Untitled Quiz
49 Questions
0 Views

Choose a study mode

Play Quiz
Study Flashcards
Spaced Repetition
Chat to lesson

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What is a key difference between PWI and VWI regarding companies' impact on their movement?

  • Both indices are equally affected by large companies.
  • VWI is influenced more by smaller companies than PWI.
  • VWI does not account for any company size in its calculations.
  • PWI is more impacted by high share price stocks, while VWI is affected by market capitalisation. (correct)

    • Which of the following statements describes a disadvantage of market orders?

  • They do not allow for immediate execution.
  • They may lead to a price moving to a more advantageous level.
  • They avoid paying the bid-ask spread.
  • They may execute at a price lower than the specified limit price. (correct)

    • What is a benefit of using limit orders in trading?

  • They provide a price indication, potentially leading to better trade prices. (correct)
  • They can only be placed during specific market hours.
  • They ensure immediate execution of trades.
  • They execute at the best market price with no limitations.

    • Which of the following indices is fund managers more likely to benchmark against due to a focus on risk-adjusted value?

    <p>S&amp;P 500 (VWI)</p> Signup and view all the answers

    What type of order involves an instruction to trade at the current market price without price indication?

    <p>Market order</p> Signup and view all the answers

    What does a price weighted index measure?

    <p>Average price of all stocks in the index.</p> Signup and view all the answers

    Which index is an example of a market-value weighted index?

    <p>NASDAQ Composite</p> Signup and view all the answers

    How is each stock weighted in a value weighted index?

    <p>Proportional to its market capitalization.</p> Signup and view all the answers

    What happens to the divisor in a price weighted index when a stock splits?

    <p>It needs to be amended to reflect the change.</p> Signup and view all the answers

    Which indices are not traded directly by investors?

    <p>Price weighted indices</p> Signup and view all the answers

    What is the simplest way to calculate a price weighted index?

    <p>Add up stock prices and divide by the number of stocks.</p> Signup and view all the answers

    Which of the following indices is an example of an equally weighted index?

    <p>Value Line Index</p> Signup and view all the answers

    In a value weighted index, which factor plays a critical role in the calculation?

    <p>The market capitalisation of the stocks.</p> Signup and view all the answers

    What is a characteristic of money market instruments?

    <p>Maturity of less than 1 year</p> Signup and view all the answers

    Which type of security represents an ownership share in a corporation?

    <p>Common stock</p> Signup and view all the answers

    What differentiates preferred stock from common stock?

    <p>Preferred stock has fixed and cumulative dividends</p> Signup and view all the answers

    What is a primary challenge faced by bond indices?

    <p>Dynamic turnover due to bond maturity</p> Signup and view all the answers

    Which of the following is an example of a derivative?

    <p>Options</p> Signup and view all the answers

    Which financial asset class typically promises a fixed stream of income?

    <p>Debt securities</p> Signup and view all the answers

    What is a defining feature of equity securities?

    <p>They represent ownership in a corporation</p> Signup and view all the answers

    Which of the following describes the bond market?

    <p>Investments with medium to long-term debts ranging from 1 to 30+ years</p> Signup and view all the answers

    Which stock market index is known for including 30 large U.S. companies?

    <p>Dow Jones Industrial Average (DJIA)</p> Signup and view all the answers

    What type of margin trading involves borrowing money to buy securities?

    <p>Buying on margin</p> Signup and view all the answers

    What is the primary disadvantage of avoiding the bid-ask spread?

    <p>The trade may not execute, creating execution risk.</p> Signup and view all the answers

    What are explicit costs in trading primarily comprised of?

    <p>Commissions and transaction taxes.</p> Signup and view all the answers

    What does the bid-ask spread represent?

    <p>The difference between the highest buying and lowest selling prices.</p> Signup and view all the answers

    What does the maintenance margin ensure for an investor?

    <p>It establishes a minimum equity level to avoid margin calls.</p> Signup and view all the answers

    How is the initial margin amount determined for margin trading in the US?

    <p>It is regulated by the Federal Reserve with a minimum of 50%.</p> Signup and view all the answers

    What is a margin call?

    <p>A request for additional equity to maintain the investment.</p> Signup and view all the answers

    When executing a market order, what prices are used?

    <p>Ask price for buying and bid price for selling.</p> Signup and view all the answers

    What do improvement costs represent in trading?

    <p>Indirect costs from affecting market prices.</p> Signup and view all the answers

    What is the formula to calculate margin equity?

    <p>Margin = Share Portfolio Value - Margin Loan.</p> Signup and view all the answers

    To avoid a margin call, how must the margin percentage behave?

