Equity Transactions: Cash and Margin Accounts

Questions and Answers

What must a dealer member obtain from a client before transacting business on a margin account?

A detailed financial analysis

An investment risk disclosure statement

An authorized Margin Account Agreement Form (correct)

A personal credit report

What is the minimum margin required for equity securities listed on a recognized exchange priced at $1.75?

40% of market value

60% of market value (correct)

50% of market value

70% of market value

Which organization regulates the amount of credit that dealer members may extend to clients for the purchase of securities?

Financial Services Regulatory Authority (FSRA)

Canadian Stock Exchange (CSE)

Canadian Investment Regulatory Organization (CIRO) (correct)

Securities Commission of Canada (SCC)

What margin percentage is generally required for securities trading at $1.50 to $1.74?

80% of market value Signup and view all the answers

How much margin is required for securities priced under $1.50?

100% of market value Signup and view all the answers

What is the minimum margin required for securities eligible for reduced margin?

30% of market value Signup and view all the answers

Which sector primarily invests in the short-term market?

Major chartered banks Signup and view all the answers

What action does the Canadian Investment Regulatory Organization (CIRO) take to ensure compliance among dealer members regarding margin accounts?

Spot checks and regular field examinations Signup and view all the answers

What does the market segmentation theory suggest influences the yield curve?

Supply and demand for bonds based on term preferences Signup and view all the answers

Which statement best summarizes a common limitation placed by many firms on margin positions?

Clients cannot take margin positions on stocks under $3. Signup and view all the answers

Which of the following theories explains all types of yield curves?

Market segmentation theory Signup and view all the answers

Which of the following categories is NOT mentioned as part of the long margin accounts?

Government bonds Signup and view all the answers

How do bond prices typically react to increases in interest rates?

Bond prices usually decrease Signup and view all the answers

What is the primary purpose of the minimum margin requirements established by CIRO?

To protect clients from excessive risk Signup and view all the answers

What feature of a bond significantly impacts its reaction to interest rate changes?

The bond's maturity and coupon rate Signup and view all the answers

What is primarily used to evaluate the pricing of bonds in a market?

Current interest rate levels and term structure Signup and view all the answers

What is the margin requirement for a client who buys 1,000 shares of ABC Company at $25 per share with a loan rate of 50%?

$12,500 Signup and view all the answers

If the price of ABC stock increases to $29, what is the value of the client's investment?

$31,000 Signup and view all the answers

In Scenario 1, when the price of ABC stock declines to $22, what is the new value of the investment?

$22,000 Signup and view all the answers

What percentage of the total cost is put up by the firm as a loan in the initial purchase of ABC shares?

50 Signup and view all the answers

If a client puts up $12,500 in cash to buy ABC shares, how much is the total cost of the purchase?

$25,000 Signup and view all the answers

Assuming commissions are excluded, how much equity does the client have in their ABC shares initially?

$12,500 Signup and view all the answers

What is a defining characteristic of a cash account compared to a margin account?

Requires full payment for the purchase of securities by the settlement date. Signup and view all the answers

If the price of ABC stock falls to $22, what is the loss incurred by the client on the investment?

$5,000 Signup and view all the answers

What will happen to the client's margin if the price of ABC stock falls significantly?

Decrease Signup and view all the answers

Which of the following is true regarding the settlement date for Government of Canada Treasury bills?

It is the same day the transaction takes place. Signup and view all the answers

If the margin requirement is calculated as the difference between the purchase price and the loan amount, what does this imply for fluctuating stock prices?

Margin requirements decrease as prices fall Signup and view all the answers

What is a margin account primarily used for?

To secure loans based on the market value of securities. Signup and view all the answers

How does a loan rate of 50% affect the initial cash investment for purchasing ABC shares?

The client only pays half of the share price Signup and view all the answers

How does a long position differ from a short position?

A long position represents true ownership of securities. Signup and view all the answers

Which of the following best describes the action required to close a long position?

Sell the owned shares in the market. Signup and view all the answers

What condition must be satisfied when an investment is made in a cash account?

