week 2 - exam

Question 1

what regulatory guide regulates short-selling?

Answer 1

rg196

Question 2

Describe the different money market instruments.

Answer 2

certificates of deposit, which are bank term deposits;

bank accepted bills, which are debt instruments guaranteed by a bank;

commercial paper, which is debt issued by a large corporation;

Treasury bills or notes, which are short-term debt instruments issued by the government.

Question 3

Which asset class are the following instruments associated with?

Bank bills.
Preferred stock.
Mortgage-backed securities.

Answer 3

Bank bills—money market
Preferred stock—equity market
Mortgage backed securities—bond market

Question 4

Describe the various types of asset classes. Provide an example of a financial instrument under each asset class.

Answer 4

money market: short-term highly liquid debt i.e. bank bills

Bond market: long term debt - i.e. government bonds

equity market: the issuance of equities whereby owner share company profits i.e. common stock

derivative market: whereby asset backed options or futures are traded. i.e. put options

Question 5

What is meant by limited liability?

Answer 5

Limited liability means that most shareholders can lose in event of the failure of the corporation in their original investment.

Question 6

What are the key differences between common/ordinary stock, preferred stock and corporate bonds?

Answer 6

Common stock represents an ownership share in a publicly held corporation. Common shareholders have voting rights and may receive dividends.

Preferred stock also represents an ownership in a corporation. They differ from common stock as they pay a fixed dividend for the life of the stock.

Corporate bonds are long-term debt issued by corporations, typically paying semiannual coupons and returning the face value of the bond at maturity. In contrast to stocks, bonds do not represent ownership in a company.

Question 7

ou are convinced that the S&P/ASX200 will increase by 20% this month and would like to buy a derivative to profit from this view. Which of the following derivatives should you consider?

A. S&P/ASX200 call option.
B. S&P/ASX200 put option.
C. S&P/ASX200 future.

Answer 7

Both A. and C. call options and futures will increase in value with an increase of 20% in the underlying asset.

Question 8

Explain the difference between a put option and a short position in a futures contract.

Answer 8

A put option conveys the right to sell the underlying asset at the exercise price. A short position in a futures contract carries an obligation to sell the underlying asset at the futures price.

Question 9

Explain the difference between a call option and a long position in a futures contract.

Answer 9

A call option conveys the right to buy the underlying asset at the exercise price. A long position in a futures contract carries an obligation to buy the underlying asset at the futures price.

Question 10

You are running a large superannuation fund and have decided to create a new investment portfolio. You have $10 billion to invest but must follow the investment guidelines of the super fund. The guidelines state the following:

no derivatives allowed
minimum $2 billion in money-market investments
maximum $5 billion in bonds.
Which of the following portfolios are suitable?

A. $2 billion of corporate bonds, $5 billion of preferred stock, $2 billion of international bonds, and $1 billion of bank bills.
B. $2 billion of preferred stock, $3 billion of CDs, and $5 billion of T-notes.
C. $3 billion in CDs, $5 billion in T-notes, and $2 billion in options.

Answer 10

Portfolio B. is the only suitable portfolio. Option A. does not have the minimum amount of money market assets and option C. contains derivatives.

Question 11

The German stock market is measured by which market index?

Answer 11

DAX

Question 12

Preferred stock is like long-term debt in that _______.

Answer 12

it promises to pay to its holder a fixed stream of income each year

Question 13

Which of the following indexes are market value-weighted?

1. The NYSE Composite
2. The S&P 500

3.The Wilshire 5000

Answer 13

1, 2, and 3

Question 14

What would you expect to have happened to the spread between yields on commercial paper and Treasury bills immediately after September 11, 2001?

Answer 14

Increase, as the spread usually increases in response to a crisis.

Question 15

The purchase of a futures contract gives the buyer _______.

Answer 15

the obligation to buy an item at a specified price

Question 16

Ownership of a put option entitles the owner to the _______ to _______ a specific stock, on or before a specific date, at a specific price.

Answer 16

right; sell

Question 17

Treasury bills are financial instruments issued by _______ to raise funds.

Answer 17

the federal government

Question 18

The U.K. stock index is the _________.

Answer 18

FTSE

Question 19

Commercial paper is a short-term security issued by ______ to raise funds.

Answer 19

large well-known companies

Question 20

What is the difference between an IPO (initial public offering) and placement?

Answer 20

An IPO is the first time a formerly privately owned company sells shares to the general public. Placement is the issuance of shares by a company that has already undergone an IPO.

Question 21

What are some different components of the effective costs of buying or selling shares?

Answer 21

Costs can be categorised as explicit, such as brokerage fees, or implicit such as the bid−ask spread and market impact.

Question 22

What is the difference between a primary and secondary market?

Answer 22

The primary market is the market for new issues of securities, while the secondary market is the market for already-existing securities. Companies sell shares in the primary market, while investors purchase shares from other investors in the secondary market.

Question 23

What are the differences between a stop loss order, a limit sell order and a market order?

Answer 23

A stop loss order is a trade that is not to be executed unless the stock hits a specified price limit. The stop loss is used to limit losses when prices are falling. A limit sell order is an order specifying a price at which an investor is willing to sell a security. A market order directs the broker to buy or sell at whatever price is available in the market.

Question 24

How do margin trades magnify both the upside potential and downside risk of an investment portfolio?

Answer 24

Margin is a type of leverage that allows investors to post only a portion of the value of the security they purchase. As such, when the price of the security rises or falls, the gain or loss represents a much higher percentage, relative to the actual money invested.

Question 25

Initial public offerings (IPOs) are usually _______ relative to the levels at which their prices stabilize after they begin trading in the secondary market.

Answer 25

underpriced

Question 26

You short-sell 200 shares of Tuckerton Trading Company, now selling for $50 per share. What is your maximum possible loss?

Answer 26

There is no upper limit to the price of a share of stock and, therefore, no upper limit to the price you will have to pay to replace the 200 shares of Tuckerton.

Question 27

The New York Stock Exchange is a good example of a(n) _______ market.

Answer 27

auction

Question 28

The bid-ask spread exists because of _______.

Answer 28

the need for dealers to cover expenses and make a profit

Question 29

Consider the following limit order book of a specialist. The last trade in the stock occurred at a price of $40. If a market buy order for 100 shares comes in, at what price will it be filled?

Limit Buy Price Orders Shares Limit Sell Orders Orders
$ 39.75 100 $ 40.25 100
$ 39.50 100 $ 40.50 100

Answer 29

In this case the specialist would have the option of matching the buy order with the lowest limit sell order ($40.25) or setting an ask price lower than $40.25 ($40 for example) and trading the order from his own stock.

Question 30

The process of polling potential investors regarding their interest in a forthcoming initial public offering (IPO) is called ______.

Answer 30

book building

Question 31

Transactions that do not involve the original issue of securities take place in _______

Answer 31

secondary markets

Question 32

The difference between the price at which a dealer is willing to buy and the price at which a dealer is willing to sell is called the _______.

Answer 32

bid-ask spread