Securities Regulation and Short Selling

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Questions and Answers

What is a potential consequence of a regulatory ban on short selling for certain stocks?

It may create an upward spike in prices as sellers cover positions. (correct)

It allows short sellers to extend their positions indefinitely.

It has no effect on the market prices of those stocks.

It ensures all short sellers will profit.

How might the SEC's actions during the credit crisis impact investor behavior?

Investors may become more cautious in their trading strategies due to increased volatility. (correct)

Investors would likely increase their short selling activities.

Investors could ignore regulatory changes and continue as usual.

Investors would focus exclusively on buying stocks.

What is one main difference between trading long on margin and selling short?

Buying long on margin involves borrowing funds to purchase stocks, while selling short involves borrowing stocks. (correct)

Selling short is typically less risky than buying long on margin.

Selling short allows for guaranteed profits, unlike buying long on margin.

Buying long on margin is only applicable for large investors.

Why might investment dealers act as agents in a securities transaction?

To facilitate trades without assuming any financial risk. Signup and view all the answers

During times of regulatory intervention, what typically happens to short sellers?

They may have to quickly cover their positions, incurring potential losses. Signup and view all the answers

What characterizes the roles of investment dealers in a traditional trade involving two customers?

Dealers may act as principals or agents depending on the structure of the trade. Signup and view all the answers

What is the primary advantage of using a limit order?

It allows for better price control when buying or selling. Signup and view all the answers

What happens to a limit order if the specified price is never reached during the trading day?

It is canceled at the end of the trading day. Signup and view all the answers

In a market order for selling shares, which price does the seller receive?

The market price available at the time of order execution. Signup and view all the answers

Which statement best describes a day order?

It expires at the end of the trading day if not executed. Signup and view all the answers

What is a potential downside of using a limit order?

There is a chance the order may not be filled. Signup and view all the answers

If a buyer places a limit order to buy shares at $20 or less, which scenario would cause the order to execute?

At least one seller is willing to sell at $20 or less. Signup and view all the answers

What is the bid price in a market order context?

The price at which buyers are willing to purchase. Signup and view all the answers

If a limit sell order is placed at $20 or more, what is true about its execution?

It can only be filled if buyers are willing to pay at least $20. Signup and view all the answers

What is the present value of the principal when investing $67.68 at a semi-annual rate of 5% for four years?

$67.68 Signup and view all the answers

What is the sum of the present values of both the coupons and the principal of the bond?

$96.77 Signup and view all the answers

If the appropriate discount rate for a bond changes due to economic conditions, what does this affect?

The fair price of the bond Signup and view all the answers

What is the calculated present value of the bond when using the financial calculator with a discount rate of 10%?

$96.77 Signup and view all the answers

What does a bond's fair value indicate about its potential price in the secondary market?

It reflects the current market conditions and investor expectations. Signup and view all the answers

What is the significance of knowing how to perform present value calculations manually?

It ensures a deeper comprehension of financial concepts. Signup and view all the answers

What is the primary risk faced by short sellers when the price of the security increases?

Unlimited loss due to rising prices Signup and view all the answers

Which order type is defined as an instruction to buy or sell at a specified price or better?

Limit order Signup and view all the answers

What happens to a day order if it is not executed on the day it is entered?

It expires Signup and view all the answers

Which order type specifies a cancellation date provided by the client?

Good Til order Signup and view all the answers

What is the purpose of an on-stop sell order?

To sell a security once a specified price is reached Signup and view all the answers

Which type of order is specifically designed for accounts of investment advisors and directors?

PRO order Signup and view all the answers

What must a buyer do once they receive confirmation of a trade?

Provide payment for the security Signup and view all the answers

What is the typical consequence if the price of a security rises unexpectedly for a short seller?

They face potential margin calls Signup and view all the answers

Which statement correctly describes the settlement date process?

It varies based on the type of security traded Signup and view all the answers

Which type of order would not execute until the security reaches a specified price?

On-stop buy order Signup and view all the answers

Study Notes

Regulatory Risk

Regulatory risk involves the potential for regulators to prohibit short selling for certain stocks, notably observed during the credit crisis.
The SEC's ban on short sales for banks and financial institutions forced short sellers to cover positions, leading to price spikes and losses.

Trading on Margin

Buying long on margin differs from selling short; understanding margin strategies is crucial for investment decisions.
Equity transactions require knowledge of trading and settlement procedures, often involving investment dealers acting as agents.

Orders in Trading

Market Order: Executed immediately at the current market price (example: buy 1,000 shares of ABC at $20.10).
Limit Order: Buy or sell at a specified price or better (example: buy ABC at $20 or less; may not execute if not reached).
Day Order: Expires at the end of the day if not executed.

Settlement Procedures

Settlement involves the exchange's data transmission system reporting trade details with confirmations sent to buyers and sellers.
Buyers provide payment, while sellers deliver the security, with timelines varying based on the type of securities.

Types of Orders

Good Til Order: Remains in effect until the date specified by the client or market.
On-stop Orders: Triggered when the security reaches a specified price (sell if it drops below a certain point, buy if it rises).
PRO Order: Reserved for accounts of partners, officers, or specified employees.

Present Value of Bonds

Fair price of a bond includes present value of coupons and principal at an appropriate discount rate.
Present value calculations consider different economic conditions and reflect expected yields.

Current Yield Calculation

Current yield formula: Current Yield = (Annual Cash Flow / Current Market Price) x 100.
Example: For a bond with a 9% annual cash flow priced at 96.77, the current yield is approximately 9.30%.

Yield to Maturity (YTM)

YTM calculates total expected return on a bond, assuming reinvestment of coupon payments at the same YTM.
Takes into account current market price, term to maturity, par value received at maturity, and coupon rate.
YTM reflects investor's returns as coupon income and any capital gains or losses realized over time.

Buying Bonds at a Premium

Investors may buy bonds at a premium, despite potential capital loss at maturity; bond valuation considers more than just purchase price.

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Description

This quiz explores the implications of regulatory bans on short selling and the effects of SEC actions during financial crises on investor behavior. It covers the differences between trading long on margin and selling short, as well as the roles of investment dealers in securities transactions. Test your understanding of these essential concepts in trading and investment regulations.