CHAPTER 1: INVESTMENTS BACKGROUND AND ISSUES

1. What are the differences between equity and fixed-income securities?

Equity is a lower priority claim and represents an ownership share in a corporation,

whereas debt has a higher priority claim but does not have an ownership interest.

Debt also pays a specified cash flow over a specific period and the claim will eventually
expire. Equity has an indefinite life.

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 CHAPTER 2: ASSET CLASSES AND FINANCIAL MARKETS

PROBLEM SETS

6. What are the key differences between common stock, preferred stock and corporate bonds?

Common stock represents an ownership share in a publicly held corporation. Common

shareholders have voting rights and may receive dividends.
Preferred stock also represents an ownership in a corporation. They differ from
common stock as they pay a fixed dividend for the life of the stock.
Corporate bonds are long-term debt issued by corporations, typically paying
semiannual coupons and returning the face value of the bond at maturity. In contrast
to stocks, bonds do not represent ownership in a company.

7. Refer to Table 2.2 and the listing for OZ Minerals.

Extract of Table 2.2

Security ASX Last Change Volume 52- 52- Div per Franked Div Div Earn P/E
description Code sale cents 100s week week share div times yield share ratio
high low covered % cents
OZ OZL 10.19 27 15 404 14.45 1.253 60.00 1.43 5.89 85.60 11.9
Minerals

a. What was the previous day’s closing price?

The previous day’s closing price was $10.19.

b. How many shares could you buy for $5000?

You could buy: $5000/$10.19 = 490.68 = 490 shares (rounded down).

c. What would be the annual dividend income from those shares?

The annual dividend income would be 490 x $0.60 = $294.00.

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 CHAPTER 3: SECURITIES MARKETS

PROBLEM SETS

5. What are the differences between a stop loss order, limit sell order and a market order?

A stop loss order is a trade that is not to be executed unless the stock hits a specified
price limit. The stop loss is used to limit losses when prices are falling.

A limit sell order is an order specifying a price at which an investor is willing to sell a
security at.

A market order directs the broker to buy or sell at whatever price is available in the
market.

7. Here is some price information on Fincorp stock. Suppose first that Fincorp trades in a
dealer market.

Bid Asked
55.25 55.50

a. Suppose you have submitted an order to your broker to buy at market. At what price will
your trade be executed?

. It will be executed at $55.50 as it is the best available market price to buy.

b. Suppose you submitted an order to sell at market. At what price will your trade be
executed?

It will be executed at $55.25 as it is the best available market price to sell.

c. Suppose you have submitted a limit order to sell at $55.62. What will happen?

The trade will not be executed because the bid price is lower than $55.62.imit sell
order.

d. Suppose you have submitted a limit order to buy at $55.37. What will happen?

The trade will not be executed because the asked price is greater than $55.37.he

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11. You are optimistic about Telecom shares. The current market price is $50 per share, and
you have $5,000 of your own to invest. You borrow an additional $5,000 from your broker
and invest $10,000 in the shares.

How far does the price of Telecom stock have to fall for you to get a margin call if the
maintenance margin is 30%? Assume the price fall happens immediately.

With $10,000 you can purchase 10,000 ÷ 50 = 200 shares.

The value of the 200 shares is 200P where P is the new price of the share. Equity is
(200P – $5,000). When the margin is 30%,

Margin = equity in account ÷ value of stock = = 0.30  P = $35.71

Thus, you will receive a margin call when the share price is $35.71 or lower

12. You are pessimistic about Telecom shares and decide to sell short 100 shares at the current
market price of $50 per share.

a. How much in cash or securities must you put into your brokerage account if the broker’s
initial margin requirement is 50% of the value of the short position?

Initial margin = 50% x 100 x $50 = $2,500.

b. How high can the price of the stock go before you get a margin call if the maintenance
margin is 30% of the value of the short position?

Total assets are $7,500 ($5,000 from the sale of the stock and $2,500 put up for margin).
Liabilities are 100P where P is the new share price. Therefore, equity is ($7,500 –
100P). When the margin is 30%,

Margin = equity in account ÷ value of stock = = 0.30  P = $57.69

Thus, a margin call will be issued when the share price is $57.69 or higher.

