Differentiate between each of the following pairs of terms.
a. Money market & capital market
a. In the money markets, short-term securities such as CDs (maturities ? 1 year), Treasury bills, and commercial paper, etc. are traded. Long-term securities such as stocks and bonds are traded in the capital markets.
Differentiate between each of the following pairs of terms.
b. Primary market & secondary market
b. New securities, first-time issues, are sold in the primary market. Once a security has been issued, it can be bought and sold in the secondary market.
Differentiate between each of the following pairs of terms.
c. Broker market & dealer market
c. Broker markets are security exchanges with centralized locations (real or virtual) where securities listed on a particular exchange are traded. Brokers facilitate trades by bringing buyers and sellers together, but don't generally buy or sell the trade
2. Briefly describe the IPO process and the role of the investment banker in underwriting public offerings.
The investment banker is a financial intermediary who specializes in selling new security issues as either initial public offerings (IPOs) or seasoned equity offerings. Underwriting involves the purchase of a security issue from the issuing firm at an agr
Differentiate among the terms public offering and private placement.
In a public offering, a firm offers its shares for sale to the general public after registering the shares with the SEC. In a private placement, rather than issue shares publicly, shares are sold directly to investors who can purchase large volumes of sha
Explain how the dealer market works. Be sure to include market makers, bid and ask prices, the Nasdaq market, and the OTC market. What role does the dealer market play in initial public offerings (IPOs) and secondary distributions?
The dealer market is really a system of markets linked together by sophisticated telecommunications systems. In the United States, it accounts for about 40% of the total dollar volume of all shares traded. These markets are made up of traders known as dea
What is the third market?
The third market consists of over-the-counter transactions made in securities listed on the NYSE or one of the other exchanges. Trades are generally made with the help of brokers who are not exchange members.
What is the fourth market?
The fourth market consists of transactions using a computer network rather than an exchange. Offers to buy and sell are computer matched when they are identical. If not, offers are posted anonymously and do not trade until an opposing, identical offer is
Differentiate between a bull market and a bear market.
A bull market is a favorable market normally associated with rising prices, investor optimism, economic recovery, and government stimulus. In contrast, bear markets are associated with falling prices, investor pessimism, economic downturn, and government
How are after-hours trades typically handled? What is the outlook for after-hours trading?
After-hours orders are typically filled only if they can be matched with identical opposing orders at the desired price. Many large brokerage firms, both traditional and online, offer after-hours trading sessions for clients.
ECNs handle after-hours tradi
What is a long purchase? What expectation underlies such a purchase?
A 'long' purchase occurs when an investor buys a security in the hope that it will increase in price and can be sold at a later time for a profit. The long purchase is the most common type of transaction. Its returns are the result of dividends or interes
What is margin trading. What is the main reason that investors sometimes use it when making long purchases?
Trading on margin involves buying securities partly with borrowed funds. Investors use margin to lower the amount of their own money involved in investments. This allows the investor to buy more securities than he otherwise could have. Using borrowed mone
How does margin trading magnify profits and losses? What are the main advantages and disadvantages of margin trading?
When buying on margin, the investor puts up part of the required capital. This is the equity portion of the investment and is the investor's margin. The investor's brokerage house then lends the remaining money necessary to make the transaction. Magnifica
Describe the procedures and regulations associated with margin trading. Include an explanation of restricted accounts, maintenance margin, and margin call.
To execute a margin transaction, an investor must establish a margin account. Although the Fed sets the minimum amount of equity for margin transactions, it is not uncommon for brokerage houses to set their own, more restrictive requirements.
Describe the procedures and regulations associated with margin trading. Include an explanation of restricted accounts, maintenance margin, and margin call. (continued)
Once a margin account is established, the investor must provide the minimum amount of required equity at the time of purchase. This is called the initial margin. It is intended to prevent excessive trading and speculation. If the value of the investor's a
Describe the procedures and regulations associated with margin trading. Include an explanation of restricted accounts, maintenance margin, and margin call. (continued)
The size of the margin loan is called the debit balance and is used in conjunction with the margined securities value (the collateral) to calculate the value of an investor's margin. Typically, margin is used to magnify returns on a long purchase. When a
What is the primary motive for short selling? Describe the basic short-sale procedure. Why does the short seller make an initial equity deposit? What do margin requirements have to do with the short-selling process?
