Question 1
In this module we defined financial intermediaries as institutions that facilitate between suppliers and borrowers of capital. Which of the following is NOT a financial intermediary?
Insurance company No. Insurance companies are an example of financial intermediaries.
Investment company No, that is not correct. Investment companies facilitate capital between providers and demanders of capital.
Pension fund No, pension funds are a type of financial intermediary.
Credit Unions No, credit unions are a type of financial intermediary.
None of the above. Yes, that is the correct answer. All of the institutions listed above play a role in facilitating the flow of capital between savers and borrowers.
Question 2
Which of the following is true?
Open-end funds will redeem shares for asset value at the request of the investor. Closed-end funds do not redeem shares and are traded like other securities. Yes, this statement is correct. Investors in open-end funds can cash out by selling them back to the fund at the net asset value. Investors in closed-end funds who wish to cash out must sell their securities to other investors.
Share price of a closed end fund can often deviate from its net asset value. Yes, this statement is correct. Closed end funds can often trade at a premium or discount relative to net asset value. Any others?
Hedge funds are subject to much less regulation than mutual funds. Yes, that is a correct statement. Hedge funds are like mutual funds in that they allow private investors to pool assets to be invested by a fund manager. They are subject to minimal SEC regulation and are therefore only open to wealthy or institutional investors.
Unlike mutual funds which can be traded only at the end of the day when net asset value is calculated, exchange-traded funds can be traded throughout the day like any other share of stock. Yes, that is a correct statement.
All of the above.
Question 3
If you decide to sell your Facebook shares to another investor…
A. This is a transaction that takes places in the primary market. No. this is not correct. Primary market is the market where companies issue securities for the first time. Revisit the lecture on primary and secondary markets around 2:00.
B. This is a transaction that takes place in the secondary market. Yes, that is correct.
C. This transaction will have an impact on the total number of outstanding shares of Facebook. No, this is not correct. This type of transaction does not change the total number of outstanding shares.
D. Both B and are C are correct. No, C is not a correct statement. Revisit the lecture on primary and secondary markets around 2:00.
Question 4
Which of these statements are true?
A private placement is easier and less costly to a private firm compared to an IPO. Yes, that is correct. Private placements do not require as much information and have easier registration requirements.
Private placements can be used by both private and public firms that wish to raise funds from a limited number of investors. Yes, that is correct. Private placements can be used by both private and public firms. What makes them a private placement is the fact that the securities are not offered to public at large but only to a small limited number of investors.
Privately placed shares are traded on exchanges. No, that is not correct. Private placements are not public issues and are not traded.
Private placements often lead to seasoned equity offerings. No, that is not correct. Private placements are not public offerings. So a firm would still have to do an initial public offering before they would do a seasoned equity offering.
Question 5
Which of the following is true about the IPO process?
A. The entire offering by the issuing company has to be purchased by the underwriter. No, that is not correct. The underwriter is not obligated to purchase the entire offering. It only does so, if the offer is a firm commitment.
B. The underwriter can either purchase the entire offering from the issuing company or only facilitate the sale of shares to the public. Yes, that is correct. The underwriter can choose to do either a firm commitment or best effort. In the latter, the underwriter does not purchase the offer but help sell the offer to the public.
C. The return on an IPO is always guaranteed. No, the return on an IPO is not guaranteed.
Both B and C are correct. No, b is correct, but c is not.
Question 1
Which of the following statements is true about limit orders?
A. A limit order controls the price but does not guarantee that the order will be filled. Yes, this is a true statement. A limit order is price contingent order. It will get filled if the price meets the conditions of the order.
B. Limit orders are executed at the best price available. No, this is not correct.
C. A limit order is recorded in the limit order book until it can be executed. Yes, this is a true statement. Limit orders are entered into the limit order book until they can be executed.
Both A and C Yes, both a and c are correct statements. By definition a limit order is an order to buy or sell at a maximum or minimum price, therefore it will guarantee the execution price of the order, but this type of order does not guarantee that the order will be filled. The limit order book is the collection of limit orders waiting to be executed.
Question 2
You are concerned about the value of your holdings in company A shares. You instruct your broker to sell your shares when the price falls down to $30 per share. What type of order is this?
A market order No, that is not correct. Market orders are executed at the best possible price. They are not price contingent.
A stop-loss order Yes, this is correct. Stop-loss orders ask that the stock be sold if its price falls below a certain level.
