Equity Securities Chapter Overview

Questions and Answers

What is the minimum margin requirement for shorting a listed equity priced at $1.50?

100% of market value

80% of market value (correct)

60% of market value

50% of market value

When shorting shares priced at $2.00 or more, what percentage of the market value must the investor deposit?

100%

50% (correct)

150%

30%

If an investor wants to short shares costing $0.20 each, what is the required margin?

$0.30 per share

$0.25 per share (correct)

$0.20 per share

$0.10 per share

How much must an investor have in their account when shorting shares worth $1.75 each?

180% of the market value Signup and view all the answers

What is the margin requirement for securities that are eligible for reduced margin?

30% of market value Signup and view all the answers

Which of the following conditions applies when an investor attempts a short sale?

No money is loaned to the client during the short sale. Signup and view all the answers

To short shares valued at $5.00 each, what total amount must the investor maintain in their account?

150% of market value Signup and view all the answers

If a client is shorting common shares at a price of $3.00, what is the minimum margin percentage they must deposit?

50% Signup and view all the answers

What happens if an investor shorts shares priced at $1.49?

They must deposit 100% of the market value. Signup and view all the answers

What is the primary difference between margin accounts and cash accounts?

Margin accounts can hold both long and short positions. Signup and view all the answers

What must be marked on an order placed by an employee of the dealer member?

PRO Signup and view all the answers

What happens to outstanding client orders to sell ABC at $20 when an employee places an order?

They are filled before the employee’s order. Signup and view all the answers

Under what condition does an investor earn a profit from a long margin position?

When the underlying stock price rises. Signup and view all the answers

What is the formula for calculating the minimum margin required in a transaction?

Initial cost of the transaction minus the loan. Signup and view all the answers

What is the profit mechanism for an investor using a short margin position?

Selling the borrowed securities at a lower price. Signup and view all the answers

What is the main distinction between cash accounts and margin accounts?

Cash accounts only allow for long positions while margin accounts allow for both long and short positions. Signup and view all the answers

Which statement accurately describes the requirements for establishing a short position in a margin account?

It necessitates the maintenance of a minimum amount of equity in the account at all times. Signup and view all the answers

What is the primary risk associated with short selling?

The potential for unlimited losses if the price of the security increases. Signup and view all the answers

What specific impact do price changes have on margin requirements for a long position?

Decreased prices increase the amount of required margin. Signup and view all the answers

How are equity transactions typically settled?

Within a defined settlement period post-trade execution. Signup and view all the answers

Which type of order allows an investor to buy or sell a security at a specified price or better?

Limit order Signup and view all the answers

What distinguishes a stop order from a limit order?

A stop order becomes a market order once the stop price is reached. Signup and view all the answers

What is the least favorable outcome for an investor when trading in a margin account?

Experiencing a margin call requiring additional cash or securities. Signup and view all the answers

When is a trader most likely to use a short position?

When they anticipate a decrease in the stock price. Signup and view all the answers

What is one major consequence of regulators banning short selling on certain stocks?

An upward spike in prices as short sellers cover their positions Signup and view all the answers

During the credit crisis, which organization is noted for banning short sales of banks and financial institutions?

Securities and Exchange Commission (SEC) Signup and view all the answers

What does the practice of trading on margin entail?

Borrowing funds to purchase more stocks than capital allows Signup and view all the answers

What is the result for short sellers when a ban is imposed on short selling?

They have to cover their positions, potentially at a loss Signup and view all the answers

In equity transactions, what role may an investment dealer NOT play?

Regulator Signup and view all the answers

What can be a direct impact of short sellers covering their positions during a ban?

Increased upward pressure on stock prices Signup and view all the answers

Which of the following best describes selling short?

Selling borrowed shares with the intention of buying them back later at a lower price Signup and view all the answers

In a simplified securities transaction, which statement is true regarding the roles of investment dealers?

They may act either as agents or principals in trades. Signup and view all the answers

What aspect of trading might a learning activity focus on when discussing margin strategies?

Understanding margin requirements and risks Signup and view all the answers

Why might investing dealers work primarily as agents in equity transactions?

To avoid taking on financial risk Signup and view all the answers

What price does the buyer learn is the lowest available for XYZ stock?

$10.75 Signup and view all the answers

What action do both clients take after learning the price quotations?

They instruct their advisors to get the best possible current price. Signup and view all the answers

What do the investment advisors utilize to determine the current price quotation of XYZ stock?

Communication with the stock exchange Signup and view all the answers

What do the trade details relayed to the dealers include?

The identity of the firms involved Signup and view all the answers

What type of order are the clients using to acquire the current market price for XYZ stock?

Market order Signup and view all the answers

What is the role of the investment advisors in this trading process?

To provide price quotations and confirm transactions Signup and view all the answers

How is the trade information communicated to the stock exchange?

Through the dealers' trading departments Signup and view all the answers

What happens after the execution of the trade at the exchange?

A written confirmation is sent to each client. Signup and view all the answers

What indicates that a sale is possible between the buyer and seller?

The buyer accepts the seller’s price or vice versa. Signup and view all the answers

What are the current bid and asked prices for XYZ common stock?

$10.50 bid and $10.75 asked Signup and view all the answers

Study Notes

Cash and Margin Accounts

Cash accounts require clients to pay for transactions in full upon execution, while margin accounts allow buying or selling securities on credit.
Margin accounts can hold both long and short positions; cash accounts can only hold long positions.

Margin Account Transactions

Long margin position: Investors finance part of their purchase through borrowing from the dealer. Minimum margin equals the initial transaction cost minus the loan.
Short margin position: Investors sell borrowed securities, profiting when the repurchase cost is lower than the sale price.
Different minimum margin requirements based on the price of the stocks sold short:
- Stocks priced at $2.00 and over: 50% margin
- Stocks priced between $1.75 - $1.99: 60% margin
- Stocks priced between $1.50 - $1.74: 80% margin
- Stocks priced between $0.25 - $1.49: 100% margin
- Stocks priced under $0.25: $0.25 per share

Trading and Settlement Procedures

Equity transactions involve investment dealers acting either as agents or principals.
A typical transaction in a retail setting involves buyers and sellers communicating via investment advisors for price quotes.
Orders can be relayed as market orders to achieve the best current price.

Trading Execution Example

For a transaction involving 100 shares of XYZ stock priced at $10.50 bid and $10.75 asked, buyers must be willing to meet the seller's asking price to complete the trade.
Once the trade executes, details are reported through the exchange’s data system to confirm to both advisors and clients.

Buy and Sell Orders

Selecting the appropriate order type impacts share pricing significantly. Investment advisors must assess clients’ needs to determine optimal order types.

Key Terms and Concepts

Regulatory risk pertains to potential bans on short selling by regulators, which can force short sellers to cover positions at a loss, potentially spiking prices.
The chapter emphasizes understanding the mechanics of margin trading and equity transactions, including their risks and regulatory aspects.

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Description

This quiz covers the characteristics of equity transactions, focusing on cash and margin accounts, long and short positions. It explores margin account transactions, short selling rules, techniques, and associated risks. Test your understanding of equity securities through this informative quiz.