TUNIS BUSINESS SCHOOL

UNIVERSITY OF TUNIS

Financial Markets
Homework Chapter 1

1-Which of the following is not a function of the financial system?

A. Save money for future use

B. Manage risks
C. Trade on information
D. Speculate in capital markets

Answer D

2-Markets can be classified in:

A. Primary and secondary markets

B. Spot, forward and option markets
C. Money and capital markets
D. All of the above

Answer D

3-Forward contracts are all the following, except for

A. Customized
B. Have default or counterparty risk
C. Guaranteed by a clearinghouse
D. Held to maturity

Answer C

4-A swap contract has … while a forward contract …

A. Periodic cash payments, annual cash payments

B. Periodic cash payments, single cash payment at maturity
C. Single cash payment at maturity, periodic cash payments
D. Single cash payment at maturity, no cash payments

Answer B

5-A put option is

A. The right and the obligation to sell a security at the strike price
B. The right, not the obligation to sell a security at the strike price
C. The right and the obligation to buy a security at the strike price
D. The right, not the obligation to buy a security at the strike price

Answer B

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6-A call option has a strike price of $15. At maturity, the market stock price is $12. The option holder
should:

A. Exercise the call option and buy the stock at $15

B. Exercise the call option and sell the stock at $15
C. Exercise the call option and buy the stock at $12
D. Not exercise the call option, buy at market price $12, because it’s cheaper than the strike price

Answer D

7-Mortgage backed securities are

A. Securities that represent a pool of mortgages

B. Securities that represent a pool of real estates
C. Securities that represent the largest mortgage
D. Securities that represent the largest real estate

Answer A

8-The difference between dealers and arbitrageurs is that:

A. Dealers move liquidity instantly, arbitrageurs move liquidity across markets

B. Dealers move liquidity across time, arbitrageurs move liquidity across markets
C. Dealers move liquidity on time, arbitrageurs move liquidity later
D. Dealers move liquidity in a call market, arbitrageurs move liquidity in a continuous market

Answer B

9-When buying a call, the positions on both the option and the underlying stock are

A. Long, long
B. Long, short
C. Short, long
D. Short, short

Answer A

10-A dividend reinvestment plan DRIP offers

A. Shares for the income generated

B. Coupons for the income generated
C. Shares for the dividends to be distributed
D. Coupons for the dividends to be distributed

Answer C

11-A broker has set a minimum margin requirement of 30% (minimum equity to be provided), for
buying 2000 shares of Carthage Cements. What is the maximum leverage ratio the buyer would be
allowed associated with this investment?

A. 2.86
B. 3.70
C. 1.82

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D. 3.33

Answer D

The minimum margin requirement is the minimum equity required over total investment amount (or
total asset like in accounting). So it is equal to E/A. In our case it’s equal to 30%. It’s asking us to find
to maximum leverage ratio the buyer can reach. we’re talking about the financial leverage A/E.
Therefore our leverage equals 1/minimum margin requirement = 1/(E/A) = 1/ 30% = 3.33

12-An investor has purchased on margin 1000 shares of Facebook stock. The maximum leverage ratio
provided was 2. The stock was purchased at $100 a share. 6 months later he decides to sell the stocks
at the market price of $125. What is his return, assuming no transaction fees costs, but a dividend
distribution of $5 / share was distributed and a call rate of 3% was given for the margin loan?
A. 47%
B. 52%
C. 55%
D. 57%

Answer D

Sale proceeds: 125,000

Payoff loan*: -50,000
Interest: -1,500 (=3%*50,000)
Dividend: +5,000 (=5*1000)
Sales commission: -0

Equity remaining: 78,500

Initial Equity invested: 50,000 (if there is commission, then you add the purchase commission to it, it’s
coming from your own pocket, so an equity invested as well)

Therefore: Return on initial investment = (78,500-50,000)/50,000 = 57%

*why? Max leverage=2=A/E, so minimum margin required = 1/Max leverage = 0.5, it means that
E=50%, so D= A-E = 50%. You invested $100,000 (1000*$100) with $50,000 debt

13-Sarah buys Alcatel stock on margin with 25% initial margin or equity. The stock price is $16 a share.
The maintenance margin is 15%. What is the margin call price MCP, below which a margin call is issued
to replenish the account back to initial margin.
A. $14.12
B. $12.01
C. $15.23
D. $16.12

