Cash and Margin Accounts Quiz

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Questions and Answers

What is the primary condition of a cash account regarding payment for securities?

Clients are allowed to use partial payments for their transactions.

Clients are required to deliver securities by the transaction date.

Clients must pay for securities within three business days.

Clients must make full payment for purchases by the settlement date. (correct)

Which statement accurately describes a margin account?

No portion of the purchase price is required upfront.

The investment dealer does not lend any credit to clients.

Clients must pay the entire cost of transactions on the settlement date.

Clients can buy securities using partial credit from the dealer. (correct)

What does a long position signify in investing?

The investor has actual ownership of the security. (correct)

The investor holds the securities on margin.

The investor sells securities that they do not own.

The investor has borrowed a security from a dealer.

What is a key difference between a cash account and a margin account?

Cash accounts do not grant credit, whereas margin accounts do. Signup and view all the answers

When must clients using a cash account settle their sales of securities?

On the settlement date specified in the contract. Signup and view all the answers

What occurs when an investor initiates a short position?

The investor sells securities they do not possess. Signup and view all the answers

What is the new margin requirement when the price of the security falls to $22?

$14,000 Signup and view all the answers

How much did the client originally deposit as margin?

$12,500 Signup and view all the answers

What is the amount of the margin call issued to the client?

$1,500 Signup and view all the answers

If the market price of the shares is $22, how much is the dealer willing to lend?

$11,000 Signup and view all the answers

What remains in the account after the new margin requirement is established and the original deposit is accounted for?

$0 Signup and view all the answers

Why does the margin requirement increase to $14,000 when the price falls to $22?

The original purchase price must be maintained Signup and view all the answers

What is the original cost of the ABC shares before the price change?

$25,000 Signup and view all the answers

What is the revised maximum loan from the dealer when the price of the security falls to $22?

$11,000 Signup and view all the answers

What is the definition of profit in the context of a short sale?

The difference between the proceeds of the short sale and the cost to cover the sale. Signup and view all the answers

In Scenario 1, what is the initial action taken by the client with respect to the shares?

The client sells 100 shares short at $5.00 per share. Signup and view all the answers

What would be the pre-tax profit in Scenario 1 if the shares are purchased at $1.60 after being sold at $5.00?

$340.00 Signup and view all the answers

In Scenario 2, what happens to the value of the shares after the initial sale?

The value increases to $6.00, resulting in a loss. Signup and view all the answers

If the client incurs a loss on the short sale in Scenario 2, what is the calculated amount?

$100.00 Signup and view all the answers

What principle underlies the mechanism of profit or loss calculation in a short sale?

Profit is realized when the stock price decreases relative to the short sale price. Signup and view all the answers

What is the primary belief driving an investor to sell a stock short?

The stock price will fall, allowing for a profitable buyback. Signup and view all the answers

What must an investor do after selling a security short to maintain their account?

Deposit additional margin to meet minimum balance requirements. Signup and view all the answers

If the price of the stock rises after an investor sells short, what potential issue could they face?

The investor risks incurring a loss on the investment. Signup and view all the answers

What occurs during the 'cover' step of short selling?

The investor buys back the securities to close the short position. Signup and view all the answers

What does a short seller owe after executing a short sale?

The same amount of shares that were sold short. Signup and view all the answers

In the context of short selling, what is the role of brokerages in this process?

To lend securities to clients looking to short sell. Signup and view all the answers

What happens if a client is required to return the borrowed security before they can buy it back?

They must find another lender for the securities. Signup and view all the answers

What is a potential benefit of a successful short sale?

Purchasing the securities at a price lower than the sale price. Signup and view all the answers

What does establishing a short position involve regarding security transactions?

Selling borrowed securities before making a purchase to cover. Signup and view all the answers

During what market condition is short selling particularly risky?

When stock prices are increasing rapidly. Signup and view all the answers

Study Notes

Cash Accounts and Margin Accounts

A cash account requires full payment for securities by the settlement date: same day for Canadian Treasury bills and one business day for other securities.
In a margin account, clients can buy or sell securities on credit, paying only a portion of the purchase with the dealer lending the remainder at interest.
Clients in cash accounts cannot borrow funds; they must pay in full on the settlement date.
Margin accounts allow for borrowing against the market value of securities held.

Long Positions and Short Positions

A long position indicates ownership of a security; an investor buys shares and pays for them by the settlement date.
A short position occurs when selling a security not owned, with the anticipation of buying it back at a lower price later.

Margin Call Example

If the price of a security drops, the amount the dealer will lend decreases, raising the margin requirement.
Example scenario: If ABC shares' price falls to $22, the new margin requirement might exceed the client’s original margin deposit, triggering a margin call.

Short Selling Process

Short selling involves selling borrowed securities with the expectation to repurchase them at a lower price.
The seller must deposit margin alongside the sale proceeds to meet account balance requirements.
Clients monitor position closely as stock prices can rise or fall, impacting potential losses or gains.

Profit and Loss in Short Selling

Example Scenario 1: Selling short 100 shares of FED at $5.00; if the price drops to $1.60, the profit when covering the short sale is calculated based on the difference in sale and repurchase prices.
Example Scenario 2: If price rises to $6.00, the client incurs a loss, calculated as the higher cost to repurchase compared to the initial sale price.

Buy and Sell Orders

Selecting the appropriate order type for clients is crucial as it can significantly influence share prices.
Orders must be marked PRO for employee trades, ensuring client orders are filled first.

Summary of Equity Transactions

Margin accounts permit partial financing of securities through borrowing, allowing for both long and short positions, unlike cash accounts that can only accommodate long positions.
Profits emerge in long positions when the stock price increases and in short positions when the selling price exceeds buying costs upon re-purchase.

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Description

Test your knowledge on cash accounts, margin accounts, and the differences between long and short positions in trading. This quiz covers key concepts such as ownership, borrowing, and margin calls, essential for understanding trading practices in finance.