Brokerage Accounts and Margin Requirements
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Brokerage Accounts and Margin Requirements

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Questions and Answers

What is required for cash accounts before making a trade?

  • No requirements are needed
  • Approval from a financial advisor
  • A minimum balance of $1,000
  • Funds must be settled in the account (correct)

    • What does hypothecation allow in margin accounts?

  • Loaning money without collateral
  • Selling shares to increase equity
  • Using securities as collateral for loans (correct)
  • Using the same security for multiple loans

    • What is the purpose of Regulation T in trading?

  • To regulate stock prices
  • To encourage higher investments
  • To eliminate margin accounts
  • To set margin limits for brokers (correct)

    • When a stock's price declines, which margin requirement must be maintained?

    <p>Only the maintenance margin must be met</p> Signup and view all the answers

    If your asset is $7,537 and you have a 40% maintenance margin, what minimum equity do you need?

    <p>$3,768.50</p> Signup and view all the answers

    What happens to your liability when you sell shares to meet maintenance margin requirements?

    <p>It remains unchanged</p> Signup and view all the answers

    What is the risk associated with using a margin account compared to a cash account?

    <p>Increased financial risk</p> Signup and view all the answers

    Which statement correctly describes liquidity in margin trading?

    <p>It allows for the sale of assets to fulfill margin requirements.</p> Signup and view all the answers

    What happens to R-squared when a new variable is added to a regression model?

    <p>It increases regardless of the variable's relevance.</p> Signup and view all the answers

    What is the primary purpose of Adjusted R-squared in regression analysis?

    <p>To penalize unnecessary variables in the model.</p> Signup and view all the answers

    What does the Information Ratio measure?

    <p>The portfolio's performance compared to an index, adjusted for tracking error</p> Signup and view all the answers

    What risk do we encounter when adding multiple variables to a regression model?

    <p>Overfitting the model.</p> Signup and view all the answers

    What is a common concern regarding Value at Risk (VaR) calculations?

    <p>It assumes returns are always normally distributed</p> Signup and view all the answers

    Why might researchers prefer creating new ratios in finance?

    <p>To gain recognition or fame in their field</p> Signup and view all the answers

    What is the purpose of the regularization technique in regression?

    <p>To optimize the predictive power without overfitting.</p> Signup and view all the answers

    In predictive analytics, what does the value Lambda (λ) do?

    <p>It limits the influence of specific variables.</p> Signup and view all the answers

    What should be kept in mind when using VaR as a risk measure?

    <p>The strategy of the trading desk may change over time</p> Signup and view all the answers

    Which statement about risk modeling is true?

    <p>Regulatory requirements inform the methods used in risk modeling</p> Signup and view all the answers

    What do the Fama-French factors include in asset beta calculation?

    <p>Size and value factors.</p> Signup and view all the answers

    In the context of market beta, what does 'excess returns' typically refer to?

    <p>Returns beyond the risk-free rate.</p> Signup and view all the answers

    What is emphasized regarding the use of financial measures?

    <p>Selecting the appropriate measure based on asset class and strategy</p> Signup and view all the answers

    What should you ensure before including variables in a regression model?

    <p>That variables have predictive power beyond random chance.</p> Signup and view all the answers

    What might be a potential flaw in relying solely on a single risk measure?

    <p>It may not consider individual issues of that measure</p> Signup and view all the answers

    What is the purpose of calculating standard deviations in relation to risk management?

    <p>To assess the variability of returns for desks</p> Signup and view all the answers

    What is the significance of fund managers being ranked against others in the same asset class?

    <p>It motivates fund managers to improve performance.</p> Signup and view all the answers

    Which of the following is NOT a method of analyzing differences in portfolio performance?

    <p>Attributing to passive investments.</p> Signup and view all the answers

    What does Brinson Attribution break down in portfolio performance?

    <p>The performance differences due to selection and allocation.</p> Signup and view all the answers

    In the context of portfolio management, what factor is considered challenging to conceptualize?

    <p>The concept of mix/interaction.</p> Signup and view all the answers

    How is the contribution of allocation to portfolio performance calculated?

    <p>By taking the under or over weight and multiplying it by the index performance.</p> Signup and view all the answers

    What role does investor management play when there is a list of recommended investments?

    <p>They can simply purchase every item on the list.</p> Signup and view all the answers

    Which component of attribution analysis assesses whether specific securities outperformed their industry?

    <p>Selection analysis.</p> Signup and view all the answers

    Which factor can lead to overestimated portfolio performance due to misjudgment?

    <p>Overweighting high-risk investments.</p> Signup and view all the answers

    What is the result when allocation and selection are considered together in performance analysis?

    <p>Outperformance of +3.25 bps</p> Signup and view all the answers

    What does a market neutral strategy aim to achieve?

    <p>Elimination of market beta exposure</p> Signup and view all the answers

    What is the assumption made about alphas in uncorrelated portfolios?

    <p>They may enhance overall portfolio performance</p> Signup and view all the answers

    What is implied by the strategy of porting alpha from equity to bond investments?

