19 October practical class 4 Solutions PDF

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4th PRACTICAL CLASS

19 October h 9.30

Exercises 1. Dee’s trader opens a brokerage account and purchases 300 shares of Internet Dreams at $40 per share. She borrows $4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%. a. What is the margin in De’s account when she first purchases the stock? b. If the share price falls to $30 per share by the end of the year, what is the remaining margin in her account? If the maintenance margin requirement is 30%, will she receive a margin call? c. What is the rate of return on her investment? The stock is purchased for: 300  $40 = $12,000 a.The amount borrowed is $4,000. Therefore, the investor put up equity, or margin, of $8,000. b.

If the share price falls to $30, then the value of the stock falls to $9,000. By the end of the year, the amount of the loan owed to the broker grows to: $4,000  1.08 = $4,320 Therefore, the remaining margin in the investor’s account is: $9,000 − $4,320 = $4,680 The percentage margin is now: $4,680/$9,000 = 0.52, or 52% Therefore, the investor will not receive a margin call.

c.

The rate of return on the investment over the year is: (Ending equity in the account − Initial equity)/Initial equity = ($4,680 − $8,000)/$8,000 = −0.415, or −41.5% Alternatively, divide the initial equity investments into the change in value plus the interest payment: ($3,000 loss + $320 interest)/$8,000 = -0.415.

2 Company XZ issues a coupon rate bond semiannual fixed coupon rate ( 2,5%) and a call option on loan with expiration date 1 December 2020 During the 2020 Interest rate will decrease at 2,1% Which will be the strategy of Company XZ at 1st December 2020? Company has issued a callable bond and at 1st December 2020 it will exercise the option and it reduces the cost of debt at 2,1%

3 Investor thinks that interest rate will change during the life of bond from 2% and 4,5% What is the best solution for the investor? Which options on interest rate will be applied to this bond? The best solution is to select a min- max bond By the side of investor the price of min max bond is = price floater+ short cap- long floor Short cap at strike price 4,5% Long floor at strike price 2%

4. Investor A , B , C give three different orders to the broker on the stock Y A buys 1000 shares limit price 3,5€ B sells 1000 shares when market price will touch 3,3 € C short selling 1000 shares to 3,6€ , then stop loss order 4,1€ in Tn market price is 3,3 € What is the payoff for each investor? A buys a 3.3 and B sells at 3,3 ( using short selling because he thinks that market price will decrease) C close short position with a long position at 3.3 and he takes a profit of 0.3 € for each share- cost for short selling 5. Investor is bearish but he does not have equity in his portfolio. Equity A is worth 7,5euro. He thinks that during the next month (Tn) the price will decrease under 3.5euro What is his strategy today? Does he think to hedge his position in T0? What is the final payoff supposing two different price in Tn A. Market price 11euro B. Market price 3,5 euro

His strategy is short selling a 7.5€ He hedges his position using a long call ( strike price 7,5€)

At 11€ he will lose the call premium which is the cost of debt + cost of short selling At 3,5€ he will take a profit = 7,5 – 3,5 – cost of call premium+ cost of short selling

6.Old Economy Traders opened an account to short sell 2,500 shares of Internet Dreams at $70 . The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $70 to $80, and the stock has paid a dividend of $3,5 per share. a. What is the remaining margin in the account? b. If the maintenance margin requirement is 30%, will Old Economy receive a margin call? c. What is the rate of return on the investment?

a.

The initial margin was: 0.50  2,500  $70 = $87,500 As a result of the increase in the stock price Old Economy Traders loses: $10  2,500 = $25,000 Therefore, margin decreases by $25,000. Moreover, Old Economy Traders must pay the dividend of $3.5 per share to the lender of the shares, so that the margin in the account decreases by an additional $8,750 ( 3,5*2500). Therefore, the remaining margin is: $87,500 – $25,000 – $8,750 = $53,750 b.

The percentage margin is: $53,750/$200,000 = 0.27, or 27%

200000=2500 shares *$80 So there will be a margin call. d. The equity in the account decreased from $87,500 to $53,750 in one year, for a rate of return of: (−$33,750/$87,500) = −0.3857, or −38.57%

7.Assume that you have just purchased some shares in an investment company reporting $500 million in assets, $50 million in liabilities, and 50 million shares outstanding. What is the net asset value (NAV) of these shares?

