Investments Exam 1 Review
What is a derivative?
A security that gets its value from the values of another asset (called underlying asset).
What would you expect to happen to the spread between yields on commercial paper and Treasury bills if the economy were to enter a steep recession?
A steep recession will widen the spread between yields on commercial paper and treasury bills
What re the three trading strategies?
Algorithmic trading High frequency trading Dark pools
What is the ask price?
Asked prices represent offers to sell. Investors must pay the asked price to buy the security
A _____ fund holds both equities and fixed-income securities in fairly stable proportions.
Balanced fund
What are the two components of the bid ask spread?
Bank discount method Bond equivalent yield
What is the bid price?
Bids are offers to buy. Bid-asked spread is the profit for a market in a security
A _____ fund primarily holds fixed-income securities.
Bond fund
What are the capital market securities?
Bonds Equity Derivatives: Options, Futures, and Swaps
Where would an illiquid security in a developing country most likely trade? a. Broker markets. b. Electronic crossing networks. c. Electronic limit-order markets.
Broker markets
What is a repurchase agreement?
Dealers sell collaterals (such as Treasury securities, MBS, and stocks), agree to buy back later at a slightly higher price. The repos provide short term, collateralized funding to dealers.
How does the value of a call change?
Decreases as the strike price increases
What are the advantages exchange-traded funds relative to mutual funds?
ETF relative to the open-end funds: traded on the exchange like a stock the price of ETF is determined continuously rather than based on daily closing NAV; lower expense ratio; more tax efficiency. * ETF relative to the closed-end: unlimited number of shares like open-end mutual fund shares; ease of arbitrage due to its creation/redemption feature; smaller difference between market price and NAV
An _______ fund holds primarily equities.
Equity fund
What are the disadvantages exchange-traded funds relative to mutual funds?
Higher trading cost Requires broker easy slippage (difference amount the expected price of trade and the actual price of the trade) dividends carried forward
Why are money market securities referred to as cash equivalents?
Highly liquid Low risk Easily accessible to small investors Low transaction costs
What does a wider spread indicate?
How nervous the markets are
An ____ fund attempts to match the performance of a broad market index.
Index fund
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.
Price uncertainty but not execution uncertainty.
How are stocks weighted in the index?
Price weighted (DJIA) Market-value weighted (S&P500, NASDAQ) Equally weighted (Value Line Index)
What is the federal funds rate?
Rate that American Banks loan money to each other
If a market order comes in at which price will it be filled?
The best price in the limit sell order
What do the points on a spread chart show?
The differences in percent between the investments
What problems would confront a mutual fund trying to create an index fund tied to an equally weighted index of a broad stock market?
The fund would require constant readjustment since every change in the price of a stock would bring the fund asset allocation out of balance.
What is margin?
The portion contributed by the investor, also called equity margin.
What is algorithmic trading?
The use of computer programs to make trading decisions
Why do call options with exercise prices greater than the price of the underlying stock sell for positive prices?
There is a chance that the stock price may increase in the future. if the stock price rises above the exercise price, the call option will be used in money. This predicted increase has some value and investors pay positive price for this chance
How do values of calls and puts change with time?
They both increase
Explain the difference between a call option and a long position in a futures contract.
call - holder has the right to buy long position - no right to buy and has the obligation to buy. The holder should buy the asset from the holder of the short position at the future price
What are the pricing differences between?
Open-end: Net Asset Value(NAV) Closed-end: traded on exchanges such as the NYSE or over-the-counter such as NASDAQ. Prices of closed-end shares may be traded at a premium or discount to NAV
What is the priority when paying bonds, common, and preferred stock?
1. bonds 2. preferred 3. common
Which of the following correctly describes a repurchase agreement? a. The sale of a security with a commitment to repurchase the same security at a specified future date and a designated price. b. The sale of a security with a commitment to repurchase the same security at a future date left unspecified, at a designated price. c. The purchase of a security with a commitment to purchase more of the same security at a specified future date.
A
What is the spread chart?
A chart of the two different interest rates between two different investments
An _________ fund holds both equities and fixed-income securities and varies the proportions to take advantage of forecasted market conditions
Asset allocation and flexible fund
Why can closed-end funds sell at prices that differ from net asset value while open-end funds do not?
