Podcast
Questions and Answers
In contrast with a typical forward contract, futures contracts have:
In contrast with a typical forward contract, futures contracts have:
- greater counterparty risk.
- standardized terms. (correct)
- less liquidity.
An investor purchases stock on 25% initial margin, posting $10 of the original stock price of $40 as equity. The position has a required maintenance margin of 20%. The investor later sells the stock for $45. Ignoring transaction costs and margin loan interest, which of the following statements is most accurate?
An investor purchases stock on 25% initial margin, posting $10 of the original stock price of $40 as equity. The position has a required maintenance margin of 20%. The investor later sells the stock for $45. Ignoring transaction costs and margin loan interest, which of the following statements is most accurate?
- Return on investment is 50%. (correct)
- Leverage ratio is 3:1.
- Margin call price is $36.
Which of the following orders is said to be "behind the market"?
Which of the following orders is said to be "behind the market"?
- Market sell order when the best bid is 38 and the best ask is 39.
- Limit buy order at 38 when the best bid is 39. (correct)
- Limit sell order at 38 when the best ask is 39.
Shares in a publicly traded company that owns gold mines and mining operations are considered:
Shares in a publicly traded company that owns gold mines and mining operations are considered:
Which of the following statements about the maintenance margin requirement is least accurate?
Which of the following statements about the maintenance margin requirement is least accurate?
Mark Ritchie purchased, on margin, 200 shares of TMX Corp. stock at a price of $35 per share. The margin requirement was 50%. The stock price has increased to $42 per share. What is Ritchie's return on investment before commissions and interest if he decides to sell his TMX holdings now?
Mark Ritchie purchased, on margin, 200 shares of TMX Corp. stock at a price of $35 per share. The margin requirement was 50%. The stock price has increased to $42 per share. What is Ritchie's return on investment before commissions and interest if he decides to sell his TMX holdings now?
Which of the following statements about short sales is least accurate?
Which of the following statements about short sales is least accurate?
Which of the following conditions is most likely necessary for capital to be allocated to its most valuable uses?
Which of the following conditions is most likely necessary for capital to be allocated to its most valuable uses?
An objective of financial market regulation is to:
An objective of financial market regulation is to:
An investor bought a stock on margin. The margin requirement was 60%, the current price of the stock is $80, and the stock price was $50 one year ago. If margin interest is 5%, how much equity did the investor have in the investment at year-end?
An investor bought a stock on margin. The margin requirement was 60%, the current price of the stock is $80, and the stock price was $50 one year ago. If margin interest is 5%, how much equity did the investor have in the investment at year-end?
Toby Jensen originally purchased 400 shares of CSC stock on margin at a price of $60 per share. The initial margin requirement is 50% and the maintenance margin is 25%. CSC stock price has fallen dramatically in recent months and it closed today with a sharp decline bringing the closing price to $40 per share. Will Jensen receive a margin call?
Toby Jensen originally purchased 400 shares of CSC stock on margin at a price of $60 per share. The initial margin requirement is 50% and the maintenance margin is 25%. CSC stock price has fallen dramatically in recent months and it closed today with a sharp decline bringing the closing price to $40 per share. Will Jensen receive a margin call?
A trader enters a limit order to buy 10,000 shares as a day order. The "day order" instruction is most accurately referred to as:
A trader enters a limit order to buy 10,000 shares as a day order. The "day order" instruction is most accurately referred to as:
Which of the following statements about securities exchanges is most accurate?
Which of the following statements about securities exchanges is most accurate?
Which of the following statements regarding primary and secondary markets is least accurate?
Which of the following statements regarding primary and secondary markets is least accurate?
Which of the following statements about financial intermediaries is most accurate?
Which of the following statements about financial intermediaries is most accurate?
A financial system in which transactions have low costs is said to exhibit:
A financial system in which transactions have low costs is said to exhibit:
An investor purchases 200 shares of Rubble, Inc. on margin. The shares are trading at $40. Initial and maintenance margins are 50% and 25%. If the company pays a dividend of $0.75 and the investor sells the stock at year-end for $50 per share, the return on the investment would be closest to:
An investor purchases 200 shares of Rubble, Inc. on margin. The shares are trading at $40. Initial and maintenance margins are 50% and 25%. If the company pays a dividend of $0.75 and the investor sells the stock at year-end for $50 per share, the return on the investment would be closest to:
A buy limit order is said to be "inside the market" when:
A buy limit order is said to be "inside the market" when:
Becky Kirk contacted her broker and placed an order to purchase 1,000 shares of Bricko Corp. stock at a price of $60 per share. Kirk wishes to buy on margin. Assuming the margin requirement is 40%, how much money does Kirk have to pay up front to make the purchase?
