Week 2

Question 1

What type of strategy is security selection?

Answer 1

Bottom up, we start from specific securities and whittle them down.

Question 2

What are the main fixed income options?

Answer 2

These primarily come in the form of money markets:

• Treasury bills, money loaned to the government.
• Certificates of deposits (deposits with the banks)
• Commercial paper, short term loans for companies.
• Bankers’ acceptances, telling a bank we want to make a payment to someone at a future point.
• Eurodollars, a deposit done in a currency outside the home currency.
• LIBOR (London Interbank offer rate), an interest rate used between banks for very short loans.

Question 3

What are the two main forms of company equity?

Answer 3

Common stock, in this case investors have residual claim and limited liability to the company, they have voting rights).
Preferred stocks, in this case the investor has no voting rights, and fixed dividends.
The common stock shareholders are last in line for payments from the company, they come after the preferred stock payments.

Question 4

What is the holding period return made from?

Answer 4

(Sell price of stock - buy price + dividend)/buy price, this is constructed from the dividend yield (dividend/buy) and the capital gains yield ((sell-buy)/buy)

Question 5

What do stock indices generally capture?

Answer 5

The health of the market.

Question 6

How do we generate a price weighted index?

Answer 6

Take the total index price and divide it by the number of companies.

Question 7

What is a stock split? What index does it mainly affect?

Answer 7

A stock split takes stocks and gives each person that has one two shares, though the value of each is halved. The split could be more than just two for 1.
Stock splits, and reverse splits mostly affect the value of a price weighted index.

Question 8

What is a reverse stock split?

Answer 8

People who own more than one share will have them condensed into less and the price will go up as a result.

Question 9

Why are stock splits useful?

Answer 9

They can make the share price more affordable for investors.

Question 10

Why do companies do initial public offerings?

Answer 10

Selling shares allows the company to get money to aid its expansion.

Question 11

Where can securities be traded?

Answer 11

Direct search markets (buyer finds sellers or vice versa), brokered markets (investment bankers assist buyers and sellers to find each other), dealer markets (over the counter market, typically more for bonds and foreign currency).

Question 12

What are BID and ASK prices? How does this relate to transaction price?

Answer 12

BID prices are offers to buy, ASK prices are offers to sell. Investors will buy at the ASK price and sell at the BID price.
The BID-ASK spread is given by the ASK - the BID, it can be seen as a transaction price.

Question 13

What are the main types of stock market index by weighting method?

Answer 13

Market-capitalization (total market capitalization/number of shares in total).
Price weighting (sum of price/number of stocks).
Equal weighting (average stock value)

Question 14

What occurs to a price weirghted index in the event of a stock split?

Answer 14

The price will remain the same, but the divisor of the index must change. This divisor must be used for all further index evaluations on that index, and will only change with stock splits or reverse splits.

Question 15

Why can it be useful to treat the total value of a mutual fund as a market cap?

Answer 15

This allows us to get the average price if we know the number of shares, or the number of shares given a price.

Question 16

Which price is higher ASK or BID?

Answer 16

ASK is always higher.

Question 17

What is a price-contingent order? How do these relate to but and sell orders?

Answer 17

An order to buy or sell stock once the price reaches a certain value. These could ocur when the price falls below the limit(a limit buy order or a stop-loss sell order), or when the price rises above the limit (stop-buy order or limit sell).

Question 18

What are the trading costs for investors typically made up of?

Answer 18

Transaction costs and bid-ask spread.

Question 19

What is margin? What are the main margin important values?

Answer 19

We can trade using margin, this is essentially getting a loan. We will need to pay interest on this. The initial margin requirement is typically our down payment, the maintenance margin requirement(MMR) details the minimum amount of equity we can hold in the investment, if we go below this amount a margin call will occur. MMR must remain less than our equity divided by the market value of investment

Question 20

What is a margin call?

Answer 20

A margin call occurs when we go below our margin maintenance requirement, we will have to top up to bring our equity to total investment ratio above this level. Otherwise the investment will be sold off, locking in losses.

Question 21

What is the equity of an investor given by?

Answer 21

At the start this is typically their Initial margin requirement, it is the market value - the borrowed amount.

Question 22

What is a short sale?

Answer 22

A short sale is when we sell something we don’t have by borrowing it, and then buying the item back later at a different date. For stocks we also have to make sure to give any dividends the purchaser is entitled to.
We do this when we think a stock’s value will go down.