Chapter 2: Securities Markets and Transactions Flashcards
Assume that you are 35 years old, are married with two young children, are renting a condo, and have an annual income of 90,0000. Use the follow questions to guide your preparation of a rough investment plan.
A) What are your key investment goals.
B) How might personal taxes affect your investment plans? Use current tax rates to access their impact.
C) How might your stage in the life cycle affect the types of risk you might take?
a. Since you fall into the category of a young investor, your key investment goals should be to
purchase a house and save for the education of your children. Appropriate investments should
focus on longer term goals, such as the education of your children and, though it may seem
remote, retirement.
b. You should consider the effects of taxes when investing, especially the preferential tax treatment
of capital gains and dividends and tax sheltered vehicles such as 401(k) plans. Your focus should
be on maximizing the after-tax return on your investments.
c. Since you have a relatively long investment horizon, it is appropriate to focus your portfolio on
higher-risk investments such as common stocks.
Describe how, if at all, conservative and aggressive investors might use each of the following types of transactions as part of their investment programs.
A) long purchases
B) Margin Trading
C) Short selling.
a. Long purchases are typically used by conservative investors so that they receive their expected
returns over time.
b. Margin trading is typically used by aggressive investors seeking short-term capital appreciation.
c. Short selling is typically used by aggressive investors seeking short-term profits from falling
security prices.
Elmo inc stock is currently selling at 60 dollars per share. For each of the following situations, calculate the gain or loss that Courtney Schinke realizes if she makes a 100 share transaction.
a) She sells short and repurchases the borrowed shares at 70 per share.
b. She takes a long position and sells the stock at 75 per share.
c. She sells short and repurchases the borrowed stock at 45 per share.
d. She takes a long position and sells the stock at 60 per share.
a) $1,000 loss. This is because her short sale would have realized $6,000, while the replacement of
the shares would cost Courtney Schinke $7,000.
b. A profit of $1,500. The long position would initially cost Courtney Schinke $6,000. When she
sells the stock at $75 per share, she is realizing $15 per share ($75 − $60) in profit for a total of
$1,500 (100 shares at $15 per share).
c. $1,500 profit. The short sale brings in $6,000, while the return of the shares to the owner costs
only $4,500.
d. A breakeven situation. The long position costs Courtney Schinke $6,000, and the sale of the
stock brings in $6,000, thereby providing neither a profit nor a loss.
Assume that an investor buys 100 shares of stock at 50 per share, putting up a 60% margin.
a. What is the debit balance in this transaction?
b. How much equity capital must the investor provide to make this margin transaction?
a. Debit balance is transaction amount minus margin: (100 × $50) − 0.60 × (100 × $50) = $2,000.
b. Equity is the margin amount, or 0.60 × (100 × $50) = $3,000.
Assume that an investor buys 100 shares of stock at 50 per share, putting up a 60% margin. If the stock rises to 60 per share, what is the investor’s new margin position?
Margin = (Value − Debit balance)/Value = [(100 × $60) − $2,000] ÷ (100 × $60) = 66.67%.
Assume that an investor buys 50 shares of stock at 45 per share, putting up a 70 dollar equity.
- If an individual purchases 50 shares of stock at $45 per share with a 70% margin:
a. The debit balance (or the amount borrowed in the transaction) would be:
Market value of securities = $45 × 50 shares = $2,250
Debit balance = (1 − 0.7) × $2,250 = $675
b. Equity portion = $2,250 − $675 = $1,575
c. If the stock rises to $80, we would use the formula provided in the book to find the new margin:
Value of securities Debit balance Margin (%) Value of securities
0.79
Miguel Torres purchased 100 shares of CantWin.com for 50 per share, using as little of his own money as he could. His brokehas 50 percent intial margin requirement and a 30% maintenance margin. The stock price falls to 30 per share. What does Miguel need to do?
Miguel needs to cover a margin call. His margin is ($3,000 − $2,500) ÷ $3,000 = 16.7%, below the
30% maintenance requirement. Value − (Margin × Value) = Debit balance:
$3,000 − (0.3 × $3,000) = New debit balance
$3,000 − $900 = $2,100 = New debit balance
Old debit balance − New debit balance = $2,500 − $2,100 = $400
Miguel must add $400 to the account to get back to the maintenance margin requirement of 30%.
Jerry Kingston bought 100 shares of stock at 80 dollars per share using an initial margin of 60%. Given a maintenance margin of 25 percent, how far does the stock have to drop before Jerri faces a margin call?
42.67 per share
An investor buys 200 shares of stock selling at 80 dollars per share suing a margin of 60 percent. The stock pays annual dividends of 1 per share. A margin loan can be obtained at an annual interest cost of 8 percent. Determine what returns on invested capital the investor will realize if the stock increases to 104 within 6 months. What is the annual return on this transaction.
48.38% (for the six-month period) or 2x for the year.
An investor short sells 100 shares of a stock for 20 per share. The initial margin is 50 percent. How much equity will be required in the account to complete the transactions?
1,000
