Investments Workbook

Principles of Portfolio and Equity Analysis

Michael McMillan, Jerald E. Pinto, Wendy L. Pirie, Gerhard Van de Venter

• Publisher: Wiley
• Year: 2011
• ISBN:
  9781118001196
• Edition: 1
• Topic: Commerce
• Subtopic: Investissements et valeurs mobilières

Companion workbook to the CFA Institute's Investments: Principles of Portfolio and Equity Analysis Workbook

In a world of specialization, no other profession likely requires such broad, yet in-depth knowledge than that of financial analyst. Investments: Principles of Portfolio and Equity Analysis provides the broad-based knowledge professionals and students of the markets need to manage money and maximize return. This companion Workbook, also edited by experts from the CFA Institute, allows busy professionals to gain a stronger understanding of core investment topics. The Workbook

• Includes learning outcomes, summaries, and problems and solutions sections for each chapter in the main book
• Blends theory and practice
• Provides access to the highest quality information on investment analysis and portfolio management

With Investments: Analysis and Portfolio Management Workbook, busy professionals can reinforce what they've learned in reading Investments, while doing so at their own pace.

PART I

LEARNING OUTCOMES, SUMMARY OVERVIEW, AND PROBLEMS

CHAPTER 1

MARKET ORGANIZATION AND STRUCTURE

LEARNING OUTCOMES

After completing this chapter, you will be able to do the following:

• Explain and illustrate the main functions of the financial system.
• Describe classifications of assets and markets.
• Describe the major types of securities, currencies, contracts, commodities, and real assets that trade in organized markets, including their distinguishing characteristics and major subtypes.
• Describe the types of financial intermediaries and the services that they provide.
• Compare and contrast the positions an investor can take in an asset.
• Calculate and interpret the leverage ratio, the rate of return on a margin transaction, and the security price at which the investor would receive a margin call.
• Compare and contrast execution, validity, and clearing instructions.
• Compare and contrast market orders with limit orders.
• Describe the primary and secondary markets and explain how secondary markets support primary markets.
• Describe how securities, contracts, and currencies are traded in quote-driven markets, order-driven markets, and brokered markets.
• Describe the characteristics of a well-functioning financial system.
• Describe the objectives of market regulation.

SUMMARY OVERVIEW

• The financial system consists of mechanisms that allow strangers to contract with each other to move money through time, to hedge risks, and to exchange assets that they value less for those that they value more.
• Investors move money from the present to the future when they save. They expect a normal rate of return for bearing risk through time. Borrowers move money from the future to the present to fund current projects and expenditures. Hedgers trade to reduce their exposure to risks they prefer not to take. Information-motivated traders are active investment managers who try to indentify under- and overvalued instruments.
• Securities are first sold in primary markets by their issuers. They then trade in secondary markets.
• People invest in pooled investment vehicles to benefit from the investment management services of their managers.
• Forward contracts allow buyers and sellers to arrange for future sales at predetermined prices. Futures contracts are forward contracts guaranteed by clearinghouses. The guarantee ensures that strangers are willing to trade with each other and that traders can offset their positions by trading with anybody. These features of futures contract markets make them highly attractive to hedgers and information-motivated traders.
• Many financial intermediaries connect buyers to sellers in a given instrument, acting directly as brokers and exchanges or indirectly as dealers and arbitrageurs.
• Financial intermediaries create instruments when they conduct arbitrage, securitize assets, borrow to lend, manage investment funds, or pool insurance contracts. These activities all transform cash flows and risks from one form to another. Their services allow buyers and sellers to connect with each other through instruments that meet their specific needs.
• Financial markets work best when strangers can contract with each other without worrying about whether their counterparts are able and willing to honor their contract. Clearinghouses, variation margins, maintenance margins, and settlement guarantees made by creditworthy brokers on behalf of their clients help manage credit risk and ultimately allow strangers to contract with each other.
• Information-motivated traders short sell when they expect that prices will fall. Hedgers short sell to reduce the risks of a long position in a related contract or commodity.
• Margin loans allow people to buy more securities than their equity would otherwise permit them to buy. The larger positions expose them to more risk so that gains and losses for a given amount of equity will be larger. The leverage ratio is the value of a position divided by the value of the equity supporting it. The returns to the equity in a position are equal to the leverage ratio times the returns to the unleveraged position.
• To protect against credit losses, brokers demand maintenance margin payments from their customers who have borrowed cash or securities when adverse price changes cause their customer’s equity to drop below the maintenance margin ratio. Brokers close positions for customers who do not satisfy these margin calls.
• Orders are instructions to trade. They always specify instrument, side (buy or sell), and quantity. They usually also provide several other instructions.
• Market orders tend to fill quickly but often at inferior prices. Limit orders generally fill at better prices if they fill, but they may not fill. Traders choose order submission strategies on the basis of how quickly they want to trade, the prices they are willing to accept, and the consequences of failing to trade.
• Stop instructions are attached to other orders to delay efforts to fill them until the stop condition is satisfied. Although stop orders are often used to stop losses, they are not always effective.
• Issuers sell their securities using underwritten public offerings, best efforts public offerings, private placements, shelf registrations, dividend reinvestment programs, and rights offerings. Investment banks have a conflict of interests when setting the initial offering price in an IPO.
• Well-functioning secondary markets are essential to raising capital in the primary markets because investors value the ability to sell their securities if they no longer want to hold them or if they need to disinvest to raise cash. If they cannot trade their securities in a liquid market, they will not pay as much for them.
• Matching buyers and sellers in call markets is easy because the traders (or their orders) come together at the same time and place.
• Dealers provide l...