Becky Kirk contacted her broker and placed an order to purchase 1,000 shares of Bricko Corp. stock at a price of $60 per share. Kirk wishes to buy on margin. Assuming the margin requirement is 40%, how much money does Kirk have to pay up front to make the purchase?
Austin Bruno, CFA, places a fill or kill, limit buy order at 92 for a stock. Bruno's order specifies:
Austin Bruno, CFA, places a fill or kill, limit buy order at 92 for a stock. Bruno's order specifies:
Byron Campbell purchased 300 shares of Crescent, Inc., stock at a price of $80 per share. The purchase was made on margin with an initial margin requirement of 50%. Assuming the maintenance margin is 25%, the stock price of Crescent, Inc. has to fall below what level for Campbell to receive a margin call?
Byron Campbell purchased 300 shares of Crescent, Inc., stock at a price of $80 per share. The purchase was made on margin with an initial margin requirement of 50%. Assuming the maintenance margin is 25%, the stock price of Crescent, Inc. has to fall below what level for Campbell to receive a margin call?
A stock's limit order book is as follows:
Bid Size Limit Price (£) Offer Size
700 25.25
300 25.30
100 25.40
25.50 500
25.55 200
25.75 500
A new sell limit order is placed for 250 shares at £25.45. This limit order is said to be:
A stock's limit order book is as follows: Bid Size Limit Price (£) Offer Size 700 25.25 300 25.30 100 25.40 25.50 500 25.55 200 25.75 500 A new sell limit order is placed for 250 shares at £25.45. This limit order is said to be:
A trader pays $100 per share to buy 500 shares of a non-dividend-paying firm. The purchase is done on margin, and the leverage ratio at purchase is 3.0X. Three months later, the trader sells the shares for $90 per share. Ignoring transaction costs and interest paid on the margin loan, the trader's 3-month return was closest to:
A trader pays $100 per share to buy 500 shares of a non-dividend-paying firm. The purchase is done on margin, and the leverage ratio at purchase is 3.0X. Three months later, the trader sells the shares for $90 per share. Ignoring transaction costs and interest paid on the margin loan, the trader's 3-month return was closest to:
Lynne Hampton purchased 100 shares of $75 stock on margin. The margin requirement set by the Federal Reserve Board was 40%, but Hampton's brokerage firm requires a total margin of 50%. Currently the stock is selling at $62 per share. What is Hampton's return on investment before commission and interest if she sells the stock now?
Lynne Hampton purchased 100 shares of $75 stock on margin. The margin requirement set by the Federal Reserve Board was 40%, but Hampton's brokerage firm requires a total margin of 50%. Currently the stock is selling at $62 per share. What is Hampton's return on investment before commission and interest if she sells the stock now?
An investor purchases 100 shares at $75 per share with an initial margin of 50%. Assume there is no interest on the call loan and no transactions fees. If the stock price rises to $112.50, the rate of return to the investor is:
An investor purchases 100 shares at $75 per share with an initial margin of 50%. Assume there is no interest on the call loan and no transactions fees. If the stock price rises to $112.50, the rate of return to the investor is:
An investor buys 400 shares of a stock on margin for $25 a share. The initial margin requirement is 50%, and the maintenance margin requirement is 25%. At what price would the investor receive a margin call?
An investor buys 400 shares of a stock on margin for $25 a share. The initial margin requirement is 50%, and the maintenance margin requirement is 25%. At what price would the investor receive a margin call?
Which of the following is most likely an objective of market regulation?
Which of the following is most likely an objective of market regulation?
An order placed to protect a short position is called a:
An order placed to protect a short position is called a:
A trading system that matches buyers and sellers based on price and time precedence is most likely a(n):
A trading system that matches buyers and sellers based on price and time precedence is most likely a(n):
A market that directs capital to its most productive use is best described as:
A market that directs capital to its most productive use is best described as:
If an investor buys 100 shares of a $50 stock on margin when the initial margin requirement is 40%, how much money must she borrow from her broker?
If an investor buys 100 shares of a $50 stock on margin when the initial margin requirement is 40%, how much money must she borrow from her broker?
