FIN 360 Exam 1: Chapter 1-4
In what circumstances are private placements more advantageous than IPOs?
A private placement is cheaper than a public offering, because private placements do not require of expensive registration statements. In the case of small placements and when a firm wants to avoid the administrative cost of a public issue, then a private placement will be more advantageous.
What is a derivative asset?
A security with a payoff that depends on the prices of other securities.
What is a stop-loss order? How is a stop-loss order different from a limit-sell order?
A stop order is a trade is not to be executed unless stock hits a price limit. The stop-loss is used to limit losses when prices are falling. An order specifying a price at which an investor is willing to buy or sell a security is a limit order, while a market order directs the broker to buy or sell at whatever price is available in the market.
What is the difference between cross lisings and ADRs
ADRs are the stocks of firms headquartered and traded in a foreign country. The shares trade in the US through "pink slips", each representing one share of stock traded in a foreign exchange. Cross-listings are stocks of firms headquartered in a foreign country, that trade in a domestic exchange. The main difference between ADRs and cross-listings is who regulates the information disclosure of the firms issuing these securities. In the case of ADRs, it will be the monitoring body of the home country while in the case of a cross-listing is the US Securities and Exchange Commission.
What are agency problems? Give two ways reduce them.
Agency problems are conflicts of interest between firm managers and owners of a firms. Ways to solve them are: a. Tie performance to compensation b. Pay bonuses with stock and stock options. c. Let the market do its' work: non performaning firms are absorbed by other firms or eventually they will fail d. A proxy fight: when an individual sets up a contest to gain control of the board. e. Hostile takeover: a bid to buy more than 50% of the shares to gain control of the board f. Monitoring g. Enact laws to improve disclosure such as Sarbanes-Oxley
What are derivative securities?
Also known as contingent claims. Derivatives are securities that provide payoffs contingent on the prices of other assets such as stocks, stock indices, commodities and foreign exchange
What is a market index?
An aggregate value produced by combining stocks or other investment vehicles together and expressing their total values against a base value from a specific date. Market indexes are intended to represent an entire market and track the market's change over time.
How do security brokers earn their profits?
Brokers are agents that help buyers and sellers find each other. They make a profit by charging a fee for their services.
What is the difference between debt and equity securities?
Debt securities represent a financial obligation while equity securities represent ownership in a corporation. Equity securities are claims on a firm's real assets. While debt holders are promised a fixed payment, equity holders are not promised anything.
3 broad types of financial assets
Debt, equity, and derivatives
Do financial assets add to society's wealth? Yes, no, why?
Financial assets do not add to the net worth a society because a financial asset held by one person is always a financial liability for someone else. At the aggregate level all financial assets and liabilities cancel each other out. So all what's left are the real assets.
When do investors receive a margin call?
If the equity in the brokerage account falls below the maintenance margin, the broker will issue a margin call.
Derivative securities
Payoffs determined by the prices of other assets such as stock or bond prices. Ex. options and futures; hedges risk
What is the difference between a price-weighted and a market-value-weighted index
Price-weighted average: An average computed by adding the prices of the stocks and dividing by a "divisor". Market-value-weighted index: Is a return index. Is the weighted average of individual returns weighted by outstanding market value.
The material wealth of a society is ultimately determined by the
Productive capacity of its economy (the goods and services its members can create): a function of real assets
What is the difference between initial margin and maintenance margin?
The Federal Reserve Board imposes restrictions on the amount an investor can borrow. First, they decide on the initial margin, which is the initial amount you can borrow. Second, the maintenance margin, which is the amount you need to maintain after you trade. These amounts are set by the Federal Reserve Board, as well as the broker. Individual brokers can have stricter limits, but the Federal Reserve Board sets a minimum initial margin of 50% and a maintenance margin of at least 25%.
What is an investment?
The current commitment of money or other resources (time and effort) with the expectation of reaping future benefits
What is the difference between real and financial assets
The difference is that while real assets generate income, financial assets determine how this income is allocated across multiple market participants.
What sets munipal bonds apart from all other bond types?
The key feature that sets munis apart from other bonds is their tax-free status. The income derived from these bonds has no tax burden attached
What is the main difference between common and preferred stock?
The main difference is that while common stock has voting rights, preferred stocks are non-voting. Also, preferred shares usually pay a fixed stream of dividends (making them more like a perpetual bond) while the common shares may or may not pay dividends
What is the difference between money markets and capital markets?
