Reading 33: Market Organizations and Structure:

- The maintenance margin requirement is the minimum amount of equity required as a percentage of position - Margin call: request to pay additional equity when account balance falls below maintenance margin so account balance equals initial margin requirement. Margin call price = P x (1-inital margin)/(1-maintenance margin)

- Maintenance margin requirement: the minimum amount of equity required as a percentage of position - Margin call: request to pay additional equity when account balance falls below [...] margin so account balance equals [...] [...]. Margin call price = P x (1-[...] margin)/(1-[...] margin)

B. B is correct. Buying a put option on the dollar will ensure a minimum exchange rate but does not have to be exercised if the exchange rate moves in a favorable direction. Forward and futures contracts would lock in a fixed rate but would not allow for the possibility to profit in case the value of the dollar three months later in the spot market turns out to be greater than the value in the forward or futures contract.

A German company that exports machinery is expecting to receive $10 million in three months. The firm converts all its foreign currency receipts into euros. The chief financial officer of the company wishes to lock in a minimum fixed rate for converting the $10 million to euro but also wants to keep the flexibility to use the future spot rate if it is favorable. What hedging transaction is most likely to achieve this objective? A. Selling dollars forward. B. Buying put options on the dollar. C. Selling futures contracts on dollars.

A. A is correct. In the quote-driven currency markets, dealers are counterparties to currency exchange transactions. B is incorrect. A Japanese exporter pays no fee or commission to dealers. Dealers will profit from the bid-ask spreads. C is incorrect. In the quote-driven currency markets, currency exchange transactions take place in the over-the-counter, not organized, exchanges.

A Japanese exporter will sell US dollars for Japanese yen in the quote-driven currency markets. Which of the following statements best describes her currency exchange transactions? A. Her counterparties are dealers. B. She will pay commissions for exchange services. C. This currency exchange transaction takes place in organized exchanges.

B. Initial margin for 55% leverage = 45% (1 - 0.55) --> Margin call price = $35 x (1-0.45)/(1-0.30) = $27.50

A brokerage allows its clients to make leveraged investments subject to initial margin and maintenance margin requirements of 40% and a 30%, respectively. An investor uses 55% leverage to purchase shares currently trading at a price of $35.00. The share price below which this investor would receive a margin call is closest to: A. $22.50. B. $27.50. C. $30.00.

Value of equity required = Value of position/Leverage ratio = $20x1,000/2.5 = $8,000 Debt required = $20x1,000 = $8,000 = $12,000 Initial investment = Equity + commission = $8,000 + 0.01x1,000 = $8,010 Sales proceed at end of year = $15x1,000 + dividend = $15,000 + $0.10x1,000 = $15,100 Cost incurred during the year = Loan repayment + interest on loan + sales commission = $12,000 + 0.05x$12,000 + $0.01x1,000 = $12,370 Equity at the end of year = Sales proceeds - Costs = $15,100 - $12,370 = $2,730 Return on investment = $2,730/$8,010 - 1 = 65.9% Return on unleveraged position = $15x1,000/$20x1,000 - 1 = -25% Return on leveraged position ignoring commission and interest = ($15,000 - $12,000)/$8,000 - 1 = -62.5% --> Return on leveraged position = Leverage ratio x Return on unleveraged position = 2.5 x (-25%) = -62.5% (ignoring commission and interest cost) Using calculator: Select CF function: - CF0 = -8,010, C1 = 2,730, CPT IRR = -65.917

A buyer buys stock on margin and holds the position for exactly one year, during which time the stock pays a dividend. For simplicity, assume that the interest on the loan and the dividend are both paid at the end of the year. Purchase price: $20/share Sale price: $15/share Shares purchased: 1,000 Leverage ratio: 2.5 Call money rate: 5% Dividend: $0.10/share Commission: $0.01/share Calculate the return on investment at the end of 1 year and compare unleveraged return with leveraged return

A. A is correct. Closed-end funds may trade at a premium (discount) to net asset value when investors believe that the portfolio securities are undervalued (overvalued). B is incorrect. Concerns about the quality of management could suggest discounts from net asset value. C is incorrect. Excess redemption demand suggests selling pressure, which could indicate a discount to net asset value.

A closed-end fund is trading at a premium to its net asset value. This scenario most likely reflects: A. a belief that the portfolio securities are undervalued. B. concerns about the quality of management. C. excess demand for redemption of the shares.

C. When investors want to sell their shares, investors of an open-end fund sell the shares back to the fund whereas investors of a closed-end fund sell the shares to others in the secondary market. Closed-end funds are available to new investors but they must purchase shares in the fund in the secondary market. The shares of a closed-end fund trade at a premium or discount to net asset value.

A friend has asked you to explain the differences between open-end and closed-end funds. Which of the following will you most likely include in your explanation? A. Closed-end funds are unavailable to new investors. B. When investors sell the shares of an open-end fund, they can receive a discount or a premium to the fund's net asset value. C. When selling shares, investors in an open-end fund sell the shares back to the fund whereas investors in a closed-end fund sell the shares to others in the secondary market.

B. Ian's average trade price is: £19.92=(300×£20.02+400×£19.89+200×£19.84)/(300+400+200) (OR: (20.2+19.89+19.84)/3 = 19.92) Ian's sell order first fills with the most aggressively priced buy order, which is Mary's order for 300 shares at £20.02. Ian still has 700 shares for sale. The next most aggressively priced buy order is Ann's order for 400 shares at £19.89. This order is filled. Ian still has 300 shares for sale. The next most aggressively priced buy order is Paul's order for 200 shares at £19.84. A third trade takes place. Ian still has 100 shares for sale. The next buy order is Keith's order for 1,000 shares at £19.70. However, this price is below Ian's limit price of £19.83. Therefore, no more trade is possible.

A market has the following limit orders standing on its book for a particular stock: Ian submits a day order to sell 1,000 shares, limit £19.83. Assuming that no more buy orders are submitted on that day after Ian submits his order, what would be Ian's average trade price? A. £19.70. B. £19.92. C. £20.05.

A. A is correct. The limit buy order will be filled first with the most aggressively priced limit sell order and will be followed by filling with the higher priced limit sell orders that are needed up to and including the limit buy price until the order is filled. Average price = [(200 × $20.20) + (300 × $20.35) + (200 ×$20.50)]/700 = $20.35. C is incorrect. It simply uses the sell limit price that is exactly equal to the limit buy order. B is incorrect. It starts filling the order with the highest limit sell price and moves downward. Average price = [(200 × $20.70) + (100 × $20.65) + (400 × $20.50)]/700 = $20.58

A market has the following limit orders standing on its book for a particular stock: If a trader submits an immediate-or-cancel limit buy order for 700 shares at a price of $20.50, the average price the trader would pay is closest to: A. $20.35. B. $20.58. C. $20.50.