Explanation: NAV = ($500 - $50)/50 = $9

MULTIPLECHOICES

01Which one of the following statements about convertibles is true?

A. The longer the call protection on a convertible, the less the security is worth. B. The more volatile the underlying stock, the greater the value of the conversion feature. C. The smaller the spread between the dividend yield on the stock and the yield-to-maturity on the bond, the more the convertible is worth. D. The collateral that is used to secure a convertible bond is one reason convertibles are more attractive than the underlying stock. E. Convertibles are not callable. The longer the call protection the more attractive the bond. The smaller the spread (c), the less the bond is worth. Convertibles are debentures (unsecured bonds). All convertibles are callable at the option of the issuer.

2. Which of the following is (are) true about dark pools? I. They allow anonymity in trading. II. They often involve large blocks of stocks. III. Trades made through them might not be reported. A. I and II only B. II and III only C. I and III only D. I, II, and III 3. __________ often accompany short sales and are used to limit potential losses from the short position. A. Limit orders B. Restricted orders C. Stop-buy orders D. Limit loss orders

4 .An order to buy or sell a security at the current price is a ______________. A. limit order B. market order C. stop-loss order D. stop-buy order

5.If an investor places a _________ order, the stock will be sold if its price falls to the stipulated level. If an investor places a __________ order, the stock will be bought if its price rises above the stipulated level. A. stop-loss; stop-buy B. stop-buy; stop-loss C. market; limit D. limit; market

6. Rank the following types of markets from least integrated and organized to most integrated and organized: I. Brokered markets II. Continuous auction markets III. Dealer markets IV. Direct search markets A) IV, II, I, III B) I, III, IV, II C) II, III, IV, I D) IV, I, III, II Answer: D 7.You purchased XYZ stock at $50 per share. The stock is currently selling at $65. Your gains could be protected by placing a ________. A) limit buy order B) limit sell order C) market order D) stop-loss order Answer: D 8.You short-sell 200 shares of Tuckerton Trading Co., now selling for $50 per share. What is your maximum possible loss? A) $50 B) $150 C) $10,000 D) unlimited Answer: D Explanation: There is no upper limit to the price of a share of stock and, therefore, no upper limit to the price you will have to pay to replace the 200 shares of Tuckerton.

9.________ often accompany short sales and are used to limit potential losses from the short position.

A) Limit orders B) Restricted orders C) Limit loss orders D) Stop-buy orders 10.Rank the following fund categories from most risky to least risky: I. Equity growth fund II. Balanced fund III. Sector fund IV. Money market fund A) IV, I, III, II B) III, II, IV, I C) I, II, III, IV D) III, I, II, IV Answer: D

11.Disadvantages of ETFs include all of the following except A) investors incur a bid-ask spread when purchasing. B) investors must pay a broker fee when purchasing. C) prices are only quoted once each day. D) prices can depart from NAV at times. Answer: C

OPEN QUESTIONS 1 Could you explain the term “latency” ? 2. Define the following terms: maintenance margin and margin call 3.Why is American long call option worth more from alive than from dead, write an numerical example ? 4.Describe the limit order and the stop loss order ? 5.Describe the benefits for investors to use long collar instead of long cap ? 6.How could you hedge your short selling position ( describe also this position) using derivatives? 7. Describe Exchange Traded Fund

Open questions 1.Latency is the time that takes to accept, process and deliver a trading order 2.Maintenance margin is the minimum level of your margin account during the period of your trade ( buying on margin or short selling) while margin call is applied by your broker when your margin account is under maintenance margin 3.Because if you sell the option you receive the intrinsic value + time value , while if you exercise the option you will receive only the intrinsic value 4.A limit order is an order placed with a brokerage to execute a buy or sell transaction at a set number of shares and at a specified limit price or better. A stop-loss order is an order placed with a broker to sell a security when it reaches a certain price. Stop-loss orders are designed to limit an investor's loss on a position in a security. 5.If you buy a long collar you reduce the cost of premium but you could suffer a loss when interest rate will go down the strike rate of the short floor. If you buy a cap you will have a loss equal to the premium 6.Opening a long call to hedge if the stock market will increase. Short selling means that investor borrows a share from a broker and sell it. Later the short seller must purchase a share in order to replace the share that was borrowed 7. ETF are offshoots of mutual funds that allow investors to trade index positions. Investor can trade ETF just like any other share...