Investments test 2
5. What is the effect of market wide maintenance margin calls?
$MM = $Loan / ( 1 - Maintenance Margin %)Maintenance margin is the minimum balance the trader must have in the account to keep the position open. If the account loses money and the balance drops below the maintenance margin level (also varies by contract), then the trader will receive a margin call
2. What is a GTC order?
A Good-Til-Cancelled (GTC) order is an order to buy or sell a stock that lasts until the order is completed or cancelled. Brokerage firms typically limit the length of time an investor can leave a GTC order open. This time frame may vary from broker to broker. Investors should contact their brokerage firms to determine what time limit would apply to GTC orders.
1. What are limit orders?
A limit order is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. A limit order is not guaranteed to execute. A limit order can only be filled if the stock's market price reaches the limit price.
4. What is margin? Why is it important?
Actual margin % = ($MV - $Margin Loan) / $MV Margin is the money borrowed from a brokerage firm to purchase an investment, The investor is using borrowed money, or leverage, and therefore both the losses and gains will be magnified as a result
13. What advantages do mutual funds present to ordinary investors?
Advanced portfolio management Dividend reinvestment Risk reduction Convenience Fair pricing
9. What are 2 criticisms of HFT(high frequency trading)?
Allows institutional players to gain an upper hand in trading because they are able to trade in large blocks using algorithms The liquidity produced using HFT is momentary
10. What are 3 of the five HFT strategies?
Automated Liquidity Provision - serving as a market maker ( ie buy low sell high ) to profit on small trading imbalances ( D > S or S > D ). Rebate Trading -HFT are paid by exchanges to provide liquidity ($3 per 1000 shares). Order Anticipation Strategies - reverse engineer volume and price behavior to predict future price movement. This can be filtered for large volume or price events. Event Arbitrage - some algo's can read earnings releases, analyze a CEO's comments, trade a Federal Reserve announcement in milliseconds. The Fed/Treasury Dept was selling advance notice of different data releases to hedge funds / HFT firms willing to pay for the edge. Statistical ( HF Stat Arb ) Trading - analyzes moves across markets and currencies to determine trade direction....ie increasing risk aversion increasing usually has traders buying bonds and selling equities.
25. What is the buy write myth?
Buy-write is an option trading strategy where an investor buys a security that is generally a stock with options available on it and simultaneously writes (sells) a call option on that security. The goal is to generate income from option premiums on that security. This is because the option security only decreases in value if the value of the underlying security increases. The downside risk of writing the option then is minimized.
20. List 3 behavioral effects.
Fixation - investors will not sell because of tax gain as values are being removed by market Framing -- judgments on returns affected by prior experience or decisions Gambler's Fallacy -- believing a trend changes the probability of the next return, it does not Greater Fool - buy it to sell it to someone higher regardless of intrinsic value Herding -- following the crowd, believing crowd is right, creates momentum Home Bias - buying most stocks from your country or industry
15. Describe Morningstar style boxes and their use? The value of their star system ?
Graphical descriptions of a mutual fund's characteristics. Vertical axis has small, medium, and large referring to market cap, while the horizontal axis has value, blend, and growth and is based on valuation. Mutual fund can be classified as one of 9 possibilities: Large value, Large blend, Large growth, etc. Star system gives mutual funds 1 through 5 stars for comparison to similar funds
19. Explain Hubris and its effect on valuation.
Hubris is the characteristic of excessive confidence or arrogance, which leads a person to believe that he or she may do no wrong. This can cause stock prices to rise and become overvalued if someone is very confident in a company.
11. Why are HFT funds obsessed with latency?
Latency is the time it takes a signal to be received. Firms want as low as latency as possible to gain a competitive edge in trading.
17. M&A Arb requires what for the arb to work successfully?
M&A arb requires an Acquirer to bid for a Target in a stock swap. If a share of A is worth $100 and a share of B is worth $30, A could offer 4/10ths of a share for B's stock or $40. The target shares would climb towards $40 and may exceed $40 based on deal risks, probabilities, and expected bids.