B. Markets are said to be allocationally efficient when capital is directed to its most productive uses. Operationally efficient markets are those that have low trading costs. Informationally efficient markets are those in which security prices reflect all information associated with fundamental value in a timely fashion.

A market that directs capital to its most productive use is best described as: A)operationally efficient. B)allocationally efficient. C)informationally efficient.

A. The exchange can be described as part of the secondary capital markets. A security is first issued in the primary market, and then it trades among investors in the secondary market. The money market refers to the market for short-term debt instruments (usually with maturities of less than one year) such as T-bills.

A securities exchange where traders buy and sell long-term government bonds from and to other traders would best be described as part of the: A)capital market. B)money market. C)primary market.

A. The short seller pays all dividends to the lender, loses if stock prices rise, and is required to post a margin account. A short seller often places a stop buy order to protect the short sale position from a rising market.

A short seller: A)does not receive the dividends. B)loses if the price of the stock sold short decreases. C)often also places a stop loss sell order.

A. A is correct. A trader who has entered into a short sale will incur losses if the stock price begins to increase. A stop-buy order helps limit the loss on a short position because it becomes valid for execution when the stock price rises above the specified stop price.

A stop-buy order is most likely placed when a trader: A. wants to limit the loss on a short position. B. thinks that the stock is overvalued. C. wants to limit the loss on a long position.

C.

A trader buys 500 shares of a stock on margin at $36 a share using an initial leverage ratio of 1.66. The maintenance margin requirement for the position is 30%. The stock price at which the margin call will occur is closest to: A. $25.20. B. $30.86. C. $20.57.

A. A is correct. Option contracts can be viewed as limit orders for which execution is guaranteed at the strike price. Therefore, a put buy order at a strike price of $25 will guarantee selling the stock at $25. C is incorrect. A "GTC, stop $25, market sell" order becomes a market order when the price drops to or below $25 and is executed at the best price available in the market. Thus, the selling price of $25 is not guaranteed. B is incorrect. A "GTC, stop $25, limit $25 sell" order limits the lower boundary to $25 but it does not guarantee execution at $25; in a fast-moving market prices may have dropped below the limit and the order will then not be executed.

A trader buys a stock at $30 and wants to limit downside risk. Which of the following orders will most likely guarantee that he can sell the stock at $25? (GTC means good till cancelled) A. Put option buy market order with a strike price of $25 B. GTC, stop $25, limit $25 sell order C. GTC, stop $25, market sell order

B. B is correct. The trader has a long forward position in the euro, which means she has committed to purchase euros in exchange for British pounds sometime in the future at an exchange rate determined when the contract was initiated. A is incorrect. This is a spot transaction, so there is no contract. C is incorrect. Forward contracts do not require holding one of the currencies; in most cases, one party will be receiving a foreign currency in the future (a payment in a foreign currency for example), and one party wishes to convert that into the domestic currency at that time without worrying about the exchange rate at the time of payment.

A trader describes her currency contract exposure as "long the euro against the British pound." Which of the following situations best fits her description? She has a: A. contract that allowed her to sell British pounds and acquire euros. B. forward contract to buy euros in exchange for British pounds at a predetermined exchange rate. C. forward contract to buy British pounds, using euros she currently holds.

B. B is correct. The order becomes valid when the price falls to, or below, $90. The "limit $85 sell" indicates that the trader is unwilling to sell below $85. Thus, the trader faces a maximum loss of $15 ($100 - $85). A is incorrect. The order becomes invalid for execution when the price falls below $85. C is incorrect. The order can be executed at any prices between $85 and $90.

A trader who owns shares of a stock currently trading at $100 per share places a "GTC, stop $90, limit $85 sell" order (GTC means good till cancelled). Assuming the specified stop condition is satisfied and the order becomes executed, which of the following statements is most accurate? A. The order becomes a market order when the price falls below $85 and remains valid for execution. B. The trader faces a maximum realized loss of $15. C. The order will be executed at either $90 or $85.

B. In an order-driven market, buy orders and sell orders are matched up by the exchange according to order matching rules. In a quote-driven market, customers trade with dealers at bid and ask prices set by the dealers. In a brokered market, brokers organize trades among their clients.

A trading system that matches buyers and sellers based on price and time precedence is most likely a(n): A)quote-driven market. B)order-driven market. C)brokered market.

- timely and accurate information on price and volume of past transactions. - timely and accurate information on the supply and demand for current transactions. - liquidity (as indicated by low bid-ask spreads). marketability. - price continuity. - depth (many buyers and sellers). - operational efficiency (low transaction costs). - informational efficiency (rapidly adjusting prices)

A well-functioning securities market includes the following characteristics...

B. Accounting standards and reporting requirements that allow meaningful and timely financial disclosures reduce the costs of obtaining fundamental information and thereby allow analysts to form more accurate estimates of fundamental values. They support informationally efficient markets. A is incorrect. Allocational efficiency refers to making resources available where they are most valuable. C is incorrect. Operational efficiency relates to the costs of arranging trades, which can be reduced via organized exchanges, brokerages, securitization, clearing houses, and so forth.

Accounting standards and reporting requirements that produce meaningful and timely financial disclosures are most critical for achieving which of the following efficiencies associated with a well-functioning financial system? A. Allocational B. Informational C. Operational

B. A broker who both fills orders for clients and trades with them is called a broker-dealer. By contrast, pure agency dealers do not trade with clients. Block brokers are pure agency brokers who fill orders for clients with larger order sizes.

An agent who fills orders for and trades with clients is most accurately described as a: A. block broker. B. broker-dealer. C. pure agency broker.

B. A crossing network is an example of an order-driven market. Orders are batched together and crossed (matched) at specific times during the trading day at prices based on those of another exchange. Price-driven markets and quote-driven markets are other terms for dealer or over-the-counter markets.

An electronic crossing network is best described as: A)a quote-driven market. B)an order-driven market. C)a price-driven market.

A. Swaps and futures have potentially large risks and can vary widely in value based on changes in the value of the assets underlying them. Call options are risky as well, but the worst-case scenario of a call option is losing the original investment, which is typically a small percentage of the price of the underlying asset. Video Solution

An individual seeking to minimize downside risk exposure would most likely prefer to take a long position in a: A. call option. B. swap contract. C. futures contract.

A. An issuer expects an investment bank that it has chosen to underwrite its initial public offering to obtain the highest price for its shares. However, the investment bank will be motivated to undervalue the company in order to avoid having to purchase any shares that cannot be sold. Although this dynamic exists for underwritten offerings, it does not exist for best efforts offerings. In such cases, the investment bank acts only as a broker and is not obligated to purchase any unsold shares. This eliminates the potential for a conflict of interest.

