation.) Or improved it? (Your basis is increased by the cost of the improvements.) The second year of law school is devoted entirely to this paragraph.

Common stocks. The foundation of the economy, the source of corporate capital; also known as equities. Shares of stock represent shares of corporate ownership--though management frequently tends to forget that.

Debt and equity. The typical company will be funded with two kinds of capital. Money the owners paid in to get the business going (along with profits they decided to leave in to help the business grow)--called equity. And borrowed money that must some day be paid back--debt.

A firm's debt-to-equity ratio is thus a fundamental measure of its solidity. A firm that has $20,000,000 in debt and $10,000,000 in equity (a nerve-chilling two-to-one ratio) is far less solid, other things being equal, than one with $5,000,000 in debt and $25,000,000 in equity (a debt/equity ratio of .2).

Bid and asked. Ask for a price Out There and you get a question: Are you buying or selling? A stock or a bond that's quoted "74, 76" is "$74 bid, $76 asked." I'm trying to find a country where that means you can buy it for $74 or sell it for $76, but so far, every place I've been, it works the other way around. Maybe Bulgaria.

Long and short. If you own 150 shares of G.M., you are "long G.M." If you've sold 150 shares of G.M. that you don't own (and will thus some day have to buy back), you are "short G.M."

When you short a stock, you borrow it from your broker in order to sell it. You get none of the cash for selling it (the broker keeps that, plus the interest it earns), but you do make a profit if, when you go to buy it back, it costs less than what you paid. There's no time limit within which you must return the stock to your broker--it's not like a library book--and, in fact, the longer you're short, the happier the broker is, because he's earning interest on the proceeds of your sale. Currently, with about 200,000,000 shares short, at perhaps $25 each, the brokerage community is earning interest on five billion dollars in customer short sales and passing on not a penny of it to customers (except to a scant few powerful ones who have the muscle to demand it). I realize this is much more than you ever wanted to know about the subject, but it accounts for half a billion dollars a year in profit to Wall Street, so I'm telling you anyway.

Now. If the stock you're short pays a dividend, you don't get it--you pay it. Your broker (continued on page 148)Money 101(continued from page 67) slips that cash into the account of the true owner of the shares you borrowed, who will never even know they're gone. (Should he wish to sell his shares before you've returned them, the broker quick like a bunny borrows them from someone else.)

You can't short everything, but you can short a lot: cotton, pork bellies, the yen, many stocks, all publicly traded commodities and currencies and options. To do so successfully takes luck and courage that borders on the witless. Some very tall people are short but, with time, get cut down to size.

Puts and calls. These are options to buy or sell shares of stock. They are not unlike the red and black lines at roulette, only at roulette, your odds of winning are better and you get free drinks.

You buy a call on G.M. if you expect it to go up, a put if you expect it to go down. You can also sell a call instead of buying a put or sell a put instead of buying a call or buy and sell a couple of each to set up "spreads" and "straddles," but all this means is you're getting hooked in a way that ultimately profits only your broker.

Debentures. Bonds.

Convertible bonds. Bonds that have an "equity kicker"--namely, they can be traded for a set number of shares of stock. For example, Pan Am has a 15 percent convertible bond that promises to pay $1000 at maturity but that currently sells for $1250. Why? Because part of the deal is that you can convert it into 182 shares of Pan Am common stock, currently worth more than $6 apiece.

Municipal bonds. Issued by local governments and county sewage authorities, they are free of Federal (and their own state) tax. As has been pointed out ad nauseam: To someone in the 50 percent tax bracket, a nine percent tax-free bond is equivalent to an 18 percent taxable one.

Call features. Many bonds are "callable" after just a few years. That gives the issuer the right to redeem them years in advance of maturity--just as you have the right to prepay your mortgage--if interest rates go down. Most recently issued municipal bonds don't mature for 20 years or more but are callable in ten.

