Topic 4

Question 1

What are stocks (/common stock/equity)?

Answer 1

Shares in a firms ownership

Question 2

2 rights stockholders have?

Answer 2

Entitled to share in the profits

Entitled to vote at firms annual meeting

Question 3

Returns from stocks given by?

Answer 3

Increasing price of stocks or dividends

Question 4

What is a residual claimant?

Answer 4

The last people to get paid if a firm is shutting down

Stockholders are these people

Question 5

How much liability do stockholders have in a firm?

Answer 5

Limited - if a firm fails the most they can lose is their initial investment

Question 6

2 main changes in a firm when public stocks are issued?

Answer 6

Changes in ownership (increase in number of owners)

Changes in a firms capital structure (increase in equity investment)

Question 7

What is an IPO?

Answer 7

Initial public offer:

Initial issuing of stocks to the public

Question 8

4 stages of IPO?

Answer 8

1) develop prospectus (contains info about a firm and its financial status)
2) pricing (price of shares at time of IPO)
3) allocation of IPO shares
4) transaction costs

Question 9

What is ‘leaving money on the table’?

Answer 9

Selling shares for a lower price

Question 10

What is ‘flipping shares’?

Answer 10

Purchasing stock at its offer price and selling it shortly afterwards

Question 11

What are organised exchanges?

Answer 11

Auction markets that use floor traders who specialise in particular exchanges (secondary market)

Question 12

What are over the counter dealers?

Answer 12

A collection of dealers in the secondary market who trade with one another electronically

Question 13

What is an order driven market?

Answer 13

A market where all participants are natural buyers and sellers with no dealer acting as an intermediary

Question 14

What is a quote driven market?

Answer 14

A market where the price is determined by the dealer, based on prevailing market conditions

Question 15

Define orders?

Answer 15

Instructions to trade that traders give to their brokers and exchanges that arrange their deals

Question 16

What do orders specify? (3)

Answer 16

Security to be traded
Quantity to be traded
Buy or sell

Question 17

What is a bid?

Answer 17

A buy order specifying a price

Question 18

What is an offer (/ask)?

Answer 18

Sell order specifying a price

Question 19

What is a best bid?

Answer 19

A standing buy order that bids the highest price bid

Question 20

What is a best offer?

Answer 20

A standing sell order that has the lowest price offer

Question 21

What is a bid ask spread?

Answer 21

Difference between best offer and best bid

Question 22

Condition for profit when trading stocks?

Answer 22

Ask - bid > 0

Question 23

What are propriety orders?

Answer 23

Orders submitted by traders for their own account

Question 24

What are market orders?

Answer 24

Orders to buy or sell at the best available price currently in the market

Question 25

What are limit orders?

Answer 25

designated price thresholds for the trade

Question 26

What is short selling?

Answer 26

Selling a stock you don’t own and you have to buy it back later

Question 27

What is long selling?

Answer 27

Selling a stock after buying it yourself

Question 28

What is buying on margin?

Answer 28

Borrowing to buy securities and using them as collateral

Question 29

What are ECNs and what do they do?

Answer 29

Electronic communications networks - allow brokers and traders to trade without an intermediary

Question 30

4 advantages of ECNs?

Answer 30

Provide: transparency, cost reduction, faster execution, after-hours trading

Question 31

3 problems of ECNs?

Answer 31

Only work well for high volumes of stocks
Different ECNs competing for volume therefore confusing
Main exchanges are fighting ECNs by expanding their own auto trading systems

Question 32

What do exchange traded funds (ETFs) do and what are they?

Answer 32

‘Basket of securities’, all known, that are traded on exchanges

They keep down transaction costs and provide diversification

Question 33

What are stock market indexes?

Answer 33

Indexes used to monitor the behaviour of a group of stocks

Question 34

3 uses of stock market indexes?

Answer 34

• tells change in average stock
• tells change in average wealth
• performance indicator for money managers

Question 35

What is a price weighted average index?

Answer 35

An index giving greater weight to shares with higher prices tf higher priced stocks dominate the movement of the index (DJIA)

Question 36

What is the Dow Jones industrial average index?

Answer 36

30 largest US companies, measures value of purchasing a single share of each of the stocks in the index

Question 37

What is a value weighted index?

Answer 37

Larger firms carry more weight

Question 38

What does the standard and poor’s 500 index measure?

Answer 38

Based in >500 largest US firms, tracks total value of those firms

Question 39

Market capitalisation = ?

Answer 39

Stock Quantity x stock price

Question 40

2 benefits of stock markets?

Answer 40

Helps to allocate resources efficiently and see how the economy is doing

Question 41

2 ways stock market can be misleading way to judge the economy?

Answer 41

Euphoria - high confidence leads to increased prices of stock tf ‘bubbles’ tf crashes
Depression - vice versa

Question 42

What is a bubble?

Answer 42

A gap between the true stock price and the selling prices on the market