A stop-buy order No, that is not correct. A stop-buy order specifies that a stock should be bought when its price rises above a certain limit.
Question 3
You would like to liquidate your shares in company B, but you only want to sell them if the price is at least $25 per share. What kind of order would you place with your broker?
A market order No that is not correct. A market order is executed at the best possible price. It is used for immediacy.
A limit order Yes, that is correct. Limit orders are price contingent orders.
A stop-loss order No, that is not correct. Stop-loss orders specify that the stock be sold if its price falls below a certain level.
A stop buy order No, that is not correct. A stop-buy order specifies that a stock should be bought when its price rises above a certain limit.
Question 4
Which of the following is true?
A maintenance margin is the minimum amount the margin account can decline to without an investor having to take any action. Yes, maintenance margin is the threshold that indicates that an investor’s margin account has fallen to its lowest permissible level.
A maintenance margin is the maximum amount the margin account can decline to without an investor having to take any action. No, that is not correct.
A maintenance margin is the amount that the margin account must be kept at all times. No, that is not correct.
Question 5
Which of the following statements is true?
A margin call is a request to sell the securities that you have on your account No, that is not correct. You do not need to sell the securities when you receive a margin call.
A margin call is a request to buy more of the securities you already have. No, that is not correct. A margin call is not a request to buy more of the securities you already have.
A margin call is a request to add more capital to your margin account indicating that the investor’s margin balance has fallen below the maintenance requirement. Yes, that is correct. You receive a margin call, if your equity in your margin account falls below the maintenance requirement and you are asked to add more cash or cash like securities to bring up your equity share to a required level.
A margin call is prank call by marginal investors. No, a margin call is not a prank call.
Question 6
Suppose the initial margin requirement is 5% and you want to purchase 100 shares of Beta stock currently trading at $20 a share. How much would you have to deposit in the margin account to meet this requirement?
When you purchase securities, you can borrow part of the cost. The initial margin requirement is the amount you have to deposit into margin account when you are borrowing the rest.
The value of your holdings is $20 x 100 = $2000. A 5% initial margin requirement means that you have to put at least 5% in your own cash or cash equivalents. 5% x 2000 = $100.
The rest can be borrowed from the broker which gives you a levered position.
Question 7
Consider your holdings in Beta stock in Question 6. Let’s suppose that the maintenance margin requirement is 4%. If you get a margin call stating that your margin has fallen down to 2.564%, what is the current price of Beta stock?
Think about what is the fraction of your equity in the account? How would you solve for the price that makes your equity as a fraction of your holdings equal to 2.564%?
Recall that initially you had to put $100 and borrow $1900 when you bought the shares on margin. That met the initial margin requirement : 100 / (100 x $20) = 5%.
Let P be the price of the stock. The value of your 100 shares is then 100P and the equity in the account is 100P - 1900.
The margin is equal to = (100P - 1900) / 100P
If your margin has fallen to 2.564%, it must be:
2.564% = (100 x P - 1900) / (100 x P)
Solving for P = 19.5
Question 8
Suppose that you expect that Bubblenet stock price is going to decline. So you decide to ask your broker to short sell 1000 shares. The current market price is $50. The proceeds from the short sale $50,000 is credited into your account. A few days later the market price of the stock declines to $30 per share. What is your profit from this transaction?
Recall that short-selling is borrowing shares to sell now with the expectation to replace them later when the price has declined.
The proceeds from the short selling is $50 x 1000= 50,000. You will have to cover the short position buying 100 shares at $30 each share: 1000 x $30= 30,000. The profits from this transaction is the difference between $50,000 and $30,000, which is $20,000 or equivalently $20 per share.
Question 9
Suppose your broker has 50% margin requirements for short sales and you short 500 shares of GS-Biz Inc., currently trading at $50 per share. What is the amount that you need to deposit in the margin account to serve as margin on the short sale?
The broker has 50% margin requirement on short sales. This means that you must have other cash or securities in your account worth at least 50% of the short sale.
When you short-sell 500 shares at $50, 500 x $50= $25,000 is deposited to your account. Because the broker has 50% margin requirement on short sales, this means that you must have other cash or securities in your account worth at least $12,500 that can serve as the margin on the short sale.
