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Meaning / Definition of

Tracking Stock

Categories: Investing and Trading, Stocks,

Best defined with an example. Suppose Company A purchases a business from Company B and pays B with 1 million shares of A's stock. The agreement provides that B cannot sell the 1 million shares for 60 days, and also prohibits B from hedging by purchasing put options on A's shares or short-selling A's shares. B is worried that the market may fall in the next 60 days. B could hedge by purchasing put options or selling the futures on the s&p 500. However, it is possible that A's business is much more cyclical than the s&p 500. One solution to this problem is to find a tracking stock. This is a stock that has high correlation with A. Let us call it Company C. The solution is to sell short or buy protective put options on this tracking stock C. This protects B from fluctuations in the price of A's stock over the next 60 days. Because the degree of the protection is related to the correlation of A and C's stock, it is extremely unlikely that the protection is perfect. Multidivisional firms have used a form of restructuring called tracking stock since 1984 to segment the performance of a particular division -- similar to a spin-off or carve-out, except that the parent firm does not relinquish control of the tracked division. Previously, this was known as alphabet stock, but the technically correct name is tracking stock (e.g., EDS traded for years as a tracking stock of GM). This is a way to reward managers for good divisional performance with an equity that is tied to their division-rather than potentially penalizing them compensation for bad performance in a division they have no control over.

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Definition / Meaning of

Circuit Breaker

Categories: Investing and Trading,

After the stock market crash of 1987, stock and commodities exchanges established a system of trigger-point rules known as circuit breakers. They temporarily restrict trading in stocks, stock options, and stock index futures when prices fall too far, too fast.Currently, trading on the new york stock exchange (NYSE) is halted when the dow jones industrial average (DJIA) drops 10% any time before 2:30 p.m., sooner if the drop is 20%. But trading could resume, depending on the time of day the loss occurs. However, if the DJIA drops 30% at any point in the day, trading ends for the day. The actual number of points the DJIA would need to drop to hit the trigger is set four times a year, at the end of each quarter, based on the average value of the DJIA in the previous month.The only time the circuit breakers have been triggered was on October 27, 1997, when the DJIA fell 554 points, or 7.2%, and the shut-down level was lower. In fact, the DJIA has dropped as much as 10% in a single day only three times in its history.

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