TOPIC 2 - INVESTMENT VEHICLES

Question 1

Firms issue securities to:

Answer 1

raise capital necessary to finance their investments. Investment bankers market these securities to public on primary market.

Question 2

Investment bankers act as:

Answer 2

underwriters purchasing securities from the firm and selling them to the public at a markup –> before they can sell to public must publish an SEC approved prospectus that provides info on the firm’s prospects

Question 3

already issued securities are traded on

Answer 3

the secondary market (organised stock market - on over the counter market and sometimes direct negotiation for super large trades)

Question 4

brokerage firms with access to exchanges sell

Answer 4

their services to individuals, charging commissions for executing trades on their behalf

Question 5

Trading can occur in dealer markets, via

Answer 5

electronic communication networks or in specialist/designated market maker markets

Question 6

What happens in a dealer market?

Answer 6

security dealers post bid and ask prices they’re willing to trade at. Brokers execute trades for their clients at best price available.

Question 7

What happens in electronic markets?

Answer 7

existing book of limit orders provides the terms at which trades can be executed. Mutually agreeable offers to buy or sell securities are automatically crossed by the computer system operating the market

Question 8

NASDAQ was traditionally what

Answer 8

dealer market - network of dealers negotiated directly over sales of securities. –> but now pretty much all electronic (Same for NYSE which was traditionally a specialist market)

Question 9

Buying on margin

Answer 9

borrowing money from a broker to buy more securities than can be purchased with one’s money alone.

Question 10

By buying shares on margin, what does an investor do?

Answer 10

they magnify the upside potential and downside risk. If the equity in a margin account falls below the required maintenance level, the investor will get a margin call from the broker.

Question 11

Short-selling is the practice of

Answer 11

selling securities that the seller doesn’t own.

Question 12

Short-seller borrows the securities from ….. and then

Answer 12

a broker, sells them and may be required to cover the short position at any time on demand.

Question 13

The cash proceeds of a short sale are kept in

Answer 13

escrow by the broker and the broker usually requires that the short-seller deposit additional cash or securities to serve as margin (collateral).

Question 14

Securities trading regulation largely pertains to

Answer 14

full disclosure of relevant info concerning the securities in question.

Question 15

Insider trading rules prohibit

Answer 15

traders from attempting to profit from inside information.

Question 16

investment companies comprise:

Answer 16

1) unit investment trusts
2) closed-end management companies
3) open-end management companies

Question 17

unit investment trusts

Answer 17

unmanaged - once portfolio is established, it’s fixed

–> pools of $ invested in a portfolio that’s fixed for the life of the fund

Question 18

managed investment companies

Answer 18

portfolio can change composition of portfolio as they see fit (comprised of closed-end and open-end funds)

Question 19

closed-end fund

Answer 19

traded like other securities, they don’t redeem shares for their investors (unlike open-end funds).

Question 20

open-end funds (mutual funds)

Answer 20

redeem shares for net asset value at the request of the investor
- priced at the NAV

Question 21

if you hold $ in a unit investment trust, what sort of strategy does this reflect

Answer 21

buy and hold, no effort put into portfolio = lower transactions bc there’s less turnover (no constant buying and selling)

Question 22

with open-end funds, if you redeem the shares noting they’re priced at the NAV, what happens?

Answer 22

$20/share can liquidate investment redeem it with the fund provider at the NAV, sell it back to the mutual fund at price of $20/share.

Question 23

How do you get out of a closed-end fund since you can’t redeem when you wish at any time

Answer 23

sell into secondary markets.

The no. shares outstanding is constant and investors cash out by selling to new investors.

Question 24

closed -end funds - how are shares priced?

Answer 24

at premium or discount to NAV

Question 25

why are closed end fund’s shares priced at a premium or discount?

Answer 25

• Bc units can’t redeemed with fund provider at NAV, market pricing of the units can be at a premium/discount to NAV –> price can be different!

Eg, where market participants make an assessment of the liabilities of the closed end fund than that reported by the fund itself.

(Remember NAV involves subtracting liabilities – if market disagrees about value of the liabilities, then market pricing for the fund can be different to the NAV)

Question 26

Net asset value =

Answer 26

market value of assets held by a fund - liabilities of the fund divided by the shares outstanding

Question 27

Mutual funds good bc they free the individual from:

Answer 27

many of the administrative burdens of owning individual securities and offer professional management of the portfolio

Question 28

additional reason for why mutual funds are advantageous for individual investors

Answer 28

gives individual investor access to advantages only available to large scale investors such as lower trading costs.

Question 29

What’s a possible downside to mutual funds?

Answer 29

Funds are assessed management fees and incur other expenses which reduce the investor’s rate of return.

