Question

Paul Chang and Deborah Barry, friends who work for a large software company, decided to leave the relative security of their employer and join the staff of OnlineSpeed, Inc., a 2-year-old company working on new fiber-optic technology for fast Internet access. Paul will be a vice president for new-product development; Deborah will be treasurer. Although they are excited about the potential their new jobs offer, they recognize the need to consider the financial implications of the move. Of immediate concern are their 401(k) retirement plans. On leaving their current employer, each of them will receive a lump-sum settlement of about $75,000 that they must roll over into self-directed, tax-deferred retirement accounts. The friends met over lunch to discuss their options for investing these funds. Paul is 30 years old and single, with a bachelor’s degree in computer science. He rents an apartment and would like to buy a condominium fairly soon but is in no rush. For now, he is happy using his money on the luxuries of life. He considers himself a bit of a risk taker and has dabbled in the stock market from time to time, using his technology expertise to invest in software and Internet companies. Deborah’s undergraduate degree was in English, followed by an M.B.A. in finance. She is 32, is married, and hopes to start a family very soon. Her husband is a physician in private practice. Paul is very computer-savvy and likes to pick stocks on the basis of his own Internet research. Although Deborah’s finance background gives her a solid understanding of investing fundamentals, she is more conservative and has thus far stayed with blue-chip stocks and mutual funds. Among the topics that come up during their lunchtime conversation are stockbrokers and financial planners. Paul is leaning toward a bare-bones basic discount broker with low cost per online trade that is offering free trades for a limited time. Deborah is also cost-conscious but warns Paul that the low costs can be deceptive if you have to pay for other services or find yourself trading more often. She also thinks Paul is too focused on the technology sector and encourages him to seek financial advice to balance his portfolio. They agree to research a number of brokerage firms and investment advisors and meet again to compare notes.

a. Research at least two different full-service, premium discount, and basic discount stock brokerage firms, and compare the services and costs. What brokers would suit Paul’s needs best,

and why? What brokers would suit Deborah’s needs best, and why? What are some key questions each should ask when interviewing potential brokers?

b. What factors should Paul and Deborah consider before deciding to use a particular broker?

Compare the pros and cons of getting the personal attention of a full-service broker with the

services provided by the discount brokers.

c. Do you think that a broker that assists in making transactions and focuses on personal attention

would be a good choice for either Paul or Deborah?

d. Paul mentioned to Deborah that he had read an article about day trading and wanted to try

it. What would you advise Paul about the risks and rewards of this strategy?

e. Prepare a brief overview of the traditional and online sources of investment advice that could

help Paul and Deborah create suitable portfolios. Which type of advisor would you recommend

for Paul? For Deborah? Explain your reasoning.

Answer 1

Answer:

a) A premium discount broker could be a firm like Fidelity or Charles Schwab.

The commission rates are somewhere between the discount brokers and the full-service brokers
Premium Discount Brokers have branch offices where you can go to get investment advice & guidance, and they make investment research from third parties available to their customers.

A discount broker is a brokerage firm that offers lower commission rates than a full-service broker, but does not offer services such as advice, research, and portfolio planning. Interactive brokers and Etrade are two discount brokers.

A discount broker allows you to make all your own investment decisions.

Comparison of cost structures and other parameters is attached below.

Since Paul is a high risk-taker and is low on financial knowledge, Full-service premium discount brokers will be best suited for him as he can avail their research and recommendations for just a small premium.

Since Deborah is conservative and has sound knowledge in Finance owing to her MBA in Finance, she should opt discount brokers as she can do her own research and avail the low cost.

Some potential questions they should ask :

1. Are there any hidden or undisclosed charges?

2. What Service And Support Is Offered?

3. What Online Tools Are Offered?

4. How Much Proprietary Research And Analysis Is Offered?

5. Do They Offer Access To International Markets?

6. Is The Firm Itself Risky?

7. What Promotions Or Incentives Are They Offering To Lure Customers?

b) Pros of full-service brokers:

Offer guidance and advice

Provide access to research

Help you achieve your investment objectives

Make investment decisions on your behalf

Cons :

Views could be different than yours

Higher fees than discount brokers

Calls could be biased as they might generate commissions on certain calls

Pros of discount brokers:

Lower fees than full-service brokers

Unbiased service

Access to online information

Cons:

No guidance

Minimal customer service

Hidden fees like issuance of stock certificate or mailing statement

c) Yes, Paul would certainly benefit from the guidance of a broker who assists in making transactions and focuses on personal attention. Not sure that Deborah would appreciate the broker's views as they might clash at certain times and she can transact on her own being from that background

d) Day trading involves making dozens of trades in a single day, based on technical analysis and sophisticated charting systems. The day trader's objective is to make a living from trading stocks, commodities or currencies, by making small profits on numerous trades and capping losses on unprofitable trades. Day traders typically do not keep any positions or own any securities overnight.

Risks:

1) Many day traders incur huge losses on borrowed monies, either through margined trades or capital borrowed from family or other sources. These losses may not only curtail their day trading career, but also put them in substantial debt.
2) Day traders have to compete with high-frequency traders, hedge funds, and other market professionals who spend millions to gain trading advantages. In this environment, a day trader has little choice but to spend heavily on a trading platform, charting software, state-of-the-art computers, and the like. Ongoing expenses include costs for obtaining live price quotes and commission expenses that can add up because of the volume of trades
3) A trader must quit his day job and give up his steady monthly paycheck. From then on, the day trader must depend entirely on his own skill and efforts to generate enough profit to pay the bills and enjoy a decent lifestyle.
4) Day trading is stressful because of the need to watch multiple screens to spot trading opportunities, and then act quickly to exploit them. This has to be done day after day, and the requirement for such a high degree of focus and concentration can often lead to burnout.

Rewards:

1) The biggest lure of day trading is the potential for spectacular profits. But this is may only be a possibility for the rare individual who possesses all the traits—such as decisiveness, discipline and diligence—required to become a successful day trader.
2) The day trader works alone, independent from the whims of corporate bigwigs. He can have a flexible working schedule, take time off whenever needed, and work at his own pace, unlike someone on the corporate treadmill.
3) Long-time day traders love the thrill of pitting their wits against the market and other professionals day in and day out. The adrenaline rush from rapid-fire trading is something that not many traders will admit to, but is a big factor in their decision to make a living from trading, compared with spending their days selling widgets or poring over numbers in an office cubicle.
4) For many jobs in finance, having the right degree from the right university is a prerequisite just for an interview. Day trading, in contrast, does not require an expensive education from an Ivy League school. While there are no formal educational requirements for becoming a day trader (see Best Undergraduate Degrees for Day Traders), courses in technical analysis and computerized trading may be very helpful
5) As a self-employed individual, a day trader can write off certain expenses for tax purposes, which cannot be claimed by an employed individual.