Full payment must be made on or before the settlement date. Signup and view all the answers

In what scenario would a client likely use a margin account?

When they seek to leverage their investment with borrowed funds. Signup and view all the answers

What does the term 'short selling' refer to?

Selling securities owned by another investor with the expectation of repurchasing them at a lower price. Signup and view all the answers

What is one potential risk of trading on margin?

Increased losses due to interest on borrowed funds. Signup and view all the answers

What is the primary method used to determine the value of a bond?

Calculating present value Signup and view all the answers

If $1,000 is the future value and the interest rate is 5%, what investment today results in this future sum?

$952.38 Signup and view all the answers

Which equation correctly represents the relationship between present value, interest rate, and future value?

Future Value = Present Value * (1 + Interest Rate) Signup and view all the answers

Why is the present value of a bond generally less than its future value?

It reflects the time value of money Signup and view all the answers

What is the essential component of the cash flow for a typical bond?

Regular coupon payments and principal return Signup and view all the answers

In the example given, what would be the future value if $952.38 is invested at a 5% interest rate?

$1,000.00 Signup and view all the answers

Which of the following is not a characteristic of fixed-income securities?

Growth dependent on market trends Signup and view all the answers

When evaluating the price of a fixed-income security, which factor is crucial?

Current interest rates Signup and view all the answers

What approach would typically be inaccurate when determining the price of a bond?

Using historical sales data Signup and view all the answers

What is the expected outcome of investing in a bond today?

Receiving a fixed cash flow stream Signup and view all the answers

Study Notes

Cash Accounts vs. Margin Accounts

Cash Accounts: Require full payment for purchases or full delivery for sales by the settlement date.
Settlement Dates:
- Government of Canada Treasury bills: same day as the transaction.
- All other securities: one business day after the transaction.
Margin Accounts: Allow clients to buy or sell securities on partial credit, where the investment dealer provides a loan for the remaining balance, charging interest.

Long and Short Positions

Long Position: Represents actual ownership of a security.
Short Position: Created by selling a security that the investor does not own.
Example: Buying shares initiates a long position, while selling those shares in the market closes it.

Long Margin Accounts

Credit extended to clients for security purchases is regulated by the Canadian Investment Regulatory Organization (CIRO).
Minimum Margin Requirements:
- Equities at $2.00 and over: 50% margin
- Equities at $1.75 to $1.99: 60% margin
- Equities at $1.50 to $1.74: 80% margin
- Equities under $1.50: 100% margin (no loan value)
- Reduced margin stocks: 30% margin
Dealer members may impose stricter requirements, often not allowing margin positions on stocks under $3.

Margin Calculations Example

Buying 1,000 shares of ABC Company at $25/share:
- Total cost: $25,000
- Client puts up 50% margin: $12,500 (loaned amount matches client's contribution).

Bond Pricing and Yield Calculation

Present Value: The amount paid today for a guaranteed future cash sum.
Example: To receive $1,000 in one year at a 5% interest rate, the present value would be approximately $952.38.
Cash flows for bonds include regular coupon payments and the principal at maturity.

Market Segmentation Theory

Explains yield curves based on supply and demand for bonds of various terms.
Key players (e.g., banks and insurance companies) influence the market segmentation.

Yield Curve Theories

Expectations Theory: Relates future interest rates and current yield curves.
Liquidity Preference Theory: Investors prefer liquidity and will demand higher yields for longer maturities.
Market Segmentation Theory: Each market segment has its own supply and demand influences.

Impact of Interest Rates on Bond Prices

Bond prices react inversely to changes in interest rates.
Individual bond features (maturity, coupon rate, yield) determine reactions to interest rate fluctuations.
Accurate bond pricing involves present value calculations with continuous reinvestment strategies.

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Description

This quiz covers essential concepts of equity transactions, focusing on cash and margin accounts. Learn about the different types of orders used for trading stocks, as well as the implications of margin and short selling. This chapter is crucial for understanding stock trading fundamentals.