Preferred stocks. These shares are like bonds that never mature: They pay a dividend that never goes up, no matter how prosperous the company, but that won't go down, either, unless things get really bad. Most are "cumulative" preferreds, meaning that if dividends are omitted, they must all be paid before a nickel can be paid out to the common shareholders. Some preferreds are "convertible" into common stocks, and some are callable.

Corporations like to buy preferred stocks because--for reasons long forgotten--for corporations, preferred dividends are 85 percent tax-free.

Commercial paper. Short-term corporate I.O.U.'s backed by nothing more than a big company's promise to repay. These have nothing to do with you or me. They come in denominations like $1,000,000 and are placed with the Big Guys.

Diversification. Eggs, baskets ... you know.

Dividends. There are two problems with dividends: They are relatively small and they are fully taxed. Real men don't dream of dividends, they dream of doubling their money overnight. That is why real men have these great craggy jaws and hypermasculine footwear but little in the way of financial security.

Stock dividends. These are what a company pays when it can't afford to pay real dividends. No tax is due on them, because they are entirely worthless. Previously, there was a pie that was split up into a lot of little slices. Now there is the same pie, only it is split up into slightly smaller pieces. Management hopes you will be too stupid to realize this.

Dividend-reinvestment plans. This is different. Here, you opt to use your real dividends to buy more shares. You do have to pay taxes--except in the case of utility stocks, many of which afford a tax break. (Ask your broker.)

Earnings. The preferred word for a company's profits. And what are profits? The sum of all the positive bookkeeping entries, many of which have nothing to do with real cash coming in the door (such as sales that have been made but not paid for), less all the negative entries, many of which--that's right--have nothing to do with real cash going out the door (such as taxes that would have had to be paid if ways hadn't been found to defer them).

Cash flow. In many respects more important than earnings, this is the simple-minded measure of how much cash is pouring in or draining out. Real-estate operations always report bad earnings (because of the depreciation they claim, for tax purposes, on their properties), but the cash just rolls in bigger and bigger each year (because the properties actually appreciate and the rents get raised).

Earnings per share. All the earnings divided by all the shares.

Retained earnings. The portion of earnings not paid out to shareholders in dividends. Sometimes this money is retained by the company for expansion and reinvestment, and sometimes it is retained because it exists only on paper. (Sometimes it exists only on paper but is paid out anyway by taking the company deeper into hock.)

Float. Because money has "time value," it's great to have someone else's, even for a little while, without having to pay interest on it. When you charge something on your American Express card, you have use of American Express' money until (A) they bill you, which takes a while; (B) you pay them, which takes a while longer; (C) your check clears, which takes a while longer still. This is "the float" and it is one reason American Express has 16,000,000 fans. But American Express understands float, too. (How's that for understatement?) All those traveler's checks we buy are interest-free cash in Amex' pocket until they're redeemed.

Futures. One of the few ways in life to lose more than you bet. You put up only $2000 to control 15,000 pounds of frozen orange juice worth $22,500. Your hope is not to take delivery of the juice when it's due--at a specified date in the future--but to sell it at a profit to someone else. If your juice, worth $22,500 when you bought it, goes to $24,500, you've doubled your bazuzzas. If it falls to $16,000, you're screwed. You lose not just the $2000 but another $4500, and commissions, besides. There are commodity futures and currency futures. To be certain of losing only what you invest, but no more, you can buy options on futures.

Go public. The modern equivalent of "strike gold." Namely, when a privately held company first offers stock on the open market.

Gold. If you expect virulent inflation, buy some. Better yet, buy silver.

Interest rates. When they're headed up, everything else goes down and infants whimper in their cribs (it's instinctual). When they're headed down, everything else goes up and it's as if a box of David's Cookies has just been delivered to every family's door.

Investing. Taking your savings out of the bank (because you think only plodders keep their money in banks) and placing it at greater risk. When interest rates are headed down, you'll do well. When they're headed up, you'll do poorly. If you get to thinking you can psych out which way they're headed, you'll be sorry.

