Reading 36: market organization and structure Flashcards
An investor who buys a government bond from a dealer’s inventory is said to obtain:
a real asset in a primary market transaction.
a financial asset in a primary market transaction.
a financial asset in a secondary market transaction.
Bonds are financial assets. Real assets are physical things such as a commodity or a factory. Buying a bond from a dealer is a secondary market transaction. A primary market transaction is an issuance of securities by an entity that is raising funds. (Module 36.1, LOS 36.b)
Daniel Ferramosco is concerned that a long-term bond he holds might default. He therefore buys a contract that will compensate him in the case of default. What type of contract does he hold?
Physical derivative contract.
Primary derivative contract.
Financial derivative contract.
Daniel holds a derivative contract that has a value determined by another financial contract; in this case, the long-term bond. (Module 36.1, LOS 36.c)
A financial intermediary buys a stock and then resells it a few days later at a higher price. Which intermediary would this most likely describe?
Broker.
Dealer.
Arbitrageur.
This situation best describes a dealer. A dealer buys an asset for its inventory in the hopes of reselling it later at a higher price. Brokers stand between buyers and sellers of the same security at the same location and time. Arbitrageurs trade in the same security simultaneously in different markets. (Module 36.1, LOS 36.d)
Which of the following is most similar to a short position in the underlying asset?
Buying a put.
Writing a put.
Buying a call.
Buying a put is most similar to a short position in the underlying asset because the put increases in value if the underlying asset value decreases. The writer of a put and the holder of a call have a long exposure to the underlying asset because their positions increase in value if the underlying asset value increases. (Module 36.2, LOS 36.e)
An investor buys 1,000 shares of a stock on margin at a price of $50 per share. The initial margin requirement is 40% and the margin lending rate is 3%. The investor’s broker charges a commission of $0.01 per share on purchases and sales. The stock pays an annual dividend of $0.30 per share. One year later, the investor sells the 1,000 shares at a price of $56 per share. The investor’s rate of return is closest to:
12%.
27%.
36%.
The total purchase price is 1,000 × $50 = $50,000. The investor must post initial margin of 40% × $50,000 = $20,000. The remaining $30,000 is borrowed. The commission on the purchase is 1,000 × $0.01 = $10. Thus, the initial equity investment is $20,010.
In one year, the sales price is 1,000 × $56 = $56,000. Dividends received are 1,000 × $0.30 = $300. Interest paid is $30,000 × 3% = $900. The commission on the sale is 1,000 × $0.01 = $10. Thus, the ending value is $56,000 − $30,000 + $300 − $900 − $10 = $25,390.
The return on the equity investment is $25,390 / $20,010 − 1 = 26.89%. (Module 36.2, LOS 36.f)
A stock is selling at $50. An investor’s valuation model estimates its intrinsic value to be $40. Based on her estimate, she would most likely place:
a short-sale order.
a stop order to buy.
a market order to buy.
If the investor believes the stock is overvalued in the market, the investor should place a short-sale order, which would be profitable if the stock moves toward her value estimate. (LOS 36.g, 36.h)
Which of the following limit buy orders would be the most likely to go unexecuted?
A marketable order.
An order behind the market.
An order making a new market.
A behind-the-market limit order would be least likely executed. In the case of a buy, the limit buy order price is below the best bid. It will likely not execute until security prices decline. A marketable buy order is the most likely to trade because it is close to the best ask price. In an order that is making a new market or inside the market, the limit buy order price is between the best bid and ask. (LOS 36.h)
New issues of securities are transactions in:
the primary market.
the secondary market.
the seasoned market.
The primary market refers to the market for newly issued securities. (LOS 36.i)
In which of the following types of markets do stocks trade any time the market is open?
Exchange markets.
Call markets.
Continuous markets.
Continuous markets are defined as markets where stocks can trade any time the market is open. Some exchange markets are call markets where orders are accumulated and executed at specific times. (LOS 36.j)
A market is said to be informationally efficient if it features:
market prices that reflect all available information about the value of the securities traded.
timely and accurate information about current supply and demand conditions.
many buyers and sellers that are willing to trade at prices above and below the prevailing market price.
Informational efficiency means the prevailing price reflects all available information about the value of the asset, and the price reacts quickly to new information. (LOS 36.k)
Which of the following would least likely be an objective of market regulation?
Reduce burdensome accounting standards.
Make it easier for investors to evaluate performance.
Prevent investors from using inside information in securities trading.
Market regulation should require financial reporting standards so that information gathering is less expensive and the informational efficiency of the markets is enhanced. (LOS 36.l)