    <p>A stock manager's alpha can benefit bonds through strategic investment</p> Signup and view all the answers

    What is a key challenge in portfolio construction and execution?

    <p>Quickly executing good investment theses</p> Signup and view all the answers

    How should one view the ability to time the markets according to managerial strategies?

    <p>As an inconsistent way to generate profits</p> Signup and view all the answers

    Which of the following describes isolation of alpha in portfolio management?

    <p>Separating alpha from market beta to evaluate true performance</p> Signup and view all the answers

    What is a potential outcome of combining strategies that are not correlated with each other?

    <p>Increased overall portfolio return</p> Signup and view all the answers

    Study Notes

    Brokerage Accounts

    • Cash Accounts: Require settled funds for trading
    • Margin Accounts (Reg T): Use securities as collateral for loans, offer higher risk and strict regulations.
      • Hypothecation: The practice of using securities as collateral.

    Margin Requirements

    • Regulation T: Sets margin limits for brokers.
      • Initial Margin: Minimum equity percentage required to open a margin position.
      • Maintenance Margin: Minimum equity percentage required to maintain a margin position.
    • Portfolio Margin: Advanced margin calculation for sophisticated investors often resulting in looser requirements.

    Margin Example

    • Scenario: Buying 100 shares of NKE without full funds.
    • Margin Use: 50% initial margin (50% equity, 50% borrowed from broker).
    • Maintenance Margin: Usually 25% but may be higher depending on the broker and security.
    • Margin Call: Required when equity dips below maintenance margin, restoring to initial margin or maintenance margin (depending on broker policy).

    Overfitting

    • Overfitting: Including irrelevant variables in a regression model, leading to higher R-squared but inaccurate results.
    • Adjusted R-squared: Adjusts R-squared to account for chance and penalizes for variable size.
    • Regularization: Constrains model complexity and prevents overfitting by applying a penalty to coefficients.
      • Lambda (λ): Value used in regression to regulate the model's complexity.

    Fama-French Model

    • Multi-factor model: Expands on traditional beta by adding value and size factors to explain asset returns.
    • Value and Size Factors: Variables believed to impact asset returns beyond market beta.

    Information Ratio

    • Information Ratio: Measures a portfolio's performance relative to a benchmark, considering tracking error.
      • Formula: (Portfolio - Index) / Tracking Error
    • Potential Issues: May not account for all relevant risk factors or market conditions.

    Value at Risk (VaR)

    • Risk Management Tool: Estimates potential losses for a portfolio at a given confidence level.
    • Standard Deviation and Percentile: Typically calculated using standard deviations and a specific percentile (e.g., 2nd percentile).
    • Application: Used by banks and portfolio managers to manage risk and allocate resources.
    • VaR Calculation: Utilizes standard deviation of portfolio returns and a chosen percentile (e.g., 2nd percentile).
    • VaR Expressing: Often expressed in dollars, representing potential losses at the chosen percentile.

    VaR Limitations

    • Assumptions: Assumes normal distribution of returns, consistent strategy, and sufficient historical data.
    • Market Volatility: May not accurately reflect changes in market volatility or regimes.
    • Single Measure: Should not be used in isolation; multiple measures and analysis are crucial.

    Performance Attribution

    • FP&A (Financial Planning & Analysis): Similar to portfolio attribution, used to analyze performance deviations from forecasts.
    • Attribution Analysis: Identifies factors contributing to performance differences.
    • Brinson Attribution: Breaks down performance attribution into selection, allocation, and interaction.
      • Selection: Outperformance of specific securities within a portfolio.
      • Allocation: Outperformance due to overweighting certain industries or asset classes.
      • Interaction: The combined effect of selection and allocation.

    Hedging and Portfolio Strategies

    • Risk-Adjusted Returns: Objective for portfolio managers, seeking to maximize returns while controlling risk.
    • Market Timing: Attempting to predict market movements, generally considered unreliable.
    • Market Neutral: Strategies aiming for zero market beta, isolating alpha through factor models or shorting the index.
    • Factor Investing: Using identified factors (e.g., size, value) to construct market-neutral portfolios with alpha.

    Portfolio Construction and Execution

    • Theses and Execution: Maintaining strong investment ideas and effectively executing them is critical.
    • Investment Horizon: Time required to execute an investment strategy, potentially impacting its effectiveness.
    • Alpha Porting: Translating alpha from one asset class to another (e.g., stock alpha to bond portfolio).

    Portfolio Construction, Execution, Personal Portfolios

    • Portfolio Construction: The art and science of building portfolios designed for specific goals, risk tolerance, and time horizons.
    • Portfolio Execution: The act of putting a portfolio plan into action by choosing and investing in specific securities.
    • Personal Portfolios: Portfolios created and managed for one's own financial needs, not for clients.

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    FINA 4321 Notes (1) PDF

    Description

    Explore the key concepts of cash and margin accounts in trading. Understand the regulations set by Regulation T regarding margin requirements, including initial and maintenance margins. Dive into practical examples of margin use and learn about the implications of margin calls.

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