IRAs, Keoghs, salary-reduction plans. Personal pension funds, the tax shelter for Little Guys. Can't be recommended highly enough.

JNL. One of several all-but-incomprehensible abbreviations found on monthly brokerage statements. It stands for "journal" and means, "This is a journal entry only. It didn't really happen. We're not completely clear on what it means, either." Other common abbreviations include FDS (funds); TFR (transfer, as in the fds that are forever being mysteriously tfrd from your tp1 acct to your tp6 acct and then jnld to tp2); ADJ (adjustment, which means "We screwed up"); and UNC FDS (uncollected funds, which means you screwed up, by sending in a rubber check).

K-1. See limited partnership. Not to be confused with 10Ks, which companies must file with the SEC each year (the real annual report), or 10Qs, which they must file quarterly. Nor 13Ds, which must be filed if they acquire five percent or more of another company's shares. Nor 10b-5, the rule under which those who trade on inside information get their bones cracked.

Letter stock. This is stock that comes with special rules attached and, hey, it's great stuff. Nationwide Nursing Centers is selling in the open market at $22 a share; one of the founders is hot to sell 200,000 shares. The SEC restricts the sale of "unregistered" shares but allows them to be placed privately. So Nationwide (how fly-by-night could they be if they're nationwide?) offers it to you at $8. The only catch is that it's "letter stock," also known as restricted stock, and there's a big fat paragraph on the certificate that says you've got to wait two years before you sell so much as a single share. Two years is a long time to wait with a stock like Nationwide Nursing Centers.

Leverage and hedging. Leverage is a way to increase risk--and reward--usually through the use of debt. If you buy a $100,000 house for cash and it appreciates $10,000, you've made ten percent on your money. If you buy the same house with $5000 down and it appreciates $10,000, you've made 200 percent on your money. (Assuming the folks you've rented it to pay you enough to cover the mortgage and expenses--a big assumption these days.)

Hedging is a way to reduce risk. If you buy 100 shares of G.M., hoping it will go up, you can hedge your bet by buying a put on G.M. shares, in case they go down. It always costs something to hedge--usually too much--but sometimes it's worth it. Like insurance. The cheapest way to hedge is to diversify (see diversification).

Leveraged buy-outs. Here you and your buddies pool $50,000 in hard cash and make a bid to take over Time, Inc. You do that by borrowing three or four billion dollars from a large bank on the understanding that the minute you've bought the company, you'll use its own cash and underutilized borrowing power to pay off the loan (and if that's not enough, you'll sell off Sports Illustrated and your condo in Aspen).

Sounds crazy, I know, but in our little village of Anatevka....

Life insurance. A great buy if you have dependents who would suffer financially if you died today. If so, shop for inexpensive renewable term insurance. If not, skip it. (If you're a healthy nonsmoker under 35, coverage should cost you well under $200 per $100,000.)

Limited partnership. An entity through which to give up all control over your money in hope of great gain. You may invest in as many of these deals as you like--both the private kind, often limited to just 35 investors, and the public kind, which come to you from All The Major Firms--and they entitle you, if nothing else, to a K-1 shortly after the end of the year. The K-1 documents your share of the partnership's income or loss, which you then report on tax forms such as Schedule E. The K-1 is invariably promised to arrive by mid-March, to give you time to file your taxes. In fact, it generally arrives April 14, late in the afternoon. (See also tax shelter.)

Liquidity. Cash is liquid. Stocks and bonds are liquid, too: You can sell them and have cash in a week. Real estate is illiquid (it takes a while to sell) but not nearly so illiquid as many limited-partnership units, with which you can be stuck for years and years and years. Wine, strangely enough, is only semiliquid.

Millionaire. Anyone with $5,000,000 or more. (Well, let's be realistic.)