An investment bank leading a best efforts initial public offering most likely has: A. no conflict of interest with the issuer. B. a conflict of interest that creates an incentive to overvalue the issuer. C. a conflict of interest that creates an incentive to undervalue the issuer.

C. Interest paid should be divided by 2 (0.05/2)

An investor buys a stock on margin. Assume that the interest on the loan and the dividend are both paid at the end of the holding period. The data related to the transaction are as follows: Number of shares 500 Purchase price per share$28 Leverage ratio 3.33 Commission $0.05/share Position holding period: Six months Sale price per share $30 Call money rate 5% per year Dividend $0.40/share The investor's total return on this investment over the margin holding period is closest to: A. 15.6%. B. 16.7%. C. 21.4%.

(50 - 40) / (40 × 0.6) = 41.67%.

An investor purchased 725 shares of stock at $40 per share and posted initial margin of 60%. He subsequently sold the shares at $50 per share. Based only on this information, the investor's holding period return is closest to: A)20%. B)25%. C)40%.

A. $75/share × 100 shares = $7,500. 50% margin means investor only pays half of the $7,500 in cash, or $3,750, and borrows the remaining $3,750. Rate of return = (market value - initial investment - margin loan repayment) / initial equity = ($11,250 - $3,750 - $3,750) / $3,750 = 100%.

An investor purchases 100 shares at $75 per share with an initial margin of 50%. Assume there is no interest on the call loan and no transactions fees. If the stock price rises to $112.50, the rate of return to the investor is: A)100%. B)200%. C)50%.

A. 26 × (1 - 0.5)/(1 - 0.25) = $17.33.

An investor purchases 100 shares of Lloyd Computer at $26 a share. The initial margin requirement is 50%, and the maintenance margin requirement is 25%. The price below which the investor would receive a margin call is closest to: A)17.33. B)15.25. C)19.45.

B. The investor in this example has bought a stock and will suffer losses if the market price of that stock decreases. In order to offset this long risk exposure, the investor must establish a position that pays off if this price decrease occurs, which can be done by being the long party to a put option contract. By contrast, if the price of the underlying increased, a short put position would not be profitable and a long call position would compound the investor's losses.

An investor who has long position in a stock will most likely be able to offset this risk exposure by taking which position in an option contract based on the underlying equity? A. Long call B. Long put C. Short put

Traders who engage in arbitrage. · They trade when they can identify opportunities to buy and sell identical or essentially similar instruments at different prices in different markets · If markets are efficient, pure arbitrage rarely exists

Arbitrageurs

Brokers help their clients buy and sell securities by finding counterparties to trades Block brokers help clients with large trades Investment banks help corporations sell debt and equity to investors and help with M&A and raising capital Exchanges provide a venue for traders and sometimes act as brokers by providing electronic order matching Alternative trading systems (ATS) are exchanges with no regulatory function. ATS that do not reveal current client order volume are known as dark pools. Dealers facilitate trading by buying and selling from their own inventory Broker-dealers have a conflict of interest since broker should help client find the best price but dealers want to sell with highest price and buy with lowest price Primary dealers trade with central banks to buy or sell government securities

Brokers help their clients buy and sell securities by finding [...] to trades [...] brokers help clients with large trades [...] [...] help corporations sell debt and equity to investors and help with M&A and raising capital [...] provide a venue for traders and sometimes act as brokers by providing electronic order matching Alternative trading systems (ATS) are exchanges with no [...] function. ATS that do not reveal current client order volume are known as [...] [...]. [...] facilitate trading by buying and selling from their own inventory Broker-dealers have a conflict of interest since [...] should help client find the best price but [...] want to sell with highest price and buy with lowest price Primary dealers trade with [...] [...] to buy or sell [...] securities

Call option: buy at strike price profits made when market price is higher than strike price breakeven: market price - strike price = premium Put option: sell at strike price profits made when market price is lower than strike price breakeven: strike price - market price = premium

Call option: [...] at strike price profits made when market price is [...] than strike price breakeven: [...] price - [...] price = premium Put option: [...] at strike price profits made when market price is [...] than strike price breakeven: [...] price - [...] price = premium

· if markets function well and investors are well informed about the risk and return characteristics of various investments · Allocation of capital to its most valuable uses does not require that all investors have complete information or that financial markets are frictionless

Capital will flow to its most valuable uses if?

1. Spot vs Forward Market: immediate delivery or future delivery of assets 2. Primary vs Secondary Market: issuers sell directly to investors vs. investors selling to other investors 3. Money vs. Capital Market: trading debt instruments maturing in 1 year or less (repo, government bill, commercial paper) vs. debt with long maturity (bonds, equities) 4. Traditional vs Alternative Market: publicly traded debt & equity vs. hedge funds, private equities, commodities, securitized debt etc.

Classifications of Markets

· include precious metals, energy products, industrial metals, agricultural products, and carbon credits · they trade in spot, forward, and futures markets · they are traded in spot markets for immediate delivery and in forward and futures markets for future delivery

Commodities

C. Commodities that can be stored and delivered at low cost are typically nonperishable items with high value-to-weight ratio. Examples include industrial diamonds, precious metals and high-value industrial metals.

Commodities that can be stored and delivered at low cost are most likely: A. perishable with a high value-to-weight ratio. B. nonperishable with a low value-to-weight ratio. C. nonperishable with a high value-to-weight ratio.

C. Because regulated markets are more informationally efficient, there are fewer arbitrage opportunities. A is incorrect. Regulated markets tend to be more operationally efficient, which leads to lower transactions costs. B is incorrect. Regulations help to level the playing field for market participants. When participants believe that markets are fair, they continue to trade in the market, thus increasing trading volumes.

Compared with unregulated markets, regulated markets are best characterized by: A. higher transaction costs. B. lower trading volumes. C. reduced arbitrage opportunities.

markets in which trading can occur at any time, with prices free to fluctuate as trading occurs

Continuous Markets

Allow people to speculate on the price of an underlying asset - the buyer benefits if the price of the underlying asset increases - these are derivative contracts because their value is derived from the underlying asset

Contracts for differences

contracts that offer insurance to bondholders. They make payments to a bondholder if a borrower defaults on its bonds

Credit default swaps

A. A is correct. This order is said to take the market. The new sell order is at $54.62, which is at the current best bid. Therefore, the new sell order will immediately trade with the current best bid and is taking the market.

Currently, the market in a stock is "$54.62 bid, offered at $54.71." A new sell limit order is placed at $54.62. This limit order is said to: A. take the market. B. make the market. C. make a new market.