Investors who attempt to profit by short selling, intend to 'sell high and buy low.' This is the reverse order of the usual (long purchase) transaction. The investor borrows shares and sells them, hoping to buy them back at a later time at a lower price.
What is the primary motive for short selling? Describe the basic short-sale procedure. Why does the short seller make an initial equity deposit? What do margin requirements have to do with the short-selling process?(continued)
Equity capital must be deposited with the brokerage house by the short seller. The amount is the same as the broker's initial margin requirements. This margin and the proceeds of the short sale provide the broker with assurance that the securities can be
What are the main advantages and disadvantages of short selling?
The major advantage of short selling is the chance to make money when the price of a security falls. The major disadvantage of short selling is the high risk exposure in the face of limited returns and unlimited potential losses. In addition, short seller
. From 1990 to 2005, the average IPO rose by more than 20% in its first day of trading. In 1999, 117 deals doubled in price on the first day, compared to only 39 in the previous 24 years combined. Since 2000, no deals have doubled on their first day. What
One reason for initial high returns is the significant amount of hype that surrounds new issues and underpricing by underwriters. This was especially true in the late 1990s during the 'tech bubble.' Investor demand for shares of new tech firms far exceede
Why do some large, well-known companies such as Cisco Systems, Intel, and Microsoft prefer to trade on Nasdaq rather than on the NYSE? Discuss the pros and cons of listing on security exchanges.
The main advantage of listing on the NYSE is the perception of greater prestige and public awareness of the firm. At one time, the NYSE was thought to provide the highest level of liquidity. Over time, however, the size of Nasdaq increased and its transac
On the basis of the current structure of the world' financial markets and your knowledge of the NYSE and Nasdaq markets, describe the main features, functions and problems that would be faced by a single global market exchange on which transactions could
Not all security markets are open simultaneously although, the possibility of trading in after-hour markets exists. This assumes that markets are equivalent in terms of liquidity and information-providing ability. There is talk of a market that could trad
Describe how, if at all, conservative and aggressive investors might use each of the following types of transactions as part of their investment programs. Contrast these two types of investors in view of these preferences.
a. Long purchase
(a) Long purchases are typically used by more conservative investors. They are most able to ride-out negative market conditions and are betting with general, long-term market trends (up).
Describe how, if at all, conservative and aggressive investors might use each of the following types of transactions as part of their investment programs. Contrast these two types of investors in view of these preferences.
b. Margin trading
(b) Margin trading is typically used by aggressive investors seeking short-term capital appreciation (increase in value).
Describe how, if at all, conservative and aggressive investors might use each of the following types of transactions as part of their investment programs. Contrast these two types of investors in view of these preferences.
c. Short selling
(c) Short selling is typically used by aggressive investors seeking short-term profits from falling security prices. They are betting against long-term market trends.
An American investor believes that the U.S. dollar will rise in value relative to the Japanese yen. This investor is considering two investments with identical risk and return characteristics: One is a Japanese yen investment whose returns he will have to
No. The investor will lose money in the currency exchange if the U.S. dollar gains strength relative to the Japanese yen.
Elmo Inc.'s stock is currently selling at $60 per share. For each of the following situations (ignoring transactions costs), calculate the gain or loss that an investor realizes if she makes a 100 share transactions.
a. She sells short and repurchases the
Securities' price = $60 x 100 shares = $6000
If the investor sells short, her account is credited with $6000.
When she repurchases, the securities' price = $70 x 100 = $7,000.
