17 Questions
What does a call option give its owner the right to do?
Buy shares at a fixed exercise price
If a stock falls, what happens to the value of the investment for a call option holder?
It decreases to zero
In Tanya's example, what was her profit per share after exercising the call option and selling the shares?
$3
If Tanya had not exercised her call option on XYZ shares, what would have been her loss in this example?
$200
What happens when an investor exercises a call option?
They buy shares at a higher price than market value
How is the profit on a call option investment calculated?
By subtracting the premium paid to buy the call from the profit from selling the shares
What type of security is traded on a stock exchange according to the passage?
Preferred shares
What is the role of investment dealers in the government bond market described in the passage?
They buy bonds directly from the government and sell them to the public.
What type of order does the passage describe as allowing an investor to buy or sell a stock at a specific price?
Limit order
According to the passage, what happens when a limit order is placed on a stock exchange?
The order is held in the exchange's consolidated electronic order book and executed at the first best possible price.
Which of the following securities is NOT mentioned in the passage as being traded on a stock exchange?
Bonds
What is the primary role of a broker in exchange-based trading?
To facilitate transactions by acting as an agent for the investor
What is the expected return for an investor holding preferred shares?
Regular interest income and potential capital gains
Which type of transaction allows an investor to buy securities using borrowed funds?
Margin account
What is the primary role of an underwriter in the securities market?
To facilitate the issuance of new securities by acting as an intermediary
What type of security allows investors to speculate on price movements without owning the underlying asset?
Derivative securities
Which of the following statements about exchange-traded options is true?
They are traded on exchanges and derive their value from underlying assets
Study Notes
Broker's Role in Exchange-Based Trading
- A broker acts as an agent of the investor, not owning the securities at any time during the transactions.
- The broker's profit is the agent's commission charged for each transaction.
Types of Market Transactions
- Simplest type of market transaction is buying or selling a security.
- Fixed-income securities provide regular income and potential capital gains if interest rates fall.
- Common shares are bought for dividend income and capital gains.
Margin Accounts
- A margin account allows clients to buy securities using borrowed money from a stockbroker.
- Clients pay only part of the full price, with the securities firm lending the remainder and charging interest.
- The securities firm grants credit based on the market value and quality of securities in the margin account.
Options Contracts
- A call option gives the owner the right to buy shares at a fixed exercise price prior to the expiration date.
- The owner benefits on a dollar-for-dollar basis with the increase in the stock price, minus the option premium.
- If the stock falls, the owner may lose the entire investment.
Example of a Call Option
- Tanya buys a three-month call option on XYZ shares for $2, giving her the right to buy at $20.
- If the stock price increases to $25, Tanya exercises the option and sells the shares at $25 for a profit of $5 per share.
- If the stock price falls, Tanya loses the $2 premium paid for the call option.
Trading Securities
- Trading of Canadian equity securities takes place on a stock exchange.
- Investors contact their stockbroker to give an order to buy or sell a certain number of shares.
- The order is forwarded electronically to the exchange and can be filled immediately if it's a market order.
Types of Orders
- Market order: an order to buy or sell at the current market price.
- Limit order: an order to buy or sell at a specific price, which is visible to all dealer members in the exchange's consolidated electronic order book.
- When the order is filled, the client receives a confirmation with the transaction details.
Learn about the fundamentals of call options, including the concept of buying shares at a fixed exercise price and the impact of stock price movements on call option investments. Understand the relationship between option premium and potential gains or losses.
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