Fin3244 Final Exam Review These notes are based off the lectures and much of the book Markets and Transactions Leverage the use of borrowed funds to buy securities Margin of an investors equity o If an investor makes 1000 investment 750 are his And 250 are borrowed Than the 750 part is the margin o It is the amount of the investor s equity Margin is the collateral for a broker loan o Can be cash or acceptable securities stocks bonds mutual funds or derivatives Portfolio a group of financial securities o Value sum of its individual holdings o Value in Stk 1 stk 2 stk 3 bond Why trade on margins Magnifies gains But also magnifies losses Ex 5000 to invest o With no margin you can buy 100 shares o However on margin you can use your 5000 to borrow 5000 and can now own 200 shares Buying on margin Disadvantages magnify losses interest paid on margin loans possible margin calls Margin calls allow you to add money back up to original loan amount If not done then broker will have to sell securities in your account to cover loan cost Rules for trading on margin Must have a margin account with broker Must have 100 of purchase price Basically you borrow from brokerage for investments Minimum margin requirement set by the Fed Securities are kept by broker until loan is repaid o Depends on securities risk o Can vary with firms o OTC stocks cant be margined no collateral value Types of Margin Initial margin minimum equity an investor must have in his account at the time of purchase Maintenance margin minimum equity an investor must have in his account Margin call notice that equity in an account is below the maintenance at all times margin o Must be returned to maintenance margin level Restricted Margin Account equity is below initial margin required but higher than maintenance margin o No margin purchases Look at margin problem in chapter 8 for practice Notes Trading on margin has no impact on stock price direction The amount of margin in an account moves in the same direction as the value of the stock portfolio The more stock shares you hold the greater the dollar return gain or loss It doesn t matter where the money to buy the stock came from Personal investors funds or borrowed funds The smaller portion of investors funds used the greater the rate of return gain or loss The return is based on the amount of the investors personal funds The cost of a margin loan depends on current market interest rates and loan size Long purchase aka a buy that you expect to raise over time Short sell selling shares of stock that were borrowed through a broker and broker making commissions off the transactions Chapter 9 Stock Market Averages and Indexes Measure the general behavior of stock prices over time Averages reflects the arithmetic average price behavior of a representative group of stocks at a given point in time Indexes Measure the current price behavior of a representative group of stocks in relation to a base value set at an earlier point in time Dow Jones Industrial Averages Tracks general behavior of component firms The average is composed of 30 stocks selected for total market value and broad public ownership These 30 stocks are believed to be high quality stocks whose behavior reflects the overall market Value of the DJIA A sum of closing share prices of the 30 stocks divided by a divisor The purpose of the divisor is to adjust for any stock splits company changes or other stock altering events The divisor calculation is very complex Dow Jones Transportation Average similar to the industrial average a composition of 20 stocks including railroads airlines freight forwarders and mixed transportation companies Dow Jones Utility Average computed using 15 public utility stocks Dow Jones 65 Stocks Composite Average made up of all 30 industrial 20 transportation and 15 utility stock indexes Dow Jones US Total Stock Market Index Market Weighted index that measures the performance of all equity securities issued by U S companies that have readily available price data Market Weighted means that companies with large total market values have the most effect on the indexes movement Standard Poor s Indexes Similar to the DJIA in that it is a publisher of major common stock indexes Some key differences between the S P and the DJIA are S P is based on market values rather than share prices Many investors feel that S P indexes provide more broad based and representative measures of general market conditions Similarly to the DJIA S P indexes are only meaningful when compared in other time periods or to their respective base period value The DJIA and S P indexes tend to behave in similar fashion over time however their day to day magnitude and direction up or down can differ significantly because of the differences in how the indexes are constructed DJIA equally weighted S P Market Value Weighted Other S P indexes The S P 500 index comprised of 500 large sized companies The S P 100 Index comprised of 100 large sized companies with individual stock options required for each constituent The Industrial Index made up of the common stock of 400 industrial firms The S P 400 MidCap Index comprised of 400 medium sized companies The S P 600 SmallCap Index comprised of 600 small sized companies The 1500 SuperComp Index comprised of all stocks in the S P 500 400 MidCap and 600 SmallCap indexes Bond Market Indicators there are fewer indicators of overall bond market behavior than of stock market behavior Bond Yield the return an investor would receive in a bond if it were purchased and held to maturity These are reported as annual rates of return Bond Indexes a method of measuring the value of a section of the bond market It is computed from the prices of selected bonds typically a weighted average It is a tool used by investors and financial managers to describe the market and to compare the return on specific investments Stockbrokers act as intermediaries between buyers and sellers of securities by executing the buy sell orders at the best possible price Brokers are typically paid off commission Churning is the illegal and unethical practice of excessive trading by a broker on a clients account to generate commission This practice violates SEC rules and securities laws Brokers must be licensed by both the SEC and the securities exchanges on which they place orders Remember that in a broker v dealer market brokers buy and sell securities on behalf of their client s while dealers buy and trade on their own behalf Dealer
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