A. A is correct. Dark pools are trading venues that function like exchanges but do not exercise regulatory authority over their subscribers except with respect to the conduct of their trading in those venues. B is incorrect. Dark pools may be operated by investment dealers but do not necessarily trade high risk securities. C is incorrect. This is the definition of pooled investment vehicles

Dark pools are best described as: A. trading venues that exercise little regulatory authority over their subscribers. B. operated by investment dealers that specialize in high-risk securities. C. certain groups of similar assets that issue securities representing shared ownership.

Dealers buy at bid price and sell at ask/offer price Ask price is always higher than bid price The best bid is the highest bid price, the best offer is the lowest offer price Bid/ask size - the amount dealers are willing to buy/sell at bid/ask price Market bid-ask spread is the different between best bid and best offer Traders who post bids and offers are said to make a market, while those who trade with them at posted prices are said to take the market.

Dealers [...] at bid price and [...] at ask/offer price Ask price is always [...] than bid price The best bid is the [...] bid price, the best offer is the [...] offer price Bid/ask size - the amount dealers are willing to [...]/[...]at bid/ask price Market bid-ask spread is the different between best [...] and best [...] Traders who post bids and offers are said to [...] a market, while those who trade with them at posted prices are said to [...] the market.

· refers to the ownership claims by investors in companies Different types are: · common shareholders- Have a residual claim over any assets after all the senior securities have been paid · preferred shareholders- they are paid scheduled dividends before the common shareholders · warrants- give the holder a right to buy the firms security at a price within a specified time. --> call option on a stock

Equities

Market orders: Order is immediately executed at best price available. Limit orders: Sets a minimum price for sell orders, or a maximum price for buy orders. All-or-nothing orders: Order will only be executed if the entire quantity can be filled. Hidden orders: Large orders that are only known to brokers/exchanges that are executing them, until the trades are executed. Iceberg orders: A small % of a large hidden order is executed first to gauge market liquidity, before the entire order is executed.

Execution instructions types for orders Market orders Limit orders: All-or-nothing orders Hidden orders Iceberg orders

C.

Financial intermediaries that issue securities which represent interests in a pool of similar financial assets are best characterized as: A)arbitrageurs. B)block brokers. C)securitizers.

- Securities that pay an equal payment on fixed periods like a bond. - They might be collateralized

Fixed income securities

· an agreement to trade the underlying asset at a future date at a pre specified price · not traded on exchanges or in dealer markets · Forward contracts are similar to futures contracts but are customizable

Forward Contract

A. A is correct. Most forward contracts do not require an upfront cash outlay. Other hedging vehicles, such as futures (which require margin accounts) and options (which must be purchased for a fee), do require upfront payments. B is incorrect. Because forward contracts are custom agreements, it is difficult to find another party who is both willing to take over the contract obligations and acceptable to the existing counterparty. Futures would be more suitable in this circumstance because they can be closed out early. C is incorrect. Forward contracts are custom agreements that depend on each counterparty's knowledge of the creditworthiness of the other.

Forward contracts are most likely to be attractive hedging vehicles to investors who: A. do not want to make an upfront outlay of cash. B. want to reserve the right to close out their position early. C. are not in a position to investigate the creditworthiness of their counterparties.

Complete markets: Savers receive a return, borrowers can obtain capital, hedgers can manage risks, and traders can acquire needed assets. Operational efficiency: Trading costs are low. Informational efficiency: Prices reflect fundamental information quickly. Allocational efficiency: Capital is directed to its highest valued use.

Four characteristics of a well functioning financial system:

C. A warrant grants the holder the right to purchase the issuer's shares at a pre-specified price. From the perspective of issuers, this is equivalent to a short call position because they have the obligation to sell shares at a pre-specified price if holders choose to exercise their right to buy. On the other hand, from the perspective of the warrant holder, this position is equivalent to a long call position. This is because as the market price rises above the exercise price, the value of the holder's position and the likelihood of exercise will increase.

From the perspective of the issuer, the payoff profile of a warrant most closely resembles that of a: A. long call position. B. short put position. C. short call position.

an agreement to buy or sell at a specific date in the future at a predetermined price · a standardized forward contract for which amount asset characteristics and delivery date are the same · standardization ensures higher liquidity

Futures contract

A.

Governments are most likely to raise funds by issuing: A. long-term bonds in capital markets. B. long-term bonds in secondary markets. C. short-term commercial paper in money markets.

· primary markets are where entities raise money · secondary markets are markets where investors trade securities · the cost of raising capital in primary markets is lower for corporations and governments whose securities trade in liquid secondary markets · in a liquid market the transaction costs are low to trade securities · investors are willing to pay more for liquid securities and these high prices result in lower costs of capital for issuers

Importance of secondary markets to primary markets?

C. When an IPO is underwritten, the investment bank agrees to purchase any unsold shares due to undersubscription. Therefore, the issuer does not need to worry about unrealized capital. The other two items are potential concerns for the issuer, even if the IPO is underwritten.

In an underwritten initial public offering, an issuer is least likely exposed to the risk of: A. decreased public opinion. B. increased future cost of capital. C. unrealized capital due to undersubscription.

- Investors trade to move wealth from present to future - Information-motivated traders trade to profit from better information about future prices - If investors expect to earn supernormal returns, they become information-motivated

Information-Motivated Traders vs Pure Investors

C. Futures contracts are standardized contracts traded on an exchange that obligate one party to purchase and one party to sell a specific amount of an asset at a specified price on a specified future date. Forward contracts are similar to futures contracts but are customizable (i.e., not standardized) and traded over-the-counter (i.e., not exchange-traded)

Jerry Slotz enters an exchange-traded contract that obligates him to purchase a specific amount of an asset on a future date. The contract is most likely: A)a forward contract. B)an option contract. C)a futures contract.

B. B is correct. The maximum possible loss is $1,300. If the stock price crosses $50, the stop buy order will become valid and will get executed at a maximum limit price of $55. The maximum loss per share is $13 = $55 − $42, or $1,300 for 100 shares.

Jim White has sold short 100 shares of Super Stores at a price of $42 per share. He has also simultaneously placed a "good-till-cancelled, stop 50, limit 55 buy" order. Assume that if the stop condition specified by White is satisfied and the order becomes valid, it will get executed. Excluding transaction costs, what is the maximum possible loss that White can have? A. $800. B. $1,300. C. Unlimited.

A. Cross-listing is the listing of a company's common shares on a different exchange than its primary and original stock exchange.

Jorman Inc. stock is cross-listed on exchanges in Tokyo and New York. Jorman stock is best described as a: A)public security. B)private security. C)primary market security.