Question 10
Suppose you happened to be wrong on the direction of GS-Biz in Question 9. Instead of falling in value, GS-Biz price starts climbing. If the broker has 30% maintenance margin requirement, how much can the price of GS-BIz rise before you get a margin call?
Round off to one decimal points. (i.e. “x.x”)
Your short position margin is equal to your equity/value of stock. What price would make this fall below the 30% level?
Let P be the price of GS-Biz. Then the value of the shares you must pay back is 500P, and the equity in your account is 37,500 - 500P. Your short position margin is equal to equity/value of stock = (37,500 - 500P) / 500P
The critical value of P is then: 0.3 = (37,500 - 500P) / 500P
P = 57.69
Question 1
The difference between mutual funds and Exchange traded funds (ETFs) is…
☑ ETFs shares are traded on exchanges all the time but mutual funds shares can be only traded at the end of the day when their net asset value is calculated. Yes, that is correct. ETFs can be traded throughout the day just like any other stock. Mutual funds can be bought or sold only at the end of the day when their NAV is calculated.
☐ There is more variety of shares in mutual funds than on ETF’s No, that is not correct. ETFs can be traded throughout the day just like any other stock. Mutual funds can be bought or sold only at the end of the day when their NAV is calculated.
☐ None of the above. No, that is not correct. ETFs can be traded throughout the day just like any other stock. Mutual funds can be bought or sold only at the end of the day when their NAV is calculated.
Question 2
Suppose that you expect SugarCane stock price to decline. So you decide to ask your broker to short sell 2000 shares. The current market price is $40. The proceeds from the short sale $80,000 is credited into your account. However, a few days later the market price of the stock jumps to $80 per share and your broker asks you close out your position immediately. What is your profit or loss from this transaction?
☐ -60000
☐ 60000
☑ -80000
☐ 80000
The proceeds from the short selling is $40 x 2000 = $80,000. You will have to cover the short position buying 2000 shares at $80 each share: $80 x 2000 = $160,000. The loss from this transaction is the difference between $80,000 and $160,000, which is -$80,000.
Question 3
An investor has an initial margin requirement of 50% on his margin account and a maintenance margin requirement of 25%. The investor short sold 1,000 shares at $40 per share. What is the maximum price that the share can reach in the market before the investor receives a margin call?
Think about the proceeds from the short sale and how much collateral the investor has had to put up to meet the initial margin requirement. Think about the short margin ratio. What would the price have to be for this ratio to fall below the maintenance margin requirement?
The proceeds from the short sale are 1000 x $40 = $40,000.
An initial margin requirement means that the investor had to put $20,000 as collateral in cash or cash equivalents in his account.
In order for the short margin to fall below the maintenance margin requirement of 25%, 0.25 = (60,000 - 1000P) / 1000P
Solving for P = 48.
Question 4
An investment company is an institution that pools funds from investors with the purpose of investing on their behalf. There can be registered investment companies: mutual funds, unit investment trusts, and real estate investment trust.
☑ True
☐ False
Question 5
Private equity is one example of investment companies that are not registered with the SEC and make equity investment in companies that are not publicly traded.
☑ True
☐ False
Question 6
The difference between mutual funds and hedge funds is…
☐ There is no difference since there are both managed portfolios
☑ Hedge funds are not registered with the SEC since accepts only qualified investors such as high net worth individuals and institutional investors.
☐ None of the above.
Question 7
A market order has
☑ Price uncertainty but no execution uncertainty Yes, that is correct. A market order will be executed at the best possible price. There is no certainty about what that price will be but the order will be executed.
☐ Both price and execution uncertainty No, that is not correct. A market order will be executed at the best possible price. There is no certainty about what that price will be but the order will be executed.
☐ Execution uncertainty but no price uncertainty No, that is not correct. A market order will be executed at the best possible price. There is no certainty about what that price will be but the order will be executed.
Question 8
You are bullish about Bulls Eye stock. The current price is $25 per share and you have $5000 of your own to invest. You borrow an additional $5,000 from your broker at an interest rate of 8% per year and invest 10,000 in the stock. What will be your rate of return if the price of Bulls Eye stock goes up by 10% during the next year? Enter your answer as percentage. “Ex if the answer is 30% enter 30”
With the $10,000 you purchased 400 shares. At the end of the year, the value of your holdings is now $11,000. You will need to pay back what you borrowed $5,000 x (1.08) = $5,400.
Your return = ($11,000 - $5,400) / $5000 = 12%