BU121 Study Guide - Final Guide: Critical Success Factor, Annual Percentage Rate, Annuity

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BU111 Final Exam Notes
Buying and Selling Equities The Mechanics
** Assume that commission paid on these transactions if 2% on purchase and 2% on
sale of investment **
Market Order
Most common type of transaction
To buy a stock you would call a broker and ask to buy a certain number of
shares  is a typical board lot
What you pay when buying shares = Price of share × # of shares being
bought + 2% commission
What you get for selling shares = Price of share × # of shares being sold
2% commission
Capital Gain
Whenever you benefit financially by buying an asset and selling it at a higher
price
Capital Gain = Price sold Price paid
Yield
Yield = what you paid ÷ what you paid OR yield = Dollar return ÷ dollar
invested
Commission and/or interest expense will be deducted from the return and
the stock price (or dollars spent on actual investment excluding
commissions) will be used as the denominator
Going Long and Buying on Margin
Going long
o Means investor has purchased a security
o Investor is expecting profit when price of a security increases and the
investor sells it (buying low, selling high)
o Investor pays the price of the investment
Buying on margin
o Make profit when security increases in price and is old
o Borrows money for part of investment from the broker
o The minimum margin is 80% (the investor must put in at least 80% of
value of the investment)
o The investor does not have to choose to use the full margin available
(could choose to provide 90% of investment)
o Results in the investor being able to purchase a larger amount of
securities with the same amount of money they would have invested
when going long
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o Advantage is leverage you are able to increase your buying power
(buy more with same investment) therefore increasing potential
profits)
Margin Buying Costs and Risks
When borrowing money from the broker for buying on margin, you must pay
interest on the loan
Buying on margin magnifies your risk if the price falls if you do not sell
your shares before the price falls, the amount that you deposited with the
broker is no longer enough to meet to margin requirement (80%)
o Investor will receive a margin call from their broker requesting to
give him more money in order to reduce the value of the loan he has
provided
o Calculating the margin = (current market value of the investment
loan) ÷ Current market value of the investment
o To bring the margin back up to the minimum is to reduce the amount
of the loan to bring the margin back up to 80% - this is the margin call
amount
o Calculating the margin call amount (solve for margin call amount)
Minimum margin requirement = [Current Market value of
investment (Loan Margin call amount)] ÷ Current market
value of investment
Calculating Interest on Margin Loan
Assume that interest is compounded annually
Interest expense = loan × interest rate × portion of year that loan was held
Interest expense is deducted from your capital gain when calculating profit
(or return) on a stock transaction
Calculating Capital Gain and Yield when Going Long or Buying on Margin
When calculating Capital gain, you must subtract all of to your expenses from
the revenue that is generated from the sale of the sale of the investment
o When going long expenses are commission when buying and selling
security
o When buying on margin expenses are commission and interest you
had to pay
Yield = dollars returned ÷ dollars invested = capital gain ÷ dollars invested
o The denominator in yield calculation (the dollars invested will only be
actual dollars spent to purchase the security
o All expenses will be deducted from the dollars returned
Selling Short
Sell at a high price and buy back when the price drops
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You do not own the shares you are selling creating a deficit or short
position in the investors account – the subsequent purchase of the shares
covers or repays this deficit
The broker would lend the securities to the investor for them to sell but
they must declare that it is going to be a short sale
The proceeds from the sale would remain in the investors account plus
addition deposit supplied by the investor always assume that its 5% – so
the minimum credit balance in the account is 150%
o Investor would still pay broker 2%
Minimum maintenance margin that must be maintained at all times is 125%-
140%
o If the value of the stock rises and investor no longer meets
maintenance margin investor would then receive a margin call to
deposit more money into account to once again meet the maintenance
margin requirement
Broker wants the investor to make this deposit because if the
price of stock was to rise again, the broker wants to ensure that
there is a sufficient amount of money to cover to buy back the
stocks and cover the investors short position
Theoretically, the risks are unlimited because there is no limit to the price in
which the stock can rise to
When the investor covers their short position by buying the stock, the stock
is returned and investor receives profit less commissions, and the additional
deposit is released to the investor to be used in another transaction (if
desired)
Bonds
Represent debt to a company
Legal, binding agreement
Fixd rate of return (often paid semi-annually)
Fixed term principal repaid at maturity
Priority over stockholders
Types
o Secured vs Unsecured
o Registered vs. Bearer
Features
o Callable
o Serial
o Convertible
What impacts the coupon rate at bond issue?
o Prevailing interest rates
o Credit of issuer
o Features
What impacts bond price when traded?
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