    <p>It must not fall below the maintenance margin percentage.</p> Signup and view all the answers

    How can the additional collateral required during a margin call be calculated?

    <p>Additional Collateral = Recalculated SPV x Maintenance Margin - Recalculated Margin.</p> Signup and view all the answers

    What is the primary purpose of short selling?

    <p>To profit from a decline in the stock's price.</p> Signup and view all the answers

    What are implicit costs typically associated with in trading?

    <p>Market impact costs and the bid-ask spread.</p> Signup and view all the answers

    What is the primary reason institutions do not suffer losses when lending stock to short sellers?

    <p>They continue to receive dividends and cashflows.</p> Signup and view all the answers

    What percentage of the proceeds must an investor deposit as initial margin for a short sale in the U.S.?

    <p>50%</p> Signup and view all the answers

    If the calculated margin ratio falls below the maintenance margin, what is the consequence?

    <p>The investor must post additional collateral.</p> Signup and view all the answers

    What defines the final margin for a short sale?

    <p>Fixed Initial Account Balance minus Share Portfolio Value.</p> Signup and view all the answers

    How is the margin percentage for a short sale calculated?

    <p>Margin divided by Share Portfolio Value.</p> Signup and view all the answers

    What distinguishes managed investment companies from unmanaged entities?

    <p>Managed companies are regulated and actively managed.</p> Signup and view all the answers

    What structure do mutual funds fall under in terms of investment company categorization?

    <p>Managed Investment Companies.</p> Signup and view all the answers

    When does a margin call occur in a short selling scenario?

    <p>When the recalculated margin % is less than the maintenance margin.</p> Signup and view all the answers

    Which characteristic is unique to closed-end investment companies?

    <p>Their size and number of units are fixed.</p> Signup and view all the answers

    What is the main advantage of pooling funds in investment companies?

    <p>Diversification and lower transaction costs.</p> Signup and view all the answers

    Which type of investment company allows for daily redemptions at NAV?

    <p>Managed Investment Companies.</p> Signup and view all the answers

    How is the additional collateral calculated when a margin call occurs?

    <p>Recalculated SPV times maintenance margin minus recalculated margin.</p> Signup and view all the answers

    What happens to the initial account balance when proceeds from a short sale and initial margin are computed?

    <p>It is fixed and equals the total of sale proceeds and initial margin.</p> Signup and view all the answers

    Study Notes

    Introduction to Assets and Indices

    • Asset classes can be categorized into financial assets and real assets.
    • Financial assets represent claims on real assets or claims on future income generated by real assets.
    • Real assets include land, buildings, equipment, and commodities.
    • Financial assets include debt securities, equity securities, and derivatives.

    Debt Securities

    • Debt securities represent a promise of a fixed stream of income or a stream of income determined by a specific formula.
    • The debt securities category can be separated into money markets and bond markets.
    • Money market instruments are typically short-term debt securities, with a maturity of less than one year, and are considered highly marketable and liquid.
    • Examples of money market instruments include Treasury bills, commercial paper, and LIBOR market instruments.
    • The bond market includes medium-term to long-term debt securities, with a maturity of more than one year.
    • Bond markets are typically illiquid, and examples include Treasury notes and bonds, corporate bonds, mortgage-backed securities, and international bonds.

    Equity Securities

    • Equity securities represent an ownership share in a corporation.
    • Equity securities can be further broken down into common stock and preferred stock.
    • Common stock offers the holder limited liability, represents a perpetual claim on future cash flows of a corporation, and has a residual claim after all other claims are met.
    • Preferred stock offers a holder fixed and cumulative dividends, prioritizes dividends over common stock, and is considered less risky than common stock.

    Derivatives

    • Derivatives provide payoffs that are determined by the prices of other assets such as stocks, bonds, currencies, commodities, and interest rates.
    • Examples of derivatives include futures, forwards, and options (put and call).

    Indices

    • Indices are used to measure the performance of a specific group of assets.
    • Bond indices include major indices from Merrill Lynch, Barclays, and Citigroup.
    • Challenges with bond indices include a wider universe of bonds issued by a single company, illiquidity of many bonds, and high turnover as bonds mature and are replaced.
    • Stock indices are commonly used to measure the performance of a specific stock market or sector - examples include the Dow Jones Industrial Average, S&P 500, and the NASDAQ Composite.
    • Stock indices can be categorized into price weighted, market-value weighted, and equally weighted indices.
    • The DJIA is a price weighted index, measuring the average price of the 30 largest U.S. blue-chip stocks.
    • The S&P 500 is a market-value weighted index, weighting each stock by its market capitalization.
    • Investors can buy into index funds (mutual funds) or exchange-traded funds (ETFs) to track the performance of a specific index.

