Podcast
Questions and Answers
What does the expectations theory suggest about the shape of the yield curve?
What does the expectations theory suggest about the shape of the yield curve?
- It implies that the two-year interest rate equals two successive one-year rates. (correct)
- It suggests that longer-term rates predict future short-term rates.
- It reflects investor preferences for short-term over long-term investments.
- It indicates volatility in interest rate movements.
Given a current one-year bond rate of 4%, what must the second year's one-year bond return be to match the return of a two-year bond at 5%?
Given a current one-year bond rate of 4%, what must the second year's one-year bond return be to match the return of a two-year bond at 5%?
- 8.25%
- 6.25% (correct)
- 7.25%
- 7.00%
If an investor buys a six-month bond and plans to reinvest, how many times will they need to reinvest over two years?
If an investor buys a six-month bond and plans to reinvest, how many times will they need to reinvest over two years?
- Four times (correct)
- Three times
- Two times
- Five times
How is the one-year rate related to the rates of two consecutive six-month bonds according to the expectations theory?
How is the one-year rate related to the rates of two consecutive six-month bonds according to the expectations theory?
What is the calculated return on investment for a two-year bond with a rate of 5% at maturity?
What is the calculated return on investment for a two-year bond with a rate of 5% at maturity?
Which choice allows an investor to maintain equal attractiveness in the fixed-income market?
Which choice allows an investor to maintain equal attractiveness in the fixed-income market?
What is the total minimum account balance required if a client wishes to sell short 100 shares of FED Company Ltd. at $5.00?
What is the total minimum account balance required if a client wishes to sell short 100 shares of FED Company Ltd. at $5.00?
If FED's share price decreases to $4.00, what is the new minimum margin required?
If FED's share price decreases to $4.00, what is the new minimum margin required?
What is the excess margin after the client has sold short at $5.00 and the share price drops to $4.00?
What is the excess margin after the client has sold short at $5.00 and the share price drops to $4.00?
What will happen if the price of FED shares rises after a drop to $4.00?
What will happen if the price of FED shares rises after a drop to $4.00?
When the share price of FED decreases to $1.60, how is the required account balance governed?
When the share price of FED decreases to $1.60, how is the required account balance governed?
Which component is NOT included in the calculation of the minimum account balance required?
Which component is NOT included in the calculation of the minimum account balance required?
What is the percentage margin required for the short sale of FED shares?
What is the percentage margin required for the short sale of FED shares?
After selling short 100 shares of FED at $5.00, how much margin must the client deposit?
After selling short 100 shares of FED at $5.00, how much margin must the client deposit?
What is the primary characteristic of a day order?
What is the primary characteristic of a day order?
What differentiates a good til date (GTD) order from a good til cancelled (GTC) order?
What differentiates a good til date (GTD) order from a good til cancelled (GTC) order?
How does an on-stop sell order function?
How does an on-stop sell order function?
What must occur for an on-stop sell order to become active on the Toronto Stock Exchange?
What must occur for an on-stop sell order to become active on the Toronto Stock Exchange?
What is the maximum duration for a good til cancelled (GTC) order?
What is the maximum duration for a good til cancelled (GTC) order?
In what scenario is an on-stop sell order particularly useful?
In what scenario is an on-stop sell order particularly useful?
What is the minimum account balance required based on the market value before the price change?
What is the minimum account balance required based on the market value before the price change?
What is the margin deficiency that triggers a margin call when the price rises to $6.00?
What is the margin deficiency that triggers a margin call when the price rises to $6.00?
When FED’s share price is at $6.00, how much margin is required in total?
When FED’s share price is at $6.00, how much margin is required in total?
How are profits or losses on short sales calculated?
How are profits or losses on short sales calculated?
Which of the following best describes the impact of a price increase to $6.00 on the margin balance?
Which of the following best describes the impact of a price increase to $6.00 on the margin balance?
What percentage of the market value is used to determine the minimum account balance required before a potential margin call?
What percentage of the market value is used to determine the minimum account balance required before a potential margin call?
How much is the initial amount deposited in the margin account?
How much is the initial amount deposited in the margin account?
In what scenario is no additional margin required despite the share trading conditions?
In what scenario is no additional margin required despite the share trading conditions?
What was the total proceeds from the initial short sale at $5.00 per share for 100 shares?
What was the total proceeds from the initial short sale at $5.00 per share for 100 shares?
What factor triggers a margin call in this scenario?
What factor triggers a margin call in this scenario?
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Study Notes
Yield Curve and Investor Expectations
- The yield curve reflects investor expectations regarding future interest rates.
- Efficiency in the market leads to equal attractiveness among different investment strategies (e.g., two-year bond vs. rolling one-year bonds).
- The two-year interest rate equals two consecutive one-year rates, while the one-year rate is the average of two consecutive six-month rates.
Investment Example
- A two-year bond offers a current rate of 5%, yielding a total return of 10.25% at maturity (calculated as 1.05 × 1.05).
- To match the return of a two-year bond, the average return of two successive one-year bonds must align with the two-year rate.
Margin Requirements in Short Selling
- Short-selling involves selling borrowed shares to benefit from anticipated price declines.
- Minimum account balance required for short selling includes proceeds from the sale plus a margin (50% of the market value).
- If a share price drops, the client may enjoy excess margin, which can be used for further investments.
Short Sale Scenarios
- Scenario 1: If the share price drops to $4, the margin requirement lessens. The client has excess margin that can be utilized.
- Scenario 2: If shares fall to $1.60, no additional margin is needed due to a lower minimum balance requirement.
- Scenario 3: If shares rise to $6, a margin call is issued as a deficiency arises (margin required exceeds deposited amount).
Profit and Loss on Short Sales
- Profit or loss calculations on short sales mirror those of long transactions.
- Orders are classified as day orders unless specified otherwise (e.g., good til date or good til cancelled).
Order Types
- Day Orders expire at the end of the trading day if not executed.
- Good Til Date (GTD) orders remain valid until a specified date is reached.
- Good Til Canceled (GTC) orders last 90 days unless canceled earlier.
On-Stop Sell Orders
- An on-stop sell order is aimed at limiting losses; it triggers a sell when the stock price falls to a predetermined level.
- All on-stop sell orders on exchanges must have a limit price attached.
Real Rate of Return
- The real rate of return comprises the nominal rate adjusted for inflation.
- Determined by the balance of funds supplied by investors and demand for loans from businesses.
- The nominal rate = Real Rate + Inflation Rate.
Factors Affecting the Real Rate of Return
- The real interest rate fluctuates with the business cycle, generally decreasing during recessions and increasing with economic expansion.
- Inflation rate changes can impact forecasts for the real rate; unexpected inflation diminishes the real rate of return for lenders.
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