Leverage ratio: = Value of position/ Value of equity - Measures how many times larger a position can be than the equity that supports it - Measures how much more risk and return leveraged position has over unleveraged position - Maximum leverage ratio = 1/Initial margin requirement e.g.: ·With a leverage ratio of 3 and a 10% decrease in share value, the investor's return is 3 × -10% = -30%

Leverage ratio: = Value of [...]/ Value of [...] - Measures how many times larger a [... can be than the [...] that supports it - Measures how much more [...] and [...] leveraged position has over unleveraged position - Maximum leverage ratio = 1/[...] [...] [...] e.g.: ·With a leverage ratio of 3 and a 10% decrease in share value, the investor's return is 3 × -10% = -30%

Leveraged positions: - Leverage: portion of securities price (total position) funded by borrowing - Margin loan: amount borrowed - Call money rate: interest paid on margin loan, lower for institutional investors - Initial margin requirement: minimum amount of deposit as a percentage of purchase price set by authorities - Trader's equity: portion of securities price not funded by borrowing. Minimum equal to initial margin requirement

Leveraged positions: - Leverage: portion of securities price (total position) funded by [...] - Margin loan: amount [...] - Call money rate: [...] paid on margin loan, lower for [...] investors - Initial margin requirement: minimum amount of [...] as a percentage of [...] price set by authorities - Trader's equity: portion of securities price not funded by [...]. Minimum equal to [...] [...]

Limit Order: Sets a minimum [...] price or a maximum [...] price on orders. Types of limit orders: a) Marketable (aggressively priced) ensures immediate execution: Limit buy price [...] best ask, OR Limit sell price [...] best bid Easiest for trade to execute when minimum price willing to sell is [...] than maximum price market willing to buy, and when maximum price trader willing to buy is [...] than minimum price market willing to sell. b) Making a new market / inside the market: Best [...] < Limit price < Best [...] c) Behind the market: Limit buy price [...] Best bid Limit sell price [...] Best ask Hardest to execute trade when highest price willing to buy is [...] than highest price market willing to buy, and when lowest price willing to sell is [...] than lowest price market willing to sell. Order may not be executed at all if markets are fast moving or there are insufficient liquidity.

Limit Order: Sets a minimum [...] price or a maximum [...] price on orders. Types of limit orders: a) Marketable (aggressively priced) ensures immediate execution: Limit buy price [...] best ask, OR Limit sell price [...] best bid Easiest for trade to execute when minimum price willing to sell is [...] than maximum price market willing to buy, and when maximum price trader willing to buy is [...] than minimum price market willing to sell. b) Making a new market / inside the market: Best [...] < Limit price < Best [...] c) Behind the market: Limit buy price [...] Best bid Limit sell price [...] Best ask Hardest to execute trade when highest price willing to buy is [...] than highest price market willing to buy, and when lowest price willing to sell is [...] than lowest price market willing to sell. Order may not be executed at all if markets are fast moving or there are insufficient liquidity.

Long position: - Benefit from a higher price than specified price in contract - At the end of contract, sell at market price and buy at specified price for gain/loss - Loss is limited to specified price - Gain is unlimited from price increase

Long position: - Benefit from a [...] price than specified price in contract - At the end of contract, [...] at market price and [...] at specified price for gain/loss - [...] is limited to specified price - [...] is unlimited from price increase

B. Hampton originally purchased 100 shares at $75 for a total value of $7500. Half of the value ($3750) was borrowed and Hampton paid cash for the other half. The current total market value of the stock is $6200. If Hampton sells her holdings she will have $2450 left after she pays off the loan. Hampton's return on her original investment is: $2450/3750 - 1 = 0.65 - 1 = -0.35 = -35%.

Lynne Hampton purchased 100 shares of $75 stock on margin. The margin requirement set by the Federal Reserve Board was 40%, but Hampton's brokerage firm requires a total margin of 50%. Currently the stock is selling at $62 per share. What is Hampton's return on investment before commission and interest if she sells the stock now? A)-17%. B)-35%. C)-40%.

contracts that give investors the choice to buy or sell stock and other financial assets · call options - buyer gets the right to buy the underlying security -seller of the call option gets the premium upfront but has to sell the security if the buyer exercises his option to buy · put options- buyer gets the right but not the obligation to sell the underlying security -the seller gets the premium upfront but has to buy the security if the buyer exercises his option to sell

Options

Other primary market transactions Private placements: securities are sold to a small group of qualified investors, which require lower disclosures and lower prices than public placements as private placement securities are illiquid because they cannot be traded in the secondary market. A shelf registration is used by issuers to sell securities directly to secondary market investors on a piecemeal basis rather than in a single large offering. This gives the issuer the flexibility to raise capital as needed. Dividend reinvestment plans (DRIPs) allow investors to purchase new shares with dividends, sometimes at a discount. The company must issue new shares for DRIPs rather than purchasing existing shares in the secondary market. Rights offerings grant existing shareholders the option to purchase additional shares at a discount. These are effectively warrants that dilute the value of existing shares.

Other primary market transactions Private placements: securities are sold to a small group of [...] investors, which require [...] disclosures and [...] prices than public placements as private placement securities are [...] because they cannot be traded in the secondary market. A shelf registration is used by issuers to sell securities directly to [...] market investors on a piecemeal basis rather than in a single large offering. This gives the issuer the flexibility to raise capital as needed. Dividend reinvestment plans (DRIPs) allow investors to purchase new shares with [...] , sometimes at a [...]. The company must issue new shares for DRIPs rather than purchasing existing shares in the secondary market. Rights offerings grant existing shareholders the option to purchase additional shares at a [...]. These are effectively warrants that [...] the value of existing shares.

C. Equity investors who do not believe they have superior information will most likely passively hold a diversified portfolio such as one composed of stocks included in a broad market index (according to their representative weights). It is not necessary to eliminate all potential for earning an equity risk premium by holding cash until superior information can be acquired. By contrast, equity investors who believe that they are in possession of superior information will pursue an activist strategy with the expectation of realizing superior risk-adjusted returns. Information-motivated traders and passive investors are not distinguished by differences in their expected holding periods.

Over the long-term, equity investors who do not believe that they possess superior information will most likely: A. hold only cash until they acquire superior information. B. have longer holding periods than information-motivated traders. C. achieve returns that closely track the performance of a broad market index.

A.

Peg Fisk, CFA, states that two of the objectives of market regulation which CFA Institute attempts to address are minimum standards of competence among investment professionals and ease of performance evaluation for investors. Fisk is accurate with regard to: A)both of these objectives. B)neither of these objectives. C)only one of these objectives

· Physical contract- contracts are based on physical assets like oil wheat or gold · financial contract- contracts based on financial assets such as indexes, interest rates, and currencies

Physical vs financial contracts

A. A is correct. Robert's exposure to the risk of the stock of the Michelin Group is long. The exposure as a result of the long call position is long. The exposure as a result of the short put position is also long. Therefore, the combined exposure is long.