    Price Weighted Indices

    • A price weighted index equals the average price of all stocks in the index.
    • The percentage change in a price weighted index is equal to the return on a portfolio investing one share in each stock in the index.
    • Price weighted indices are adjusted for stock splits and other events that affect the divisor of the index.

    Value Weighted Indices

    • A value weighted index is calculated based on the market capitalization of the index stocks.
    • Each stock in the index is weighted based on its current market capitalization.
    • The base index is used to calculate future movements in the index over time.

    Trading Securities

    • Trading securities come with costs that are either explicit or implicit.

    Explicit Costs

    • Explicit costs are the direct costs of trading, including commissions.
    • Commissions are fees paid to brokers for facilitating transactions.
    • Online trading platforms generally have lower commissions (0% - 0.1%) compared to full-service brokers (1%+).
    • Other explicit trading costs include transaction taxes, stamp duties, and exchange fees.

    Implicit Costs

    • Implicit costs are the indirect costs of trading, including the bid-ask spread, and market impact costs.
    • Bid-ask spread is the difference between the bid (the price a counterparty is willing to buy) and the ask (the price a counterparty is willing to sell).
    • Market impact costs are the effects of large orders on market prices. Market impact costs are minimal for small orders.
    • Delay costs or slippage are costs resulting in suboptimal prices being paid or received due to delayed execution of a trade, caused by trade size.
    • Opportunity costs are profits not realized due to unfilled trades.

    Order Types

    • Market orders are executed at the best available market price.
    • Market orders are advantageous for timely execution but have the disadvantage of requiring the trader to accept the bid-ask spread.
    • Limit orders are executed at a specified limit price, or better.
    • Limit orders are advantageous for avoiding the bid-ask spread, but face the possibility of not being filled.

    Trading on Margin

    • Trading on margin involves using borrowed money to amplify returns and losses on a specific trade.
    • Investors borrow money from brokers to purchase securities, which allows them to control a larger portfolio than they would using their own capital.
    • Margin is the residual amount of the investment after subtracting the margin loan.
    • Margin (equity) is calculated by subtracting the margin loan from the share portfolio value.

    Terminology

    • Initial Margin is the initial amount of equity invested when the margin loan is set up.
    • Maintenance Margin is the minimum level an investor's margin percentage can fall to without triggering a margin call.
    • Margin Call is a request from the broker for additional collateral to be posted to ensure that the investor's margin percentage meets the minimum requirements.
    • Additional Collateral is the amount of money needed to bring the margin percentage back to the maintenance margin level.

    Buying on Margin - Long Position

    • Margin can be used for both long and short positions.
    • A long position on margin involves borrowing money from a broker to purchase shares and profiting when the share price increases.
    • It can also be used to profit from a decline in the value of a stock.
    • The trade will be profitable as long as the price appreciation exceeds the interest charged on the margin loan plus other transaction costs.
    • Margin trading can amplify both returns and losses.

    Short Selling

    • Short selling involves borrowing shares from a broker, selling them in the market, hoping to buy them back at a lower price later, and return the borrowed shares to the broker in the future.
    • The proceeds of the short sale are deposited with the broker as collateral (margin).
    • Short selling is a relatively high-risk strategy since losses can be unlimited, though the potential for profit is limited to the initial sale price.
    • If the security price increases, the short seller will need to buy back the shares at a higher price resulting in a loss on the transaction.
    • Short selling can provide risk management benefits by hedging long positions, enabling investors to speculate on price declines, and providing liquidity in the market.
    • Short selling is a complex strategy that should not be undertaken by beginners.

    Short Squeeze

    • Short squeezes occur when short sellers are forced to buy back shares at a higher price due to scarcity and a rapid increase in the stock price.
    • Short sellers face unlimited losses and are forced to cover their positions.
    • Short squeezes can push prices up quickly and dramatically.

    Institutional Overview

    • The funds management industry uses a variety of investment vehicles including mutual funds, hedge funds, and exchange-traded funds (ETFs).

    Mutual Funds

    • Mutual funds are investment vehicles that pool money from many investors and invest it in a diversified portfolio of securities.
    • Mutual funds are typically classified based on investment style such as growth, value, or income funds.
    • Mutual funds are often actively managed, with managers seeking to outperform the market or a benchmark index.

    Hedge Funds

    • Hedge funds are private investment partnerships that use advanced investment strategies to achieve high returns. They pool money from a limited number of sophisticated investors.
    • Hedge funds have less regulation than mutual funds and can employ a wider range of investment strategies.
    • Hedge funds typically use leverage, derivatives, and short selling, to generate returns.

