Questions Flashcards
ch.1
Investment bankers generally agree to sell a new issue on a ……………
a) Best Efforts
b) Firm Committment
b) Firm Commitment
The investment banker buys the offering from the firm and resells it to the investors.
The most basic function that brokers and their firms perform is to link investors to the securities markets.
True
A specialist is charged by an exchange to make a market in a security.
True
Churning is the practice of
Churning is the practice of placing trades for the primary purpose of generating commission income for the broker.
Money market instruments are traded in the
a) OTC
b) NYSE
c) Regional Exchanges
a) OTC (over the counter) market.
The three major costs of executing a trade are:
commissions, bid-ask spread, and price impact
A specialist is charged with managing the auction activity in a security.
True
What is the: Primary market Secondary Market Third Market Fourth market
Primary: New issue stock. IPO’s. Managed by investment bankers.
Secondary: The secondary market is where investors buy and sell securities they already own. It is what most people typically think of as the “stock market,”
Third: The third market involves exchange-listed securities that are being traded over-the-counter between broker-dealers and large institutional investors.
Fourth: Arrangements for direct trading between institutions are referred to as the fourth market.
A stock could trade simultaneously on the NYSE, a regional exchange, and in the OTC market.
True
What are Alternative trading systems (ATSs) and what is their purpose?
Alternative trading systems are the organizations and programs that facilitate trading in the fourth market (direct between institutions). They are not used in the third market because the third market is trading between institutions and brokers. ATSs include electronic communication networks (ECNs) and dark
pools.
Explain a Limit Order?
A limit order to buy sets the maximum price the investor is willing to pay, and a limit order
to sell sets the lowest price an investor will accept
Explain a Stop Loss Order?
A stop-sell order is a request to activate a market order if the stock trades at or below the designated stop price, which is itself below the current market price.
Explain Stop-Limit Orders?
The difference between stop-limit orders and stop orders is that stop orders convert to market orders and stop-limit orders convert to limit orders once the stop price is hit. When placing a stop-limit order, one must specify both the stop price and the limit price, although they could be the same.
An all-or-nothing order must be either executed immediately or canceled?
False. An all-or-nothing order can be executed only when sufficient volume is available because the order must trade as a unit. However, the order does not have to be executed immediately; it can wait until sufficient volume exists for a single transaction. The type of order that must be either executed immediately or canceled is a fill-or-kill order.
The vast majority of trading is done with which type of orders?
Market and limit orders.
Investors who sell short can invest the proceeds of the sale as they see fit?
False. The proceeds from a short sale are left with the brokerage firm as collateral, along with additional collateral.
SIPC coverage is based on account title and is only available to U.S. citizens?
False. It is based on account title but It applies to anyone holding an account at a covered brokerage firm, regardless of nationality or where they live.
Cash accounts are Type …… and margin accounts are type …….
Cash = type 1 Margin = type 2
SIPC insurance coverage does not apply to cash left on deposit in a brokerage account for the primary purpose of earning interest income.
True
Portfolio Turnover Ratio
The portfolio turnover ratio measures the trading
activity in an account. The ratio is computed in a two-step process. The first step is to add up all of the purchases in an account during a period and add up all of the sales during that same period. The second step is to divide the lesser of these two numbers by the average value of total assets.
Relates the profit on an investment directly to its beginning price is a definition for what?
HPR (Holding Period Return)
For an individual investment, the HPR is the sum of all the income received from this investment during
the holding period and the change in its price, divided by the beginning price of the
investment.
? = Beginning price / Income received + Change in price
HPR
? = Beginning price / Income received + Ending price
HPRR
An asset’s per-period return (PPR) is defined as the sum of that period’s income payments and price appreciation divided by its beginning-of-period price.
True
The arithmetic mean return for an investment that earned successive annual
rates of return of –12 percent, 20 percent, and 22 percent equals:
-12% + 20% + 22% / 3 = 10%
Dispersion of possible returns refers to what term in investments?
“Risk”
In insurance, one can insure for the expected profit, as well as compensation for loss.
False. In insurance, one can only insure for loss of value, not for loss of potential profits.
The risk that one might unexpectedly have to put additional monies into an investment is called?
‘Additional commitment risk’
Refers to the degree to which an investment is affected by changes in interest rates. This type of risk has two components: price risk and reinvestment rate risk.
We think about it primarily in conjunction with the bond investments.
Interest Rate Risk
The potential inability to quickly sell an asset with no price concession is
Liquidity Risk
The risk from events that affect a particular company.
Business Risk
Risks that come from events while operating in a foreign country, such as expropriation.
Political Risk
Risk of owing more taxes than one expected to owe due to changes in the tax code or tax rates.
Tax Risk
The most fundamental measurement of risk is
Variance
The most commonly used measurement of risk is?
Standard Deviation
Calculating standard deviation on the calculator?
You note that the returns on a stock for the last 3 years are –15 percent, 5 percent, and 28 percent. You believe these returns are representative of future returns, and you are willing to base your estimate of expected return and standard deviation on these historical data. The expected return and standard deviation are computed as follows?