Margin. You can buy securities for cash, or you can buy them "on margin." The Federal Reserve sets the minimum down payments, currently 50 percent for stocks. The rest of the purchase price is lent to you by your broker at no risk (to him) but considerable profit.

Bonds may be purchased on even thinner margin and Treasury securities on the thinnest of all.

Should your stocks or bonds or Treasuries decline in value, you will begin getting urgent Mailgrams long before your equity is wiped out. If you don't send more cash or instruct your broker to sell something, your broker will take it upon himself to sell something for you.

O.P.M. "Other people's money." As in, "The secret of business is never to put any of your own money on the line--do the deal with O.P.M. If it works out, you've got a fat share of the profit for putting it together; if it bombs, well, the investors knew it was risky." O.P.M. is particularly useful to entrepreneurs who have no M of their own.

Pink sheets.The Wall Street Journal lists lots of stocks and bonds, but by no means all of them. If you ask your broker for a price on some ridiculous little number you heard about in the locker room, he will yell, "Harry! You got the pink sheets over there?" And Harry will toss over a stapled sheaf of thin pink paper loaded with bid and ask prices for the stocks of a zillion little companies. The yellow sheets are for obscure corporate bonds, the blue sheets for municipal bonds (virtually all of which are obscure).

Par. A bond that sells at par sells at 100 cents on the dollar, which is to say its full $1000 face value.

Par value. With a bond, $1000. With a stock, meaningless.

P/e. A stock's p/e is its "price/earnings ratio," or "multiple." If a stock "earns" $4.40 a share and sells for $45, it's selling for a tad above ten times earnings. Its p/e is 10.2. It gets a little more complicated, since it's next year's earnings that are most interesting, not last year's; but at this writing, for example, with the Dow Jones industrial average at about 1150, the average p/e of the 26 Dow stocks that had any e last year is 11.3.

Present value. A dollar today is worth more than the promise of a dollar a year from now, even if you're absolutely certain that promise will be fulfilled. ("Hey, the guy's never screwed me before!") That's because of "the time value of money": namely, what you can do with it in the meantime. If you can earn 11 percent interest on your dollar in a year, then, really, a dollar a year from now is worth only about 90 cents now--its present value. Why? Because 90 cents will grow to a dollar a year from now.

The present value of $236,981.34 eight and a half years from now is a slightly more complicated calculation but the very same idea. The present value depends on the "discount rate" you choose. Above, we chose 11 percent, because that's what we thought money could earn in a year. The higher the rate you assume, the less future money is worth today. And vice versa.

The entire first year of business school is devoted to this concept.

Precious metals. Some are more precious than others and all are less precious than they were when the world was ending not long ago.

Strategic metals. These include chromium, germanium, iridium, titanium, vanadium, zirconium, ruthenium and columbium, among others, and were the subject of a brief flurry of speculative attention around the same time. Lithium is the only one you should ever even consider, and then only on the advice of your physician.

Mutual fund. Takes your cash and everybody else's and invests more or less as advertised. Some invest aggressively for capital gains (and get mauled in a bear market), some invest mostly in foreign stocks or gold stocks or technology stocks or high-grade bonds or low-grade bonds or "a diversified portfolio of seasoned equities balanced so as to provide meaningful income while seeking to enhance values through capital appreciation." (The big money, let's face it, is in writing brochures.)

All mutual funds charge a modest management fee, but some charge a one-time sales fee, as well. Called the load, it is often as high as 8.5 percent of your investments. Ordinarily, you will want to stick to "no-load" funds.

Money-market fund. A mutual fund designed to be a cross between a savings account and a checking account. It invests mostly in short-term Government and corporate securities, for liquidity, safety and yield.

Sinking fund. G.M. sells $100,000,000 in 20-year bonds (say), and one of the provisions of the bond is that G.M. must set up a sinking fund to redeem a certain portion of the bonds each year. A trustee is engaged to pull numbers out of a hat to see whose bonds get redeemed. This is a lottery one generally hopes not to win.

