FINC13-303 Midterm: Review for Mid-Semester
Week 1
Security Markets
Functions of the financial markets:
oOverall purpose: facilitate low cost investment
oBringing together buyers and sellers at low cost
oProviding adequate liquidity
oSet and update the prices of financial assets
oReducing information costs associated with investing
Primary VS Secondary – primary initial public offering, secondary – investor to investor
Types of markets: Direct search, brokered, dealer, auction.
Bid: price “market” will buy from you
Ask: price “market” will sell to you
Spread: ask- bid.
Types of orders
- Market order – execute immediately at best price
- Price-contingent order- buy/sell at specific price or better (stop order and limit
order)
Profit= (ending price + dividend)-Initial price
Short sales
Purpose: profit from a price fall in a stock you don’t own
Mechanics: borrow a stock from a dealer/broker, sell it and deposit proceeds and margin in
an account, any dividend must be paid to the lender. Closing the position- buy back the
stock and return it to the lender.
Margin requirements:
Initial margin- deposit now
Maintenance margin: need to make sure the balance is above the limit, otherwise have to
deposit additional finds
Profit: Balance (sales proceeds +margin) – buying back the stock price – initial margin
deposit.
Profit = Initial price (Ending price + dividend)
Calculating the margin call:
((Starting price + margin) -current price)/current price = your equity in the stock
Buying on margin
Securities purchased with money borrowed in part from the broker. Initial margin
requirement (IMR) – minimum % initial investor equity.
1-IMR= Maximum % amount investor can borrow
Equity
- Position value – Borrowing +additional cash
- Maintenance margin requirement (MMR) – minimum amount equity can be before
additional funds must be put into the account.
- Margin call –notification from the broker that you must contribute additional funds
or have the position liquidated
Stock margin Trading
Borrow money from the broker to purchase shares
Initial margin: how much of the position value must be in cash/equity
Maintenance margin: minimum level of equity that will be accepted
Margin call: call for more funds
Maintenance margin calculation how far the price can fall before you receive a margin call
(P1-how much equity you have per share)/$P1 =maintenance margin
Why buy on margin?
Able to increase the overall the potential upside and downside as there are more funds
involved.
Week 2
Risk and return: past and prologue
Period returns VS continues compounded returns
Period – general benchmark; forecasting based on a past sample
Continuously compounded returns- simplest for time aggregation; used in valuing derivative
securities
Time aggregation – putting together returns from shorter intervals to obtain the return
earned over the longer interval
Averaging multiple period returns
- Time weighted returns return from one unit if investment, all proceeds reinvested
oArithmetic
oGeometric
- Value (dollar) weighted returns
Incorporates cash flows sin and out of the fund
Document Summary
Functions of the financial markets: overall purpose: facilitate low cost investment, bringing together buyers and sellers at low cost, providing adequate liquidity, set and update the prices of financial assets, reducing information costs associated with investing. Primary vs secondary primary initial public offering, secondary investor to investor. Types of markets: direct search, brokered, dealer, auction. Market order execute immediately at best price. Price-contingent order- buy/sell at specific price or better (stop order and limit order) Purpose: profit from a price fall in a stock you don"t own. Mechanics: borrow a stock from a dealer/broker, sell it and deposit proceeds and margin in an account, any dividend must be paid to the lender. Closing the position- buy back the stock and return it to the lender. Maintenance margin: need to make sure the balance is above the limit, otherwise have to deposit additional finds. Profit: balance (sales proceeds +margin) buying back the stock price initial margin deposit.