Pierre-Louis Robert just purchased a call option on shares of the Michelin Group. A few days ago he wrote a put option on Michelin shares. The call and put options have the same exercise price, expiration date, and number of shares underlying. Considering both positions, Robert's exposure to the risk of the stock of the Michelin Group is: A. long. B. short. C. neutral.

- Mutual funds: pool money from many investors to invest in different assets. + Open-ended funds allow direct trade + Closed-end funds shares can be purchased in secondary market - Exchange-traded funds: open-ended funds that can be traded in secondary market; offer in-kind deposits and redemption (securities deposit rather than cash) - Asset-backed securities: owners receive a portion directly from the assets e.g. mortgage, car loans, credit card debt. - Hedge funds: funds with complex and high-risk investment strategies that only qualified and wealthy individuals are allowed to invest in

Pooled investments

Companies, government & other organizations that raise capital by issuing securities. Investors buy directly from these organizations.

Primary capital markets

1. Saving 2. Borrowing 3. Raising Equity Capital 4. Managing Risks 5. Exchanging Assets 6. Information-motivated trading

Purposes for using the financial system (6)

· tangible assets such as real estate, machinery, and airplanes which are normally held by operating companies · real assets are unique, illiquid, and costly to manage · they have low correlation with other investments and provide income and tax benefits to investors

Real assets

· The process of buying assets, placing them in a pool, and then selling assets that represent ownership of the pool (Mortgage-backed securities) Benefits: · Improves liquidity in the mortgage markets as it allows investors to indirectly invest in mortgages that they would otherwise not buy · Reduces the cost of borrowing for homeowners. Higher liquidity means individuals are willing to pay more for securitized mortgages which results in higher mortgage prices and lower interest rates · Diversification of portfolio for individual investors who wish to invest in mortgages but can't service it efficiently · Losses from default and early prepayments are more predictable

Securitizing

· A clearinghouse helps clients settle their trades · In futures markets, they guarantee contract performance and eliminate counterparty risk · They ensure there's no defaults · Depositories or custodians hold securities for their clients so that investors are insulated from loss of securities through fraud or natural disasters

Settlement and Custodial Services

Short position: - Benefit from a lower price than price specified in contract - At the end of contract, buy at market price and sell at specified price for gain/loss - Gain is limited to specified price - Loss is unlimited from price increase

Short position: - Benefit from a [...] price than price specified in contract - At the end of contract, [...] at market price and [...] at specified price for gain/loss - [...] is limited to specified price - [...] is unlimited from price increase

Writer/Seller of an option · Created when traders borrow an asset and sell it, with an obligation to replace the asset in the future · The short seller pays all dividends to the lender, loses if stock prices rise, and is required to post a margin account · often places a stop buy order to protect the short sale position from a rising market.

Short sale:

· an agreement to swap payments of 1 asset for another · interest rate swap - floating rate payments are swapped for fixed rate payments for a specified period · Currency swap - loan in one currency swapped for loan in another currency · Equity swap- return on stock index/portfolio exchanged for interest earned on fixed income securities

Swap contract

B. B is correct. The holder of the call option will exercise the call options if the price is above the exercise price of $305 per share. Note that if the stock price is above $305 but less than $308, the option would be exercised even though the net result for the option buyer after considering the premium is a loss. For example, if the stock price is $307, the option buyer would exercise the option to make $2 = $307 − $305 per share, resulting in a loss of $1 = $3 − $2 after considering the premium. It is better to exercise and have a loss of only $1, however, rather than not exercise and lose the entire $3 premium.

The Standard & Poor's Depositary Receipts (SPDRs) is an exchange-traded fund in the United States that is designed to track the S&P 500 stock market index. The latest price of a share of SPDRs is $290. A trader has just bought call options on shares of SPDRs for a premium of $3 per share. The call options expire in six months and have an exercise price of $305 per share. On the expiration date, the trader will exercise the call options (ignore any transaction costs) if and only if the shares of SPDRs are trading: A. below $305 per share. B. above $305 per share. C. above $308 per share.

B.

The Standard & Poor's Depositary Receipts (SPDRs) is an investment that tracks the S&P 500 stock market index. Purchases and sales of SPDRs during an average trading day are best described as: A. primary market transactions in a pooled investment. B. secondary market transactions in a pooled investment. C. secondary market transactions in an actively managed investment.

Financial leverage = Equity/ Position = 10,000/20,000 = 0.5 = Initial margin --> E/P = 0.5 --> E = 0.5P Margin call occurs when E/P is below 0.3 (maintenance margin) - when price drops below ΔP (E - ΔP)/(P - ΔP) = 0.3 --> (0.5P - ΔP)/ (P - ΔP) = 0.3 --> (0.5 - Δ)/(1 - Δ) = 0.3 --> 0.5 - Δ = 0.3 - 0.3Δ --> Δ = 0.2/0.7 = 0.2857 A drop of more than 28.57% from price of $25 will trigger a margin call --> Price below $25x(1-0.2857) = 17.86 will trigger margin call Alternatively: Margin call price = $25x(1-0.5)/(1-0.3) = 17.86 % price decrease = 1 - (1-0.5)/(1-0.3) = 28.57%

The current price of a stock is $25 per share. You have $10,000 to invest. You borrow an additional $10,000 from your broker and invest $20,000 in the stock. If the maintenance margin is 30 percent: - What is the percentage drop in price that will trigger margin call - What is the price at which margin call will occur?

C. C is correct. Only 6,000 shares can be sold because the trader cannot execute below the $42.52 limit price. The average price is CHF42.53/share per the calculation below: (2,000 shares×CHF42.56)+(4,000 shares×CHF42.52)(2,000 shares+4,000 shares)=CHF42.53 A is incorrect. This is the limit price but is not the price at which the order is executed. B is incorrect. This is the average price that would be generated if the order was a market order: (2,000 shares×CHF42.56)+(4,000 shares×CHF42.52)+(3,000 shares×CHF42.44)(2,000 shares+4,000 shares+3,000 shares)=CHF42.50

The following is a trader's order book for a stock: She receives an order to sell 9,000 shares with a limit price of CHF42.52. The average price (in CHF) at which the trades will be executed is closest to: A. 42.52. B. 42.50. C. 42.53.

C. One of the purposes of the financial system is to allow investors to trade on (public) information. Other purposes of the financial system include allocating financial capital to its most productive uses, and bringing together those who wish to save with those who wish to borrow.