Funds also eliminate some of individual’s control over timing of capital gains realisations)

Question 30

mutual funds often categorised by:

Answer 30

investment policy 
(money market funds, equity funds --> then further grouped per emphasis on income vs growth/specialisation by sector, balanced funds, bond funds, international funds, asset allocation funds, index funds)

Question 31

costs of investing in mutual funds incl:

Answer 31

1) front-end loads (sales charges
2) back-end loads (redemption fees.contingent deferred sales charges)
3) 12b-1 charges (recurring fees to appy for expenses of marketing fund to public)

Question 32

how is income taxed for mutual funds?

Answer 32

not taxed at the level of the fund, instead as long as the fund meets certain requirements for pass-throughs status, the income is treated as being earned by the investors in the fund

Question 33

average rate of return of the average equity mutual fund in last 48 years has been:

Answer 33

below that of a passive index fund holding a portfolio to replicate a broad-based index like S&P 500 or Wilshrie 50000

Question 34

what are some of the reasons for why the average equity mutual fund has underperformed passive index funds?

Answer 34

• costs incurred by actively managed funds (to conduct research to pick stocks)
• trading costs due to higher turnover
  record

Question 35

New trading strategies - 3 types

Answer 35

1) Algorithmic trading
2) dark pools
3) bond trading

Question 36

1) Algorithmic trading

Answer 36

delegates trading to computer program - high frequency trading a form of this, computers quickly initiate orders –> increases liquidity

Question 37

2) dark pools

Answer 37

for large traders wanting to remain anonymous through use of ‘blocks’ in private trading systems (trades not reported until after they’re crossed)

Question 38

what has the impact of electronic been on markets?

Answer 38

pressure to make international alliances or merges to globalise markets

Question 39

2 types of trading costs

Answer 39

a) explicit (brokerage commissions)

2) implicit costs ( dealer’s bid ask spread)

Question 40

implicit costs - when we deal with investors to buy and sell stock, we’re always:

Answer 40

selling at a price that’s a bit lower than what we’re buying at – source of profit for dealer, but for us as an investor it’s a transaction cost

Question 41

what do you use buying on margin for?

Answer 41

increase overall size of the funds –> take a leveraged position in the stock through –> A broker’s call loan - borrowing from the broker

Question 42

If there’s a margin of 50% of stock worth $10k what does this imply?

Answer 42

we’re putting up $5k of our own $$$ (equity proportion as the investor) and the other $5k from a broker

Question 43

maintenance margin

Answer 43

min equity that must be kept in a margin account

Question 44

maintenance margin: if stock value falls below (say $4000), margin call is made to guard against this &

Answer 44

the broker will issue a margin call which requires the investor to add new cash/securities to the margin account.

Question 45

If investor doesn’t respond to a margin call,

Answer 45

broker may sell securities from the acc to pay off enough of the loan to restore the % margin to an acceptable level

Question 46

2 step mechanics of a short sale:

Answer 46

1. investor borrows stock from broker and sells it
2. investor must hen purchase a share of the same stock in order to replace the one that was borrowed (referred to as covering the short position)

Question 47

ETFs

Answer 47

offshoots of mutual funds that allow investors to trade index portfolios just as they do shares of stock

Question 48

margin on short position =

Answer 48

equity (contributed by investor themselves)/value of shares owed

Question 49

rate of return on investment for margins

Answer 49

= (ending value of equity - initial equity)/initial equity

Question 50

Risk and Return of Illiquid Investments: A Trade‐off for Superannuation Funds Offering Transferable Accounts - READING - main finding:

Answer 50

across both retail and not-for-profit funds, there is a broad cross-section of investment in illiquid assets; BUT not-for-profit funds have higher illiquid asset allocation on average.
In the sample period for this study, superannuation funds realise returns from illiquid investments that reflect the non-diversifiable risk these investments contribute to the funds’ portfolios.

If the diversification benefits derived from illiquid asset classes are not at a cost of reduced investment performance, funds which include these asset classes in their portfolios will offer a better risk–return trade-off.

Question 51

Investor flows and the assessed performance of open-end mutual funds (Roger)

Answer 51

Open-end mutual funds’ tendency toward underperformance has little to do with a lack of ability on the fund manager’s part. It results from the liquidity service that fund managers provide investors.

Question 52

offering price =

Answer 52

NAV/1- load

load being % fee charged by the fund

Question 53

rate of return =

Answer 53

(end E in acc - initial E in acc)/initial E in acc

Question 54

portfolio turnover rate =

Answer 54

value of the stocks sold and replaced / total market value of the shares oustanding(firm assets)

Question 55

to determine whether a fund sells at a premium or discount:

Answer 55

= (price - NAV)/NAV

Question 56

in contrast to closed-end funds, the price of open-end funds will never fall below NAV because

Answer 56

these funds stand ready to redeem at NAV. However, the offering price will exceed NAV if fund carries a load (a sales charge)