15, +/–, Σ+
5, Σ+
28, Σ+
SHIFT, x,y – – {Display: 6.00}
SHIFT, sx
,sy
{Display: 21.52}If an investment’s returns are normally distributed, then 95 percent of the time the actual return will be within one standard deviation of the expected return.
False. The actual return is within one standard deviation of the expected return only 68 percent of the time.
Skewed Returns
A skewed distribution of returns is one in which the tail on one side is longer than that on the other. An unusually large positive rate of return is more likely to occur with a positively skewed distribution of returns than with a negatively skewed distribution.
The initial margin rate is
the minimum amount of cash the investor must put up.
The Federal Reserve Board currently has set the initial margin requirement on stocks at
50%
When buying on margin, the investor will need to pay in cash the interest each month that has accumulated on the loan?
The interest on a margin loan is allowed to accumulate as an increase in the loan amount. No payment is required as long as the maintenance margin requirement is met.
The maintenance margin percentage is
the minimum amount of equity an investor must have, as a percentage of the portfolio, without having to repay part of the loan. The Federal Reserve Board also sets this rate, and brokerage firms can set a higher rate.
A margin call is issued whenever the market value of the account is less than the loan balance divided by one minus the maintenance margin rate.
True
The maintenance margin rate is lower than the initial margin rate.
True
The three ways to satisfy a margin call are?
To pay down the loan, add marginable securities to the account, or to sell holdings and use the proceeds to pay down the loan balance.
As long as an account has borrowing power, one can withdraw cash by increasing the loan balance?
True
A statistical measure of the strength of the relationship between the relative movements of two variables. The values range between -1.0 and 1.0.
Correlation Coefficient
A value of exactly 1.0 means there is a perfect positive relationship between the two variables.
A correlation coefficient of 0 does not necessarily mean there is no relationship between two sets of returns, only that there is no obvious linear relationship.
A portfolio’s return is the ……………. average of the returns of the assets included therein.
Weighted
A correlation coefficient of -1 between two assets provides the least opportunities to reduce the variability of the portfolio’s return.
False. A perfect negative correlation (–1) of the returns between two assets would provide the maximum opportunity to reduce the variability of the portfolio’s return. If the correlation coefficient is –1, then there will exist one combination of the two assets that is actually risk-free.
The efficient frontier
The efficient frontier is the set of optimal portfolios that offer the highest expected return for a defined level of risk or the lowest risk for a given level of expected return. Portfolios that lie below the efficient frontier are sub-optimal because they do not provide enough return for the level of risk. Portfolios that cluster to the right of the efficient frontier are sub-optimal because they have a higher level of risk for the defined rate of return.
Covariance
The covariance, like the mean and standard deviation, is a statistic that is almost always estimated from ex post (historical) values of the relevant variables. It measures the comovement or covariability of two variables. Thus, the covariance of two assets’ returns is an index of how their prices tend to move relative to each other.
MVP`
Minimum Variance Portfolio.
Only the most risk-averse clients should hold the minimum variance portfolio.
The portfolios that lie below the MVP portfolio are preferred to those that lie above it.
The portfolios that lie below the MVP portfolio are preferred to those that lie above it.
The optimal portfolio to hold is the one that places the investor on the highest possible indifference curve.
True
Indifference curves are based on one’s marginal utility for wealth, and may differ dramatically among investors.
True
indifference curve
An indifference curve shows a combination of two goods that give a consumer equal satisfaction and utility thereby making the consumer indifferent.
Along the curve, the consumer has no preference for either combination of goods because both goods provide the same level of utility.
Each indifference curve is convex to the origin, and no two indifference curves ever intersect.
The market portfolio
The market portfolio is the portfolio of all assets, with the weight of each based on its market value. As a practical matter, the market portfolio is an unfathomable entity, but it has interesting implications
for managing portfolios.
The capital market line (CML)
The capital market line (CML) represents portfolios that optimally combine risk and return. Capital asset pricing model (CAPM), depicts the trade-off between risk and return for efficient portfolios. It is a theoretical concept that represents all the portfolios that optimally combine the risk-free rate of return and the market portfolio of risky assets.
Risk-Free Rate and what is typically used to calculate this rate?
The risk-free rate of return is the theoretical rate of return of an investment with zero risk. The risk-free rate represents the interest an investor would expect from an absolutely risk-free investment over a specified period of time. The real risk-free rate can be calculated by subtracting the current inflation rate from the yield of the Treasury bond matching your investment duration.
The interest rate on a three-month U.S. Treasury bill is often used as the risk-free rate for U.S.-based investors.
The coefficient of determination (R2) indicates how closely changes in the value of the market portfolio are associated with changes the value of the particular?
Asset or portfolio.
One of the more common surrogates for the market portfolio is the
S&P 500
BETA
Beta, used in capital asset pricing model (CAPM), is a measure of the volatility, or systematic risk, of a security or portfolio, in comparison to the market as a whole.
The beta calculation is used to help investors understand whether a stock moves in the same direction as the rest of the market, and how volatile (risky) it is compared to the market.
The Beta for the market is always 1
Investors seeking the highest possible expected return should seek out investments with the highest possible betas.
True
The most commonly used model to analyze a security’s performance is the CAPM.
True