Stop loss sell orders are:
Stop loss sell orders are:
Peg Fisk, CFA, states that two of the objectives of market regulation which CFA Institute attempts to address are minimum standards of competence among investment professionals and ease of performance evaluation for investors. Fisk is accurate with regard to:
Peg Fisk, CFA, states that two of the objectives of market regulation which CFA Institute attempts to address are minimum standards of competence among investment professionals and ease of performance evaluation for investors. Fisk is accurate with regard to:
Which of the following statements about securities exchanges is NOT correct?
Which of the following statements about securities exchanges is NOT correct?
The prospectus for the Horizon Fund states that it invests only in real assets. Which of the following would the Horizon Fund most likely include in its portfolio?
The prospectus for the Horizon Fund states that it invests only in real assets. Which of the following would the Horizon Fund most likely include in its portfolio?
Which of the following statements regarding secondary markets is least accurate? Secondary markets are important because they provide:
Which of the following statements regarding secondary markets is least accurate? Secondary markets are important because they provide:
Sonia Fennell purchases 1,000 shares of Xpressoh Inc. for $35 per share. One year later, she sells the stock for $42 per share. Xpressoh Inc. pays no dividends. The initial margin requirement is 50%. Fennell's one-year return assuming an all-cash transaction, and if she buys on margin (assume she pays no transaction or borrowing costs and has not had to post additional margin), are closest to:
Sonia Fennell purchases 1,000 shares of Xpressoh Inc. for $35 per share. One year later, she sells the stock for $42 per share. Xpressoh Inc. pays no dividends. The initial margin requirement is 50%. Fennell's one-year return assuming an all-cash transaction, and if she buys on margin (assume she pays no transaction or borrowing costs and has not had to post additional margin), are closest to:
An investor sells a stock short. To protect against a large loss on this position, the investor is most likely to:
An investor sells a stock short. To protect against a large loss on this position, the investor is most likely to:
An investor sold a stock short and is worried about rising prices. To protect himself from rising prices he would place a:
An investor sold a stock short and is worried about rising prices. To protect himself from rising prices he would place a:
Markets for financial assets with maturities of one year or less are best characterized as:
Markets for financial assets with maturities of one year or less are best characterized as:
Using the following assumptions, calculate the rate of return on a margin transaction for an investor who purchases the stock and the stock price at which the investor would have received a margin call.
Market Price Per Share: $32
Number of Shares Purchased: 1,000
Holding Period: 1 year
Ending Share Price: $34
Initial Margin Requirement: 40%
Maintenance margin: 25%
Transaction and borrowing costs: $0
The company pays no dividends
Using the following assumptions, calculate the rate of return on a margin transaction for an investor who purchases the stock and the stock price at which the investor would have received a margin call. Market Price Per Share: $32 Number of Shares Purchased: 1,000 Holding Period: 1 year Ending Share Price: $34 Initial Margin Requirement: 40% Maintenance margin: 25% Transaction and borrowing costs: $0 The company pays no dividends
Which of the following statements regarding margin accounts is most accurate?
Which of the following statements regarding margin accounts is most accurate?
Among the classifications of investment assets, "real assets" most likely include:
Among the classifications of investment assets, "real assets" most likely include:
Which of the following is least likely a characteristic of a well-functioning market?
Which of the following is least likely a characteristic of a well-functioning market?
An investor purchased 725 shares of stock at $40 per share and posted initial margin of 60%. He subsequently sold the shares at $50 per share. Based only on this information, the investor's holding period return is closest to:
An investor purchased 725 shares of stock at $40 per share and posted initial margin of 60%. He subsequently sold the shares at $50 per share. Based only on this information, the investor's holding period return is closest to:
Which of the following statements about primary and secondary markets is least accurate?
Which of the following statements about primary and secondary markets is least accurate?
When using margin to invest in equities, which of the following defines initial margin and what level will the margin be brought back to in the event of a margin call?
When using margin to invest in equities, which of the following defines initial margin and what level will the margin be brought back to in the event of a margin call?
The main functions of the financial system least likely include:
The main functions of the financial system least likely include:
Which of the following assets are best characterized as contracts?
Which of the following assets are best characterized as contracts?
With respect to a well-functioning securities market, a market that exhibits operational efficiency will have:
With respect to a well-functioning securities market, a market that exhibits operational efficiency will have:
Evelyn Stram, CFA, places a good-till-cancelled limit buy order at 86 for a stock. Stram's order specifies:
Evelyn Stram, CFA, places a good-till-cancelled limit buy order at 86 for a stock. Stram's order specifies:
Regarding the technical points affecting the short sales of a stock, which of the following statements is most accurate?
