MGMT 3412B Midterm 1
Conceptual: (50% of the total grade, 1 extra credit point)
Multiple choice questions (3 points each)
1- Underlying all investments is the trade-off between:
a.
expected return and actual return.
b.
low risk and high risk.
c.
actual return and high risk.
d.
expected return and risk.
2- Investment decision-making traditionally consists of two steps:
a.
investment banking and security analysis.
b.
buying and selling.
c.
risk and expected return.
d.
security analysis and portfolio management.
3- Callable bonds that are “called in” are likely to be:
a. bonds already in default.
b. reissued as new bonds with a lower interest rate.
c. reissued as new bonds with a higher interest rate.
d. junk bonds.
4- Which of the following money market instruments is issued by large, well-known,
financially strong corporations?
a. Repurchase agreements
b. Negotiable CDs
c. Commercial paper
d. Warrants
5- A major difference between a closed-end investment company and an open-end
investment company is that:
a. closed-end investment companies are generally much riskier.
b. their security portfolios are substantially different.
c. closed-end investment companies are active investments and open-ends are not.
d. closed-end companies have a fixed capitalization.
6- Mutual funds are also known as:
a. open-end investment funds.
b. closed-end investment funds.
c. regulated investment companies.
d. unit investment trusts.
7- Mutual funds may be affiliated with an underwriter. This means:
a. the underwriter has an exclusive right to distribute shares.
b. the underwriter selects the securities in the portfolio.
c. there is no risk to the issuer of the mutual fund.
d. there is no risk to the investor of the mutual fund.
8- Most stock funds can be divided into two categories based on their approach to
selecting stocks. These two approaches are:
a. growth and income.
b. value and growth.
c. domestic and international.
d. conservative and aggressive.
9- An example of a mutual fund “supermarket” is a:
a. large mutual fund family that offers funds in a large variety of funds.
b. brokerage firm that offers funds of various fund families through one source.
c. mutual fund family that offers banking, insurance and other financial services.
d. brokerage firm that offers its own funds to account holders.
10- In a firm commitment underwriting arrangement, the risk is assumed by the:
a. issuer of the security.
b. securities dealers.
c. commercial bankers.
d. institutional investors
11- A criticism of the Dow Jones Industrial Average is:
a. it adjusts for even small stock dividends.
b. it is a value weighted method.
c. it has too few stocks in the average.
d. it includes too many risky stocks.
12- The Prompt Offering Qualification (POP) System:
I. is available to senior reporting issuers who are subject to continuous
disclosure requirements.
II. saves issuers a great deal of time and money.
III. has reduced the importance of best efforts underwriting.
IV. generally focuses on security price, distribution spread, use of
proceeds and security attributes.
a. I and II
b. I, II, and III
c. I, II, and IV
d. I, III, and IV
13- Direct stock purchase programs are an outgrowth of:
a.
electronic trading.
b.
dividend reinvestment plans.
c.
increased NASDAQ trading.
d.
decreased regulation.
14- The exchange member in charge of limit orders is the:
a.
commission broker.
b.
floor broker.
c.
specialist.
d.
delegate.
15- Which of the following statements regarding margin trading is true?
a.
Its major appeal is to institutional investors.
b.
It maximizes returns and minimizes losses.
c.
It magnifies both gains and losses.
d.
It is considered a strictly speculative tool.
Short answer questions (3 points each)
16- What are the risks associated with short selling? (solution in power point slides)
17- What is an all or none (AON) order and what are the advantages of this type or order?
(solution in power point slides)
Problems (50% of total grade, 1 extra credit point))
1- Stewie purchased a share in a mutual fund two years ago for $105. Today he sold
the share and realized a total return of 59.7% on his investment. This investment
provides quarterly dividends of $1.5 per quarter. At what price did Stewie sell the
mutual fund share? (5 points)
Solution
Beg. Price = $105, Total % return = 59.7%, Dividends = $1.5 x 4 x 2 = $12.
Therefore, Total % return = Dividend yield + Capital gains (loss) yield
0.597 = ($12 / 105) + (x – 105) / 105, (0.597) (105) = 12 + x -105,
62.685 = x – 93, x = 62.685 + 93 = $155.685 = End. price
2- If an investor who is in the 40% tax bracket purchased $3,650 worth of LSVCCs
for RRSP purposes. The investor lives in a province that has a 18.5% provincial
tax credit for LSVCCs. Calculate the investor’s taxable income as a percentage of
his/her total investment. How much will the investor have to invest in order to get
the maximum tax credit from the LSVCCs? (8 points)
Solution
3650 (15%) → $547.5, 3650 (18.5%) → $675.25, thus the total tax credit from
LSVCC is $1,222.75. The tax credit from using the investment for RRSP
purposes is 3650 (40%) → $1,460. Therefore, the total tax credit is $2,682.75.
Taxable income = $3,650 - $2,682.75 = $967.25
Percentage of taxable income = $967.25 / $3,650 = 26.5%
x (0.15) + x (0.185) = $1,500, 0.335 x = $1,500, x = $4,477.612 = Amount the
investor has to invest in order to get the maximum tax credit
3- An investor purchases 100 shares of a $60 stock and posts margin of 50%. The
required margin is 30% (the investor can post a margin greater than the required
margin). (10 points)
(a) How much does the investor put up initially in order to purchase the stock?
(b) Calculate the actual margin if the price of the stock drops to $55.
(c)
At what stock price will a margin call occur?
Solution
(a) initial margin = 50 per cent
50% of ($60  100) = $3000 in equity
(b)
market value – amount borrowed
$5500 – $3000
actual margin = ——————————–——— = ——————— = 45.5 per cent
market value
$5500
(c) A margin call occurs when the actual margin declines below the required margin. This
point can be found (with 30 per cent required margin) as follows:
market value – amount borrowed
30% = ——————————————
market value
.3 = (X – $3000) / X
.7X = $3000
X = $4285.71
Price per share = $4285.71  100 shares = $42.86
If the stock price declines below $42.86, a margin call will be issued.
4- An investor sells 100 shares of stock short at $40. (10 points)
(a) Ignoring commissions, at what price will the investor earn $700?
(b)
Ignoring commissions, what is the gain or loss if the stock price goes to
$53 and the investor closes out the position?
Solution
(a) When the stock drops 7 points to $33, the investor will earn $700.
(b) If the stock goes to $53, the loss will be:
purchase at $53  100 shares = $5300
sold short at $40  100 shares =
4000
loss
= $1300
5- Louis purchased 150 shares of XYZ at $100 per share. Currently the stock is
selling at $120. If she wants to be assured of a profit of at least $4050, what type
of order should she place and at what price per share? (8 points)
Solution
Profit per share = $4050 / 150 shares = $27
He should place a limit order to sell the shares at: $100 +
$27 = $127.
6- An investor purchases common shares of two companies on margin. The first
share (A) is eligible for a special (reduced) margin and is presently trading for
$10, while the second share (B) is trading at $2. (10 points, use the table below)
(a) What is the total margin requirement if the investor purchases 1,000 shares of
A and 1,000 shares of B?
(b) If the price of A immediately increases to $11 and the price of B falls rapidly
to $1.5, how much (if any) will be the required deposit in the investor’s margin
account? Solution textbook page 143 and was solved in class
Canadian Margin Requirements
Security price
Maximum loan values
Securities eligible for reduced margin
70% of market value
At $2.00 and over
50% of market value
At $1.75 to $1.99
40% of market value
At $1.50 to $1.74
20% of market value
Under $1.50
No loan value