The main difference is the maturity of the securities traded in each of these markets. In the money market, securities have maturities up to one year. In the capital market, maturities are of more than one year.
What is the difference between the price of an option and the exercise price of an option?
The price of an option is the money that an investor would have to pay to purchase the option contract. The exercise price, on the other hand, is the price of the underlying aset that determines whether the option is exercised or not.
What is the difference between a primary and a secondary market?
The primary market is the market where newly-issued securities are sold, while the secondary market is the market for trading existing securities. After firms sell their newly-issued stocks to investors in the primary market, new investors purchase stocks from existing investors in the secondary market
How do security dealers earn their profits?
The primary source of income for a securities dealer is the bid-ask spread. This is the difference between the price at which the dealer is willing to purchase a security and the price at which they are willing to sell the same security
In electronic markets
a computer matches orders with an existing limit order book and executes the trades automatically
Limit buy
buy below a stipulated price
Brokers
execute trades for people other than themselves
Short sales of exchange-listed stocks
-Proceeds from the short sale must be kept on deposit with the broker -Short-sellers must post margin with their broker to cover potential losses on the position;
IPOs
-generally underperform in the short run -often provide very good initial returns to investors -do NOT provide superior long term performance as compared to other stocks -are primarily allocated to institutional invetsors
A market order has: a. Price uncertainty but not execution uncertainty. b. Both price uncertainty and execution uncertainty. c. Execution uncertainty but not price uncertainty.
A
What is a Financial Intermediary? 3 examples
A Financial Intermediary is an institution that brings together suppliers of capital (generally households) and demanders of capital (generally firms). Types of firms: a. Commercial banks b. Investment banks c. Insurance companies d. Brokerage firms e. Mutual funds
What is the difference between a call option and a put option?
A call option gives the option-holder the right to buy an asset a future date while a put option is the right to sell
What is a limit-sell order? How is a limit-sell order different from a market order to sell a security?
A limit-sell order is an order to sell shares at a price of no less than a certain limit (a minimum price that an investor is willing to receive). It is different from a market order to sell because in the market order the sale would be executed at the current market price.
What is a market order? How is it different than a limit order?
A market order is a buy or sell order which has to be executed immediately at current market prices. In contrast, a limit order is an order in which the investor specifies the minimum sell or maximum purchase price she is willing to accept in order to execute the trade.
What is a competitive market?
A market with many buyers and sellers looking for good deals
What is the difference betweeen asset allocation and secutirty selection?
Asset allocation relates to the problem of how to distribute resources across broad asset classes. Seccurity selection is the problem of deciding which specific securities to pick within these asset classes
What is margin?
It is the net worth from the investors' brokerage accounts
What is a capital market instrument?
Securities with maturity of more than one year. Types of capital market instruments are stocks, intermediate and long term bonds, and derivatives with exercise dates more than one year into the future.
What is a money market instrument?
Securities with maturtities of less than one year. Examples are Treasury bills, Commercial paper, Banker's acceptances, eurodolalrs, Federal funds
Bid vs. Ask
Sell vs. Buy
Financial assets
Stocks and bonds; do not directly contribute to the productive capacity of the economy; allocate income among investors
What often accompanies short sales and are used to limit potential losses from the short position?
Stop-buy orders
What is the difference between the top-down and bottom-up investment approaches?
Top-down approach, the investor determines its porfolio's asset allocation first and then its security selection. Bottom-up approach, the portfolio is built by picking securities that seem undervalued without much concern for asset allocation
What is the role of an underwriter
Underwriters purchase securities from the issuing company and resell them
The average depth of the limit order book is
higher for the large stocks in the S&P 500 Index than for the smaller stocks in the Russell 2000 Index
Real assets
land, buildings, equipment, and knowledge that can be used to produce goods and services; generate net income
Equity (common stock)
ownership share in a corporation
In dealer markets
participants post bid and ask prices at which they are willing to trade; orders are not automatically executed by computer
Short position
profits from price decreases; obligation to purchase
Long position
profits from price increases; obligation to purchase
Debt securities
promise a fixed stream of income or a stream of income that is determined by a formula
Call
right to purchase
put
right to sell
Limit sell
sell above a stipulated price
Inside quote
the difference between the highest bid price and the lowest ask price in the limit order book.
Stop buy order
the stock will be bought if its price rises above the stipulated level
Stop loss order
the stock will be sold if its price falls to the stipulated level