The main functions of the financial system least likely include: A. allocating financial resources to their most productive uses. B. bringing together savers and borrowers. C. preventing investors from generating abnormal profits by trading on information.

B. The main functions of the financial system are to allow individuals and organizations to save, borrow, raise capital, and manage risks; to determine equilibrium rates of return that equate the amounts of lending and borrowing; and to allocate capital to its most productive uses. The money supply is typically controlled by countries' central banks.

The main functions of the financial system most likely include: A)allocating capital to its most productive uses and determining the supply of money. B)determining equilibrium interest rates and allocating capital to its most productive uses. C)determining the supply of money and determining equilibrium interest rates.

C. A buy order is said to take the market when it matches the best offer price. In this example, a buy order with a limit price of $10.55 is taking the market. A buy order that matches the current best bid price is said to make the market. A sell order that improves upon the current best offer price is said to make a new market.

The market in a stock is currently "$10.50 bid, offered at $10.55." Which of the following orders would most likely be described as taking the market? A. A buy order with a limit price of $10.50 B. A sell order with a limit price of $10.52 C. A buy order with a limit price of $10.55

A.

The prospectus for the Horizon Fund states that it invests only in real assets. Which of the following would the Horizon Fund most likely include in its portfolio? A)An investment in an apartment complex. B)Holdings of foreign currencies. C)Common stock of a technology company.

A. A is correct. Once you have entered into a forward contract, it is difficult to exit from the contract. As opposed to a futures contract, trading out of a forward contract is quite difficult. There is no exchange of cash at the origination of a forward contract. There is no exchange on a forward contract until the maturity of the contract.

The usefulness of a forward contract is limited by some problems. Which of the following is most likely one of those problems? A. Once you have entered into a forward contract, it is difficult to exit from the contract. B. Entering into a forward contract requires the long party to deposit an initial amount with the short party. C. If the price of the underlying asset moves adversely from the perspective of the long party, periodic payments must be made to the short party.

· Achieve the purpose for which people use the financial system · Discover the rates of return that equate aggregate savings with aggregate borrowings · Allocate capital to the best uses

Three main functions of the financial system

· underwritten offering - investment bank guarantees the amount of shares and the price at which they will be sold -this price is called the offering price · best efforts offering- investment bank only serves as a broker to bring investors to the issuer -any security is not sold will remain as is

Two major types of offerings provided by investment banks

C. Under the discriminatory pricing rule, an order is first filled at the most aggressive (standing) limit price. It is not necessary for the standing order to completely fill the arriving order because any remaining portion of the arriving order will be filled at the next most aggressively-priced order. The discriminatory pricing rule will not prioritize other orders over the standing limit order based on their size or the recency of their arrival when determining the transaction price.

Under the discriminatory pricing rule, the trade price is most likely determined by the price of the: A. largest order. B. most recent order. C. standing limit order.

Day orders: Orders that expire if unexecuted by end of day it is submitted. Good-till-cancelled orders: Orders that last until the buy or sell order is executed. Immediate or cancel orders ("fill or kill"): As per its name, once the order is submitted it has to be immediately executed. If it is not executable immediately, the order is cancelled. Good-on-close (market-on-close): Order is only executed at the close of trading. Good-on-close (market-on-open): Order is executed at the beginning of trading day Stop orders (stop-loss): Orders that come with a trigger price, designed to limit losses. E.g. stop-sell orders will execute if price is at or below stop/trigger price. Whereas, stop-buy orders will execute if price is at or above stop/trigger price.

Validity instructions types of order Day orders Good-till-cancelled orders Immediate or cancel orders (fill or kill): Good-on-close (market-on-close) Good-on-open Stop orders (stop loss)

A. A is correct. Equity swaps consist of parties exchanging fixed cash payments for payments that depend on the returns to a stock or a stock index. B is incorrect. The payments depend on the returns to a stock or a stock index, but an index fund has not been directly purchased. C is incorrect. An option contract allows the holder (the purchaser) of the option to buy or sell an underlying instrument at a specified price at or before a specified date in the future.

When parties exchange fixed cash payments for payments that depend on the returns to a stock or a stock index, they are purchasing a(n): A. equity swap. B. index fund. C. stock option.

A. A is correct. Private placements qualify as primary market transactions because they are sales of securities by issuers directly to a small group of qualified investors. B is incorrect. Market order sales take place in secondary markets. C is incorrect. The exercise of an exchange-traded call option is a secondary market transaction involving the purchase by option owner of previously issued security.

Which of the following is most likely a primary market transaction? A. A private placement of shares B. A market order sale of bonds C. The exercise of an exchange-traded call option

A. A is correct. A secondary market is where investors continue to trade the securities among themselves. Continuous trading is typically associated with secondary capital markets. B is incorrect. Lead underwriter is associated with primary markets. C is incorrect. Book building is associated with primary markets.

Which of the following is most likely associated with secondary capital markets? A. Continuous trading B. Lead underwriters C. Book building

B. A marketable limit order is a limit order which can (at least partially) execute immediately. Orders that are behind the market are limit orders which are waiting for market conditions to be fulfilled. The collection of behind the market orders is called the standing limit orders.

Which of the following orders is most likely to execute first? A. A standing limit order B. A marketable limit order C. A behind the market order

B. B is correct. The investment companies that create exchange-traded funds (ETFs) are financial intermediaries. ETFs are securities that represent ownership in the assets held by the fund. The transaction costs of trading shares of ETFs are substantially lower than the combined costs of trading the underlying assets of the ETF.

Which of the following statements about exchange-traded funds is most correct? A. Exchange-traded funds are not backed by any assets. B. The investment companies that create exchange-traded funds are financial intermediaries. C. The transaction costs of trading shares of exchange-traded funds are substantially greater than the combined costs of trading the underlying assets of the fund.

C

Which of the following statements about primary and secondary markets is least accurate? A)The primary market benefits from the liquidity provided by the secondary market. B)A primary market is a market in which new securities are sold. C)The proceeds from a sale in the secondary market go to the issuer.

C. Financial regulators impose minimum levels of capital that apply across the board to all regulated firms—not the optimum level, which is firm specific. A is incorrect. Financial regulators act to level the playing field for market participants as in the case of regulation concerning insider trading. B is incorrect. Financial regulators help define minimum standards of competence for agents (e.g., the GIPS standards from CFA Institute).

Which of the following statements concerning financial regulatory bodies is least accurate? Financial regulatory bodies: A. act to level the playing field for market participants. B. define minimum standards of competence for agents. C. require that regulated firms maintain optimum levels of capital.