$6000 (sell price) - $7000 (buy price) = -$1000. She loses $1000
Elmo Inc.'s stock is currently selling at $60 per share. For each of the following situations (ignoring transactions costs), calculate the gain or loss that an investor realizes if she makes a 100 share transactions.
b. She takes a long position and sells
Securities' price = $60 x 100 shares = $6000
Buy price = $6000
Sell price = $75 x 100 shares = $7500
$7500 (sell price) - $6000 (buy price) = $1500. She gains $1500
Elmo Inc.'s stock is currently selling at $60 per share. For each of the following situations (ignoring transactions costs), calculate the gain or loss that an investor realizes if she makes a 100 share transactions.
c. She sells short and repurchases the
Securities' price = $60 x 100 shares = $6000
Sell price = $6000
Buy price = $45 x 100 shares = $4500
$6000 (sell price) - $4500 (buy price) = $1500. She gains $1500
Elmo Inc.'s stock is currently selling at $60 per share. For each of the following situations (ignoring transactions costs), calculate the gain or loss that an investor realizes if she makes a 100 share transactions.
d. She takes a long position and sells
Securities' price = $60 x 100 shares = $6000
Buy price = $6000
Sell price = $60 x 100 shares = $6000
$6000 (sell price) - $6000 (buy price) = 0. She neither gains nor loses. In reality, there would be commission costs (both when buying and selling) which
Assume that an investor buys 100 shares of stock at $50 per share, putting up a 60% margin.
a. What is the debit balance in this transaction?
Securities' price = $50 x 100 shares = $5000
Debit = (1 - .6) = .4; $5000 x .4 = $2000
Assume that an investor buys 100 shares of stock at $50 per share, putting up a 60% margin.
b. How much equity must the investor provide to make this margin transaction?
Margin = .60 x $5000 = $3000 OR $5000 - $2000 = $3000
Assume that an investor buys 100 shares of stock at a $50 per share, putting up a 60% margin.
a. What is the debit balance in this transaction?
Securities' price = $50 x 100 shares = $5000
Debit = (1 - .6) = .4; $5000 x .4 = $2000
Assume that an investor buys 100 shares of stock at a $50 per share, putting up a 60% margin.
b. How much equity must the investor provide to make this margin transaction?
Margin = .60 x $5000 = $3000 OR $5000 - $2000 = $3000
Assume that an investor buys 100 shares of stock at a $50 per share, putting up a 60% margin.
c. If the stock rises to $60 per share, what is the investor's new margin position?
New value = $60 x 100 = $6000
Margin = (Value - Debit balance)/Value
Margin = ($6000 - $2000)/$6000 = 66.67%
Describe the basic philosophy and use of stock market averages and indexes. Explain how the behavior of an average or index can be used to classify general market conditions as bull or bear.
Stock market averages and indexes are used to measure the general behavior of the security markets they are representative of. They are a convenient way to capture the general mood of the market. When they reflect a sustained upward trend in prices over t
Differentiate among market orders, limit orders, and stop orders. What is the rationale for using a stop order rather than a limit order?
i.)market order
is an order to buy or sell a security at the best price available at the time the order is placed and It's the quickest way to make security transactions
Differentiate among market orders, limit orders, and stop orders. What is the rationale for using a stop order rather than a limit order?
ii.)limit order
is an order to buy stock at or below a specified price or to sell stock at or above a specified price. It's best used when securities prices are fluctuating within a trading range.
Differentiate among market orders, limit orders, and stop orders. What is the rationale for using a stop order rather than a limit order?
iii.) stop order
is a suspended order to buy or sell stock. When the stock's price reaches or passes through some specified price (the stop price), the suspended order is activated as a market order. This order is used primarily by investors wanting to protect themselves
Differentiate among market orders, limit orders, and stop orders. What is the rationale for using a stop order rather than a limit order?
When the stop price is reached, the automatic order execution limits how far the stock's price can move against the investor. Thus, the stop order reduces potential losses.
What is day trading. Why is it risky?
i.) day trading
Day trading is a trading strategy that involves extremely short-term trading. True day traders don't hold any stock positions overnight. The strategy uses high-risk methodologies that often include margin and short-sale transactions that can end in total
What is day trading. Why is it risky?
ii.) Why is it risky?