Regarding the technical points affecting the short sales of a stock, which of the following statements is most accurate?
Which of the following option positions is said to be a long position?
Which of the following option positions is said to be a long position?
An electronic crossing network is best described as:
An electronic crossing network is best described as:
Flashcards
Futures vs. Forward Contracts
Futures vs. Forward Contracts
Futures contracts trade on exchanges, have standardized terms, and are more liquid than forward contracts. A clearinghouse reduces counterparty risk.
Validity Instruction
Validity Instruction
The term validity instruction specifies when a trade order is to be executed, such as a day order.
Financial Assets
Financial Assets
Financial assets are claims against physical or real assets, like shares of stock in a company that owns gold mines.
Maintenance Margin Setting
Maintenance Margin Setting
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Efficient Capital Allocation
Efficient Capital Allocation
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Market Regulation Objective
Market Regulation Objective
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Operational Efficiency
Operational Efficiency
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"Inside the Market" Order
"Inside the Market" Order
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Order Instructions
Order Instructions
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Order-Driven Market
Order-Driven Market
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Allocationally Efficient
Allocationally Efficient
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Short seller duties
Short seller duties
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Secondary market function
Secondary market function
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Good-till-cancelled order instruction
Good-till-cancelled order instruction
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Allocationally efficient market definition
Allocationally efficient market definition
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Study Notes
Futures Contracts vs. Forward Contracts
- Futures contracts trade on exchanges, unlike forward contracts
- Futures have standardized terms, contrasting with the customized nature of forward contracts
- A futures clearinghouse reduces counterparty risk by guaranteeing performance
- Futures contracts are more liquid than forward contracts because they trade on organized exchanges
Return on Invested Equity Example
- Stock purchased at $40 with 25% initial margin, equity of $10
- Required maintenance margin is 20%
- Stock sold later for $45
- Return on invested equity calculated as ($45 - $40) / $10 = 50%
- Leverage ratio is purchase price / equity = $40 / $10 = 4
- The margin call price is $37.50, derived from: $40 × [(1 – 0.25) / (1 – 0.20)]
Understanding "Behind the Market" Orders
- A limit buy order is behind the market if the limit price is below the best bid
- A limit sell order is behind the market if its limit price is above the best ask
- Market orders are never considered to be behind the market
Classification of Shares
- Shares of stock in a publicly traded company that owns gold mines and mining operations, are financial assets
- Financial assets represent claims against physical or real assets
Maintenance Margin Requirement
- The Federal Reserve sets the minimum maintenance margin
- Individual investment companies can set higher margins than the minimum
Return on Investment (ROI) on Margin
- Mark Ritchie purchased 200 shares of TMX Corp at $35 per share with a 50% margin requirement
- Stock price increased to $42 per share
- Ritchie's return on investment is 40% if holdings are sold
Short Sales
- It isn't required for a short seller to replace borrowed securities within six months
- There is no maximum time for which a security can be borrowed
- The return is required whenever the lender asks for it
Allocating Capital
- Capital flows to its most valuable uses when markets function well and investors are well informed
- Investors must be well informed about the risk and return characteristics of investments
- Allocation of capital to its most valuable uses does not require that all investors have complete information, or frictionless markets
Objectives of Financial Market Regulation
- Market regulation aims to reduce information gathering costs via common financial reporting standards
- Regulations aren't about inside information being made public in a timely manner or preventing uninformed investors
Equity Investment at Year-End
- An investor's stock bought on margin had a 60% margin requirement
- The current stock price is $80, up from $50 one year ago
- If margin interest is 5%, equity at year-end is 73.8%
Margin Call Scenario
- Toby Jensen bought 400 shares of CSC at $60 on margin with 50% initial, 25% maintenance margin
- The stock price declined to $40
- Jensen receives a margin because they do not meet the minimum maintenance margin requiremen
Validity Instruction
- A limit order to buy 10,000 shares as a day order is a validity instruction
- Validity instructions specify when a trade is to be executed
Securities Exchanges
- Call markets trade stock only at specific times
- Continuous markets allow trades anytime the market is open
- Continuous markets do not need to be open 24 hours per day
Primary vs. Secondary Markets
- Prevailing market prices are determined by secondary market transactions
- Secondary markets determine the price for new issues on primary markets
Financial Intermediaries Roles
- Brokers seek traders to take opposite sides of clients' orders
- Arbitrageurs sell and buy instruments in different markets at a higher price
Operational Efficiency
- A financial system with low transaction costs is said to exhibit operational efficiency
- Informational efficiency reflects prices that quickly reflect all information
- Allocational efficiency results in capital being directed to its most productive uses.