Prospectus. A fat legal document you will not read, filled with warnings and disclosures you will ignore, that must accompany the issuance of any new security.

Proxy statements. These usually accompany annual reports and are your chance to vote the current board of directors out of office and elect a board composed entirely of Catskills comedians. All you need is another 48,000,000 shares.

Prudence. Prudence, though boring, is an attribute earnestly to be sought. It is not to be confused with the stodginess or poverty of intellect associated with certain bank trust departments.

Quarterly reports. Like annual reports, only shorter and unaudited. Meaning that the numbers are even more fanciful.

Red herring. A rough-draft prospectus for a stock or bond offering before the final numbers have been filled in and the SEC go-ahead obtained.

Saving. A terrific habit but less easily formed than some others I can think of.

Scripophily. Pronounced scri-pah-filee, it is the collection of worthless old stock and bond certificates, like the one I have from Nationwide Nursing Centers.

Speculating. Selling your shares in Ford--which only tripled in the past couple of years--to try for some really big bucks. It's true that Truman had a sign on his desk that said the buck stops here. What's less well known is that he swiped it from his broker.

Tax avoidance. Legal or quasi-legal attempts to slip through the cracks of the law and shift the burden of taxation to your neighbor.

Tax evasion. Things like failure to report income or the fabrication of phony deductions. Out-and-out fraud.

Tax shelter. A means of paying a dollar to avoid paying 50 cents in taxes. Many billions of dollars are raised for this purpose every year, of which at least 15 or 20 percent is typically skimmed off the top by the promoters, lawyers and salespeople.

Technical analysis. Trying to guess where prices are headed by looking at where they've been, as opposed to "fundamental analysis." A technical analyst might say, "Silver looks very strong; it's just pierced its 120-day moving average." A fundamental analyst would say, "Silver looks very strong; demand in both photographic and electrical-connector markets is picking up with no corresponding increase in production." A technical analyst might say, "Apple's chart looks terrific," meaning that its prior price movements point toward an imminent rise. A fundamental analyst would say, "I'm impressed by the marketing skills of the new president and the potential appeal of the products in the pipeline."

Teenies. When a stock is quoted 3 3/16, you don't say, "Three and three sixteenths"; you say, "Three and three 'steenths." Or "Three and three teenies."

Tender offers. These are tender only when they are "friendly." An unfriendly tender offer is one in which Boone Pickens of Mesa Petroleum is trying to get you to tender (sell) your shares in some giant oil company to him, at a fat price, and the management of that giant oil company is doing everything it can to save its jobs and keep you from getting that fat price.

Unit. A word, exclusive to Texas, meaning $100,000,000. As in, "Oh, Bucky? He's got a couple of units."

U.S. Savings Bonds. Still a great gift for a baby and not as bad a deal as they once were, especially for the small saver.

Would'a, could'a, should'a. What brokers hear all day from their customers. "I should'a shorted the son of a bitch! If I'd'a shorted a thousand shares, I could'a made--what?--twenty grand in a week!"

X. This is the ticker symbol for U.S. Steel, which is now primarily an oil company. XON is the symbol for the primary oil company. XRX is Xerox, IBM is IBM, JOB is General Employment Enterprises, EYE is Coopervision, BTU is Pyro Energy and AMTC is Nature's Sunshine Products. Some symbols are more immediately memorable than others. Any that have more than three letters are for stocks traded over the counter.

Yield. The income an investment throws off, be it interest or dividend, is its yield. An 8 percent bond selling at par "yields" (not surprisingly) 8 percent. But if that same bond were selling at 80 cents on the dollar, it would yield 10 percent.

Zero coupon bonds. They pay no interest but don't cost a lot, either. And one day they'll be redeemed for $1000 apiece. A great way to start an IRA. Currently, for instance, $2000 will buy $24,000 of CATS maturing in 2012. (Your broker will know what they are.)

"When interest rates are headed up, everything else goes down and infants whimper in their cribs."