[FIN 3244] - Midterm Exam Guide - Everything you need to know! (17 pages long)

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7 Feb 2017
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FIN 3244
MIDTERM EXAM
STUDY GUIDE
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FIN 3244 EXAM 3
CHAPTER 8
First Video
- Trading on the Margin
o Leverage = the use of borrowed funds to buy securities
o Margin = % of an investor’s equity
o Margin is the collateral for the broker’s loan
Can be cash or acceptable securities (stocks, bonds, mutual funds or
derivatives)
We will always use cash for this class
o Portfolio: a group of financial securities
Portfolio’s value = sum of its individual holdings
- Why Trade on Margin?
o Magnifies gains and losses
o You have $5000 to invest, you want shares of stock that cost $50
If you don’t trade on margin, you can buy 100 shares
If you trade on 50%, you can buy 200 shares
- Buying on Margin
o Advantage
Magnifies profit
o Disadvantages
Magnifies losses
Interest paid on margin loan
Possible margin calls
- Rules
o Must have margin account with broker
$2000 equity or 100% of purchase price
Whichever is least
Let’s you borrow from brokerage for investments
Can’t fix your house with this
Cash into securities
Securities kept by broker until loan is paid
Collateral
Let’s brokerage safeguard the money it lent to you
If the value of the stock is too low, you won’t have sufficient margin or
equity in your account as collateral for the loan
Broker would give you a margin call at this point and time, which
allows you to add money to bring value up
If you don’t do this, the broker will sell sufficient securities in your
account to cover the costs of the loan
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There is instances where stocks drop rapidly and you won’t get a
margin call
o Margin = % of investor’s equity
o Minimum margin requirement: set by the Fed
Least amount of margin you can have in your account initially when you
buy stock
Brokers are not permitted to lower this margin requirement
% depends on securities’ risk
Stocks = 50%
Bonds = 30%
o Safer investments
Less margin = less collateral (risker)
Brokers can set the margin amount higher than the minimum
o Can vary with the brokerage firm
OTC stocks (penny stocks) can’t be margined: no collateral value
- Types of Margin
o Initial margin: minimum equity an investor must have in his account at the time of
purchase
o Maintenance margin: minimum equity an investor must have in his account at all
times
Lower percentage of margin than initial margin
o Margin call (courtesy, not required)= notice that the equity is below the
maintenance margin
Must be returned to maintenance margin level OR
Account holdings are sold to bring it back up
Can do this without permission because you opened up a margin
account
o Restricted margin account: equity is below the initial margin required, but higher
than maintenance margin
Can’t make any purchase on margin until it is back to initial margin
requirement, however the account can fall as low as the maintenance
margin (at all times)
If you are in between the two (if you have more equity than the
maintenance margin but less equity in the initial margin) it will be
restricted
No additional margin purchases, but nothing horrendous happens
If you fall below your initial margin and get a margin call, it means that if
you borrow the maximum amount that you are allowed to do if the price of
the stock fell below even a penny, you would below the initial margin
Makes no sense to give you a margin call
So if there is a range in which a stock can go down and until the
price gets too small (doesn’t represent the same equity), which is
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