Answer A

IM=25%, means that E=25%*A (by Asset I mean total investment). I bought the stock at $16 a piece.
So I paid $4 (=25%*16) from equity E (and $12 / share as debt D). Any change in the price (from $16)
would affect my E, not my D. They’re telling me that my equity should not drop below the maintenance
margin MM of 15%, otherwise, a margin call will be issued to order me to replenish back (to the IM
level of 25%). Therefore, we need to solve this equation: [4+(P-16)]/P = MM = 15%, P=$14.12

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14-Underwriting offering is …… However, a best effort offering is ……

A. Being responsible to deliver the issue. Trying at best to deliver the issue
B. Being responsible to price the issue. Trying at best to price the issue
C. Being responsible to sell the issue. Trying at best to sell the issue
D. Being responsible to build the issue. Trying at best to build the issue.

Answer C

15-An Italian publically traded business is looking to raise capital again. It gave its existing shareholders
the opportunity to subscribe for new shares. Each could buy 2 new shares for 1 existing share at the
subscription price of $6. This is an example of:

A. Private placement
B. Initial public offering
C. Rights offering
D. Seasonal offering

Answer C

16-In call market …… In continuous market …….

A. Trades are executed at the best bid. Trades are executed at the best time
B. Trades are executed at the lowest bid. Trades are executed anytime
C. Trades are executed at the clearing price. Trades are executed anytime
D. Trades are discontinued. Trades are called.

Answer C

For questions 16 and 17 Consider the following limit order book for a stock trading in an exchange:

Bid size (# of shares) Limit price £ Ask size (# of shares)

300 62.5
460 62.7
805 63
63.6 700
64 650
64.7 910

17-A trader comes in with a new limit buy order of £63.2 a share for 350 shares total. Would you say
his order:

A. Makes a new market

B. Takes the market
C. Shares the market
D. Places the market

Answer A

If a new price comes in (whether bid or ask) and is inside the existing best bid/ask, then that new price
is making a new market

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18-Walid submits a day marketable order to sell 1300 shares, limit £62.6. What would be Walid average
price?

A. £63.32
B. £63.11
C. £62.89
D. £62.15

Answer C

He’s coming in with a new best sell offer @ 62.6, therefore, both 63 and 62.7 bids will execute:
1265 (805+460) shares valued at 79,557 (805*63+460*62.7) will go through. The remaining 35 (1300-
1265) priced at 62.6 will not because the next best bid is lower, 62.5. Then average price sold for walid
would be: 79,557/1265=62.89

19-Sabrine has sold short 100 shares of XYZ at $42 the share. She simultaneously placed a good-till-
cancelled, stop buy $50, limit $55 order. What is the maximum loss she could be making in this
scenario?

A. $500
B. $800
C. $1300
D. Unlimited

Answer C

She has sold short, she’s expecting the price to fall so she can get it back cheap and make profit. In the
meantime, she placed a stop loss order in case things don’t go her way. She placed a stop buy 50, limit
55, means when the price (instead of falling), goes up and hits the 50 mark, then she needs to start
buying at that price before it get higher, then if it keeps going up, her limit to buy the shares will be at
55. She can’t or is not worth the effort to buy at a higher price no more. So, her maximum loss is from
42 to the limit 55 (55-42=13) per share, for 100 shares, total $1300

20-A well-functioning market is

A. Allocationally efficient
B. Operationally efficient
C. Informationally efficient
D. All of the above

Answer D

21-The objectives of market regulation are all the following except for:

A. Preventing insider trading

B. Offering easy access to information
C. Imposing a minimum capital requirement
D. Providing profitable solutions

Answer D

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22- In an order driven system, which of the following limit orders will be first executed according to
the order precedence hierarchy?

Orders Price $ Time Size Instruction

1 15.19 10:23:28 180
2 15.19 10:23:14 140 hidden order
3 15.19 10:23:14 140
4 15.20 10:23:16 630

A. 1
B. 2
C. 3
D. 4

Answer C

If it’s a sell order. We eliminate 4, because it shows the highest offer, not the best. 1,2 and 3 are priced
the same, then we test their timing. 2 and 3 came earlier and at the same time, we keep them for the
next round and remove option 1. They both got the same size, so still draw, 2 is hidden, therefore the
priority is given to 3

Additional tip: It will be Answer D if it’s a buy order. If it’s a buy order, then $15.20 appears to be the
best (highest) bid, so no need to go further!