Return on Investment on Margin with Dividends
- Initial and maintenance margins are 50% and 25% respectively
- If the company pays a dividend of $0.75 and the investor sells the stock at year-end for $50 per share, the return on investment is closest to 53.75%.
"Inside the Market" for Buy Limit Orders
- A buy limit order is "inside the market" when the limit is between the best bid and the best ask
- It is also known as "making a new market"
Cost of Buying on the Margin
- To purchase 1,000 shares of Bricko Corp at $60 with a 40% margin requirement, Kirk must pay $24,000 upfront
Fill or Kill order
- A fill or kill order specifies validity and execution
- It indicates when the order can be filled and how it should be filled
Margin Call Price Calculation
- Byron Campbell bought 300 shares of Crescent, Inc., at $80 with 50% initial margin
- With a 25% maintenance margin, a margin call will occur if the stock price falls below $53.33
Impact of New Sell Limit Order
- A stock's limit order book has varying bid and offer sizes/prices
- A new sell limit order for 250 shares at £25.45 is making a new market
Return After Selling on Margin
- A trader buys 500 shares at $100 on margin, leverage ratio of 3.0X
- Ignoring transaction costs and interest, the trader's 3-month return was closest to -30% after selling for $90 per share
Return on Investment after Selling Below Original Price
- Lynne Hampton bought 100 shares at $75 with 50% margin
- Stock sells at $62; with return on investment before commission and interest at -35%
Investment After Increase In Price
- If stock rises to $112.50 after purchase, the rate of return for the investor is 100%
Margin Call Trigger Price
- At an initial margin requirement of 50% and maintenance margin of 25%
- The investor recieves the margin call if the stocks are $16.67
Objective of Market Regulation
- Market regulation aims to preserve trust in financial markets
- This includes rules against insider trading and laws against fraud
Short Position
- An order placed to protect a short position is a stop loss buy
Trading Systems
- An order-driven market matches buyers and sellers based on price and time precedence
Markets and Capital
- A market that directs capital to its most productive use is allocationally efficient
Money Borrowed on Margin
- If needing to know how much must be borrowed in a $50 dollar stock
- With 100 shares, then $3,000 must be borrowed from the broker
Stop Loss Orders
- Are utilized to protect the gains from a long position
CFA Institute's Market Regulation Objectives
- CFA Institute attempts to address minimum standards of competence among investment professionals and ease of performance evaluation for investors.
Securities Exchanges and Auctions
- In continuous markets, prices are set by either the auction process or by dealer bid-ask quotes
Horizon Fund Investment
- Real assets are assets with physical presence such an apartment complex
Secondary Markets
- Liquidity and continuous information are provided to investors from the secondary markets
Return on Margin
- To determine how much return one would recieve with an all cash vs a 50% margin, utilize this formula:
- All-cash return = 42/35 – 1 = 20%
- Margin return = (42 – 35)/[(35)(0.5)] = 40%
Prevent Loss
- A stop buy order has to be placed above for market price to execute
Limit Order
- Placed below the current market price for buying
- Is Placed above the current market price for selling
Money Markets
- Refers to markets for debt securities maturing in one year or less
Calculate Margin
- Margin Percent= [((Ending Value – Loan Payoff) / Beginning Equity Position) – 1] × 100 Percent
Equity and Brokers
- Margin accounts allow brokers to borrow part of the purchase
Well Functioning Markets
Reliable information is available on prices and volume
Investor Return
- = (50 – 40) / (40 × 0.6) = 41.67%. (to find investors return on holding shares
Market Proceeds
- Market Proceeds in primary market go to the issuing firm
- Market proceeds in secondary market got to the current owner selling the securities
Margin Requirements
When using margin to invest in equities is the minium amount of security required of the investor for a margin call action
The main function of financial system
- is to is give the ability for investors to trade on public information
Assets
- The best type of assets characterized as contracts are currency swaps
Securities Market Efficiency
- Low transaction costs means operational efficiency in an securities market
Good Till Cancelled
- Good till cancelled is and execution valididty instruction means that it describes when to get the order filled
Security
- Short sellerer must pay all dividends due when lending stock
Long Option
- Buyers of an option either calling or buying are in a long possition
Networks/Markets
Electronic crossing is done in order driven markets
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