Several important factors should be considered before trading securities. First, know how to place and confirm orders before you begin trading. Second, verify the stock symbol of the security you wish to buy. Third, don't ignore online reminders asking yo
What protection does the Securities Investor Protection Corporation (SIPC) provide to investors?
The Securities Investor Protection Corporation (SIPC), a nonprofit membership corporation, is authorized to protect customer accounts against the financial failure of brokerage firms. It does NOT protect investors against investment losses. SIPC only insu
Chris estimates that if he does 5 hours of research using data that costs him $75, there's a good chance that he can improve his expected return on a $10,000, 1-year investment from 8% to 10%. Chris feels that he must earn at least $20 per hour on the tim
Cost of research: Five hours at $20 per hour $100
Research data 75
Total $175
Chris estimates that if he does 5 hours of research using data that costs him $75, there's a good chance that he can improve his expected return on a $10,000, 1-year investment from 8% to 10%. Chris feels that he must earn at least $20 per hour on the tim
Increase in expected return:
New return of 10% - Current return of 8% = 2% increase
$10,000 investment x .02 increase = $200
q
Chris estimates that if he does 5 hours of research using data that costs him $75, there's a good chance that he can improve his expected return on a $10,000, 1-year investment from 8% to 10%. Chris feels that he must earn at least $20 per hour on the tim
Yes; the expected increase in return is greater than the cost of doing the research.
You place a limit order to buy 100 shares of ABC at $38 a share. The stock is currently selling for $41. Discuss the consequences of each of the following:
(a) The stock price drops to $39 per share two months before the limit order expires.
The order will not execute. The limit order will only execute if the stock can be bought for $38 or less. However, since there are two months remaining before the limit order expires, it's still possible that the order could execute if conditions are met.
You place a limit order to buy 100 shares of ABC at $38 a share. The stock is currently selling for $41. Discuss the consequences of each of the following:
(b) The stock price drops to $38 per share.
At a price of $38 per share, your broker will buy 100 shares of ABC stock at a total cost of $3,800. This assumes that the stock price doesn't rise above $38 before your order can execute. Orders with higher precedence levels can delay your purchase durin
You place a limit order to buy 100 shares of ABC at $38 a share. The stock is currently selling for $41. Discuss the consequences of each of the following:
c) The minimum stock price achieved before the limit order expires was $38.50. Following the order
This example illustrates that limit orders can prevent transactions from occurring. Since the price didn't go below $38.50, the limit order expired without being executed. If you had bought the stock at $41 instead of placing a limit order, you might have
If you place a stop order to sell at $23 on a stock currently selling for $26.50 per share, what is your likely minimum loss on 50 shares if the stock price rapidly declines to $20.50 per share?
The minimum loss you would experience in this case is $3.50 per share or $175 on the total investment (50 shares at $3.50 per share). It's important to realize that this is a minimum loss. This is because when the stock price falls to $23, the stop order
You short sell 100 shares of stock for $40 per share. You want to limit your loss on this transaction to no more than $500. What order should you place?
You should place a stop order to buy 100 shares at approximately $45or perhaps a slightly lower price. Since a stop order converts to a market order upon activation, you can't be sure of the exact price at which you'll exit the transaction.
You've been watching a stock that currently trades at $50 per share. You'd buy it if it were less expensive, say $47 per share. You think that by year-end, the stock will go to $70 and then level off or decline. You place a limit order to buy 100 shares a
Since the stock never fell to the limit order buy price, you never purchased it. However, if you're in a margin account, you sold it at $70 per share, so you are now short 100 shares. Because the stock is currently selling for $75, your current position i
You have $5,000 in a 50% margin account. There is a stock you'd like to buy that currently sells for $52. You decide that if the stock falls to $50, you'll buy it. You place a limit order to buy 300 shares at $50. The stock falls to $50. What happens?
Probably nothing will happen. Although you placed a stop order to buy the stock and the limit price was hit, you didn't have enough equity in your account to make the transaction. Three hundred shares at $50 per share would be a $15,000 investment. You co