Closed-end: limited in number, no change unless new stock is offered. Open-end: changes when new shares are sold or old shares are redeemed.
What are the key differences between common stock, preferred stock, and corporate bonds?
Common stock: has voting rights, variable dividends preferred stock: fixed dividends (accumulated), Failure to make payments does not set off corporate bankruptcy. corporate bonds: interest at a fixed rate
How is preferred stock like long term debt?
It pays a fixed payment like a perpetuity and holder's in the firm do not have voting rights
What are the differences from LETFS and ETFS?
LETS designed to track the return with a daily multiple using swaps and other derivatives Allow investors to execute hedge fund like strategies with the liquidity and convenience of an ETF
A ______ fund is a balanced fund in which the mix of securities depends on the age of the investor.
Life-cycle fund
A _____ order instructs the broker to buy the stock if and when its price goes above a certain level.
Limit
What are the traits of a hedge fund?
Limited liability partnerships No more than 100 investors management fee and incentive fee flexible investiments and opportunistic often use shorting leverage and options Lock up periods and require advanced redemption notices
What does Libor stand for?
London interbank offered rate
What are the advantages of private placement?
Lower floatation cost, fewer obligations to release financial statements
What are the disadvantages of Private placement?
Lower liquidity of shares
Would you expect a typical open-end fixed-income mutual fund to have higher or lower operating expenses than a fixed-income unit investment trust? Why?
Open-end fixed income mutual funds have higher operating expenses because the funds are managed actively
How do margin trades magnify both the upside potential and the downside risk of an investment position?
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
A _____ order tells the broker to buy stock at current market prices.
Market
Why are high-tax-bracket investors more inclined to invest in municipal bonds than low-bracket investors?
Municipal bonds have a lesser yield but have no federal tax. high tax bracket investors pay more tax on interest from a bond than low tax bracket investors
What is the worlds largest OTC market with a four on IT firms?
NASDAQ
What is the largest organized securities market in the United states?
NYSE
How is preferred stock like equity?
No obligation to pay dividend firm cannot be declared bankrupt if it fails to make payments has a higher priority than common equity but a lower priority than bonds if a firm is declared bankrupt
What are the traits of a mutual fund?
Require public disclosure of strategy and portfolio composition Number of Investors not limited Fixed % fee based on assets with an annual expense ratio Predictable investments Limited use of shorting leverage and options Liquidity: Can move more easily into and out of a mutual fund
What does a call option provide?
Right to buy underlying asset at the strike or exercise price.
What does a put option do?
Right to sell underlying asset at the strike or exercise price.
A _____ fund holds securities of firms in a particular industry or sector.
Sector fund
What is High frequency trading?
Special class of algorithmic with very short order execution time
What are the differences between a stop-order loss, a limit sell order, and a market order?
Stock order loss - a broker is asked to buy or sell the stock when it hits a certain price Limit sell order - broker sells at a specified price Market order - no restrictions about buy or sell price.
A _____ order gives the broker instructions to buy the stock if and when its price falls below a certain level.
Stop
What is dark pools?
Trading venues that preserve anonymity, mainly relevant in block trading
What are the money market instruments?
Treasury Bills Commercial Papers Large Denomination Time Deposits Eurodollars Libor Federal Funds Repurchase Agreements (repos) and reverse repos
What are some comparative advantages of investing in the following: a. Unit investment trusts. b. Open-end mutual funds. c. Individual stocks and bonds that you choose for yourself.
Unit investment trusts - low management fees, easy liquidity, stable portfolio, less risky Open end mutual funds - issue and sell shares at NAV, easy liquidity, no commission or dividend reinvestment Choice of Individual Stocks and Bonds - amount invested limited to the investor
What does the repo contract state?
When (a day or week) and how much the price is for the collateral to be repurchased
What is the difference between repo and a reverse repo?
Where the dealer acts as the lender
Why have average tree sizes declined in recent years?
high frequency trading trades in 100 or 200 share lots. This trading program has deteriorated the liquidity
How does the value of a put change?
increases with the strike price
What is margin trading?
part of the purchase price of the stock from the broker, with the rest by the investor cash
Hedge funds are commonly organized as?
private partnerships
Explain the difference between a put option and a short position in a futures contract.
put - holder has right to sell asset. Short position - holder does not have right. obligation to sell the asset and will be sold in the contract at future prices