B. Clearinghouses serve financial markets by arranging for the final settlement of trades. Members of clearinghouses guarantee to settle any trades that their customers present to them. In turn, clearinghouses provide assurance that they will settle any trade presented to them by their members. Non-member brokers and dealers cannot trade directly through the clearinghouses. Instead, they need to have their trades arranged by the members. Clearinghouses require their members to take steps to ensure that non-members will be able to settle their trades. Clearinghouses enforce reliable settlement of all trades. This eliminates counterparty risk and encourages investors to trade, producing higher liquidity.

Which of the following statements is most accurate? Clearinghouses: A. eliminate counterparty risk at the expense of lower liquidity. B. will settle any trade presented to them by a member who is unable to do so. C. allow non-member brokers and dealers to initiate trade by requiring additional fees.

A. Every automated trading system is an order-driven system. In order-driven markets, orders can be submitted by either dealers or customers. Although stocks typically trade in order-driven markets, almost all trading of currencies and fixed-income securities occurs in quote-driven markets.

Which of the following statements is most accurate?: A. All automated trading systems are order-driven B. All orders in order-driven markets are submitted by dealers C. The majority of currency trading is executed in order-driven markets

B. Prevailing market prices are determined by the transactions that take place on the secondary market. This information is used to determine the price of new issues sold on primary markets.

Which of the following statements regarding primary and secondary markets is least accurate? A)New issues of government securities can be sold on the primary market. B)Prevailing market prices are determined by primary market transactions and are used in pricing new issues. C)Secondary market transactions occur between two investors and do not involve the firm that originally issued the security.

B. Secondary markets are important because they provide liquidity and continuous information to investors. The liquidity of the secondary markets adds value to both the investor and firm because more investors are willing to buy issues in the primary market, when they know these issues will later become liquid in the secondary market. Therefore, the secondary market makes it easier for firms to raise external capital.

Which of the following statements regarding secondary markets is least accurate? Secondary markets are important because they provide: A)firms with greater access to external capital. B)regulators with information about market participants. C)investors with liquidity.

C. Defined-benefit pension plans may be users of risk management instruments such as interest rate swaps, but these entities are not known as designers of these instruments. By contrast, exchanges and investment banks specialize in designing instruments that help other financial market participants manage their exposure to various risks and ensuring that they can be traded in liquid markets.

Which of the following types of financial market participants is least likely to design risk management instruments? A. Exchanges B. Investment banks C. Defined-benefit pension plans

C. The key to remember for this question is that when the maintenance margin requirement is hit, the account balance must increase all the way up to the initial margin requirement. During the first day of trading, the security increases by $2, increasing the account balance by $2×20 = $40. The total at the end of Day 1 is $140. During the second day, the security decreases by $7 from its Day 1 closing price, resulting in a loss of $7×20 = $140. This reduces your account all the way down to $0. You will need to fund your account back to the initial margin ($100). On the last day, the security increases by $3, increasing your account by $3 x 20 = $60 up to $160. Note: There's a way to solve this more quickly. You are just asked what the account balance will be at the end of Day 3. By looking at the prices, you can tell that there will be a margin call on Day 2. All of the transactions up to that point become irrelevant because, at the end of Day 2, your account balance will be the initial margin requirement of $100 (after getting replenished). From there, you just have one day left, a simple increase of $3 ×× 20 = $60, and the ending balance would be $160.

You are long in 20 futures contracts. Each contract has an initial margin requirement of $5 and a maintenance margin requirement of $2. You do not add any more money than necessary to your account, and you do not withdraw anything. There are no limits. The end of day prices of the underlying asset are: Day Price ($) 0 100 1 102 2 95 3 98 At the end of Day 3, the ending account balance will be closest to: At the end of Day 3, the ending account balance will be closest to: A. $100. B. $130. C. $160.

Where investors use brokers to locate a counterparty to a trade; Useful with unique or illiquid securities; Dealers do not carry inventory; Too few trades to trade in an order-driven market · brokers arrange trades between counterparties · used for instruments that are unique or illiquid, like real estate or art

brokered markets

· trade takes place only at specific times of the day where all the traders are present and all bid ask quotes are used to arrive at one negotiated price · markets are highly liquid when the market is in session and illiquid when the market isn't in session · usually used for smaller markets or to determine the opening and closing prices at stock exchanges

call markets · trade takes place only at specific times of the day where all the traders are present and all bid ask quotes are used to arrive at one negotiated price · markets are highly liquid when the market is in session and illiquid when the market isn't in session · usually used for smaller markets or to determine the opening and closing prices at stock exchanges

· as an underwriter, it's in the interest of the investment bank to have the offering price as low as possible · but as agents for issuers the offering price should be right to raise the required amount of money for the issuer

how do investment banks have a conflict of interest?

Buyer of an option (either call or put) · Created when a trader owns an asset or has a right or obligation under a contract to purchase an asset · Investors who make a long put position, benefit from an increase in price of the security · A long position can be levered or unlevered

long position (futures)

A market (generally an auction market) that uses rules to arrange trades based on the orders that traders submit; in their pure form, such markets do not make use of dealers. · trading rules match buyers to sellers thus making them supply liquidity to each other · Order matching rules- this establishes the order precedence based on price, their arrival time, and other factors · trade pricing rules- this determines the price of the transaction

order driven markets

order matching rules. Price is the top priority - the highest buy orders and lowest sell orders are executed first. Among orders with the same price, a secondary precedence rule prioritizes those that were placed earliest. In markets where hidden orders are permitted, orders with displayed quantities are usually given priority over those with undisplayed quantities. In these markets, orders are prioritized according to price first, display status second, and arrival time third.

order matching rules. [...] is the top priority - the highest [...] orders and lowest [...] orders are executed first. Among orders with the same [...], a secondary precedence rule prioritizes those that were placed [...]. In markets where hidden orders are permitted, orders with [...] quantities are usually given priority over those with [...] quantities. In these markets, orders are prioritized according to [...] first, [...] status second, and [...] [...] third.

· if the offering price is low more investors will be interested in subscribing than the number of shares issued (oversubscribed) and vice versa

oversubscribed vs undersubscribed offerings

Investors trade with dealers; Dealers keep an inventory of securities; Most securities other than stocks trade in quote driven markets; Trading is often electronic · trade take place at the price quoted by dealers who maintain inventory of the security · dealers provide liquidity in these markets in gain from the difference in bid ask spread

quote driven markets

Protect unsophisticated investors. Establish minimum standards of competency. Help investors to evaluate performance. Prevent insiders from exploiting other investors. Promote common financial reporting requirements so that information gathering is less expensive. Require minimum levels of capital so that market participants will be able to honor their commitments and be more careful about their risks.

role of a market regulator