27. Most investment hedges require the use of financial derivatives. What are two non-derivative alternatives to lower volatility that operating firms may choose? Change contracts in operations, reduce leverage, choose to do nothing.
Make changes in the operating business Reduce holdings to decrease exposure Rely on legal contracting with customers or suppliers Actually purchase assets (PP&E)
14. What are two disadvantages of mutual funds?
No control over portfolio Capital gains Fees and expenses Over-diversification
8. What is the difference between an open and closed mutual fund?
Open: Shares are sold at the Net Asset Value (NAV). The value of the shares is determined at the end of each day depending on how the fund is doing in the market. The NAV is used to determine the value of the holdings in the mutual fund. Closed: Only issue a fixed-number of shares that are traded through the stock exchange. This price per share is determined by the supply/demand of the shares themselves. This means they can trade at premiums or discounts compared to their actual NAV's.
21. What is prospect theory and how does it impact mutual fund managers?
Prospect theory assumes that losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of perceived losses. Impacts mutual fund managers as they are looking more towards what could potentially be gained versus what may be lost.
6. What is the process to short a stock? Why is it more difficult?
Shorting involves borrowing shares from someone who owns the stock you want to sell short. Once you borrow the shares, you then sell them on the open market, getting cash from whoever buys the shares from you. At some point in the future, you'll buy back the stock and then return the shares to the investor from whom you borrowed them. It is more difficult because the market tends to grow so it is hard to find stocks that will consistently go down in value.
12. What is spoofing?
Spoofing is an illegal form of market manipulation in which a trader places a large order to buy or sell a financial asset, such as a stock, bond or futures contract, with no intention of executing. By doing so, they create an artificial impression of high demand for the asset. Simultaneously, the trader places hundreds or even thousands of smaller orders for the same asset, profiting on the increase in price brought about by the large fake order, which is then cancelled.
18. What is the purpose of a roadshow?
Take a company's message and brand around to different areas to increase brand awareness and product knowledge. Great way to spread the word in an in-person, interactive format to reach new people.
16. What are the advantages of ETFs over mutual funds?
Tax benefits Simplicity Cost-effectiveness Investing Flexibility
3. What is important about the bid - ask spread? Which do you pay ?
The "bid" is the price that a buyer is willing to pay for a share or product. He places this bid to inform sellers of the price that he is willing to pay. This reflects the value that he expects to get from the transaction. The "ask" or "offer" is the price that a seller sets and is the price that the seller believes he can get for the product. The "bid-ask spread" is the difference between the buyer's price and the seller's price. Buyer buys at ask price and seller sells at bid price The spread shows liquidity of the market and the size of the transaction cost
24. Gambler's fallacy and recency effects are aspects of behavioral trend trading. Explain each effect.
The Gambler's Fallacy occurs when an individual erroneously believes that a certain random event is less likely or more likely, given a previous event or a series of events. This line of thinking is incorrect, since past events do not change the probability that certain events will occur in the future. Recency effect skews future possibilities by memorable past events
22. When should you measure performance with beta? Sharpe?
The beta coefficient is the volatility measure of a stock portfolio to the benchmark itself. Measure performance with beta when you may have a riskier stock. The Sharpe ratio evaluates the portfolio manager on the basis of both rate of return and diversification (it considers total portfolio risk as measured by standard deviation in its denominator). Therefore, the Sharpe ratio is more appropriate for well-diversified portfolios because it more accurately takes into account the risks of the portfolio. Sharpe ratio = (Rx-Rf)/SD of Rx
26. Describe short term and long term IPO returns?
There are few IPOS that are predicted for long term performance and many are predicted to have high short term returns as people get excited about new stocks and buy a lot in the beginning.
7. What risk do short sellers face?
There is no limit on how high a stock can go, unlike when buying a stock, it can only drop down to $0. Thus when buying a stock, you know how much you can lose in a worst case scenario. When shorting, the sky's the limit for potential losses.
23. What can tracking error measure? What can the information ratio tell you?
Tracking error is a measure of financial performance that determines the difference between the return fluctuations of an investment portfolio and the return fluctuations of a chosen benchmark. The information ratio can tell you the returns beyond the returns of the benchmark