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13. Here is some price information on Marriott:

Bid Asked
Marriott 19.95 20.05

You have placed a stop loss order to sell at $20. What are you telling your broker? Given
market prices, will your order be executed?

The broker is instructed to attempt to sell your Marriott shares as soon as the
Marriott shares trade at a bid price of $20 or less. Here, the broker will attempt to
execute, but may not be able to sell at $20, since the bid price is now $19.95.

The price at which you sell may be less than $20 because the stop loss becomes a
market order to sell at current market prices.

14. You’ve borrowed $20,000 on margin to buy shares in Worley Parsons, which is now selling
at $40 per share. Your account starts at the initial margin requirement of 50%. The
maintenance margin is 35%. Two days later, the stock price falls to $35 per share.

a. Will you receive a margin call?

To compute the initial equity E, we work out the following:

E / (20,000 + E) = 0.5
E = 10,000 + 0.5E
E = 20,000

Thus, you borrowed $20,000 and with another $20,000 of your own equity you
bought 1,000 shares of Worley Parsons at $40 per share.

At $35 per share, the market value of the stock is $35,000, your equity is $35,000 -
$20,000 = $15,000, and the percentage margin is: $15,000/$35,000 = 42.9%. Your
percentage margin exceeds the required maintenance margin.

Therefore, you will not receive a margin call.

b. How low can the price of Worley Parsons shares fall before you receive a margin call?

Let the new share price be P. When the margin is 35%,

Margin = equity in account ÷ value of stock = = 0.35  P =

$30.77

You will receive a margin call when the share is $30.77 or lower.

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15.* Suppose that Intel is currently selling at $40 per share. You buy 500 shares using $15,000
of your own money, borrowing the remainder of the purchase price from your broker.

a. If the maintenance margin is 25%, how low can Intel’s price fall before you get a margin
call?

The total cost of the purchase is: $40 x 500 = $20 000
You borrow $5000 from your broker and invest $15 000 of your own funds. Your
margin account starts out with net worth of $15 000.

The value of the 500 shares is 500P. Equity is (500P – $5000). You will receive a
margin call when:
= 0.25, when P = $13.33 or lower.

b. How would your answer to (a) change if you had financed the initial purchase with only
$10,000 of your own money?

The value of the 500 shares is 500P. But you have now borrowed $10 000 instead of
$5000. Therefore, equity is (500P – $10 000). You will receive a margin call when:
= 0.25, when P = $26.67.

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CFA Problems

1. If you place a stop loss order to sell 100 shares of stock at $55 when the current price is $62,
how much will you receive for each share if the price drops to $50?

a. $50
b. $55
c. $54.87
d. Cannot tell from the information given

The broker will sell, at current market price, after the first transaction at $55 or less.

2. You wish to sell short 100 shares of XYZ Corporation stock. If the last two transactions
were at $34.12 followed by $34.25, you can sell short on the next transaction only at a price
of:

a. 34.12 or lower
b. 34.25 or higher
c. 34.25 or lower
d. 34.12 or lower

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 CHAPTER 4: MANAGED FUNDS AND INVESTMENT MANAGEMENT

1. Compare active and passive investment philosophies.

Passive managers believe markets are largely efficient (no miss-priced securities)
whereas active managers do not.

Passive managers invest in the exact market index whereas active managers will vary
according to their analysis.

Passive managers charge lower fees than active managers.

7. Describe the important functions performed by an investment manager.

Record keeping and administration: managers publish regular reports, monitor

investment cash flows and maintain records for tax purposes.

Diversification and divisibility: managers are better equipped to diversify portfolios

among a large number of shares.

Professional management: managers have teams of investment professionals that

specialise in specific areas related to the investment process. Managers may have
analysts researching securities, portfolio managers making asset allocation decisions and
dealers buying and selling securities.

Lower transaction costs: economies of scale allow managers to reduce costs involved in
the investment process.