    Exchange-Traded Funds (ETFs)

    • ETFs are investment funds that track a specific market index or asset class.
    • They trade on an exchange like a stock, and can be bought and sold throughout the day, and are generally less expensive to invest in compared to mutual funds.
    • ETFs come with lower expense ratios compared to mutual funds due to passive management.

    Summary

    • An understanding of asset classes and indices is essential to understanding the investment landscape.
    • Investors need to consider both explicit and implicit costs associated with trading securities.
    • Margin trading provides investors with leverage, allowing them to control a larger portfolio, amplify returns, and also amplify losses.
    • Short selling is a high-risk strategy that is not suitable for all investors.
    • The funds management industry provides investors with a variety of investment vehicles that can meet different risk profiles and investing goals.

    Short Selling

    • Short selling involves borrowing an asset to sell it in the market, hoping to buy back the asset in the future at a lower price to return to the lender. This is done with the expectation that the price of the asset will drop.

    • Short sellers benefit from the price decline and are compensated through the difference.

    • Institutions who lend their stock out to short sellers receive dividends, cashflows associated with stock ownership (paid by the short seller), and often borrow fees or rebates.

    Initial Setup and Margin Calculation

    • Most short selling is done on margin (borrowed money).
    • Initial Margin is the percentage of the proceeds from the short sale that must be deposited (in the US, Regulation T requires 50%).
    • Initial Account Balance (IAB) is calculated as the sum of the initial sale proceeds (shares sold x share sale price) and the initial margin.

    Post Setup Margin Calculation

    • Margin (equity) for a short sale is calculated as Initial Account Balance (IAB) minus the Share Portfolio Value (SPV).

    • Margin (equity) percentage for a short sale is calculated as Margin divided by Share Portfolio Value.

    Short Selling Margin Call

    • A Margin Call occurs when the margin percentage falls below a predetermined Maintenance Margin Percentage.
    • The Additional Collateral required to bring the margin back above the maintenance margin is calculated as: Recalculated SPV x Maintenance Margin % - Recalculated Margin.
    • The Margin Call Amount is higher for short positions compared to long positions for the same percentage change in price.

    Investment Companies

    • Investment Companies pool funds from individuals and companies and invest in a diversified portfolio.

    • Benefits of pooling funds include:

      • Diversification: Spreading risk by investing in various assets.
      • Divisibility: Accessibility for investors with varying capital amounts.
      • Lower Transaction Costs: Economies of scale through volume trading.
      • Professional Management: Expertise in managing the portfolio.
      • Record Keeping and Administration: Efficient management of investments.

    • Investment Companies are categorized as:

      • Unmanaged (e.g., Unit Investment Trusts): The sponsor selects and manages the portfolio.
      • Managed (e.g., Investment Companies, Mutual Funds): Professionals actively manage the portfolio.
      • Other Investment Organizations: Organizations not regulated like investment companies but perform similar functions.

    Types of Investment Companies

    • Managed Investment Companies:

      • Open-End (Mutual Fund): Can expand/shrink the size of funds under management as investors buy or sell shares.
      • Closed-End: Fixed number of shares at a specific point; shares are traded on the stock market.

    • Unmanaged Investment Companies:

      • Unit Investment Trusts: Fixed portfolio with a specific termination date. Units are priced at the Net Asset Value (NAV), based on the total value of the portfolio.

    • Mutual Funds: The most prevalent type of open-end managed investment company in the US representing most of the funds under management.

    • Exchange Traded Funds (ETFs): Have grown significantly in recent times. These are funds traded on exchanges, similar to stocks.

    US Investment Companies:

    • There is a significant amount of assets under management by investment companies in the US.
    • This is further segmented by types but mutual funds hold the largest proportion followed by ETFs.

    Studying That Suits You

    Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

    Quiz Team

    Related Documents

    FINS5513 Lecture 1: Investment Overview & Trading Securities PDF

    More Like This

    Untitled Quiz
    6 questions

    Untitled Quiz

    AdoredHealing avatar
    AdoredHealing
    Untitled Quiz
    37 questions

    Untitled Quiz

    WellReceivedSquirrel7948 avatar
    WellReceivedSquirrel7948
    Untitled Quiz
    55 questions

    Untitled Quiz

    StatuesquePrimrose avatar
    StatuesquePrimrose
    Untitled Quiz
    50 questions

    Untitled Quiz

    JoyousSulfur avatar
    JoyousSulfur
    Use Quizgecko on...
    Browser
    Open
    Browser
    Browser