Investments

FINN 353
Quiz 1 KEY

Name ________________________________
Roll # ___________________________

Question # Answer
1 D

2 D

3 D

4 B

5 B

6 B

7 D

8 C

9 C

10 False

Question # 11, 12&13 are to be answered in the spaces provided after the questions.
1. Suppose an investor is considering a corporate bond with a 7.17% before-tax yield and a
municipal bond with a 5.93% before-tax yield. At what marginal tax rate would the investor be
indifferent between investing in the corporate and investing in the muni?
A. 15.4%
B. 23.7%
C. 39.5%
D. 17.3%
E. 12.4%

tm = 1 − (5.93%/7.17%) = 17.29%

2. With regard to a futures contract, the long position is held by

A. the trader who bought the contract at the largest discount.
B. the trader who has to travel the farthest distance to deliver the commodity.
C. the trader who plans to hold the contract open for the lengthiest time period.
D. the trader who commits to purchasing the commodity on the delivery date.
E. the trader who commits to delivering the commodity on the delivery date.

3. A put option allows the holder to

A. buy the underlying asset at the strike price on or before the expiration date.
B. sell the underlying asset at the strike price on or before the expiration date.
C. sell the option in the open market prior to expiration.
D. sell the underlying asset at the strike price on or before the expiration date and sell the option
in the open market prior to expiration.
E. buy the underlying asset at the strike price on or before the expiration date and sell the option
in the open market prior to expiration.

4. (a)National wealth of economy are its real and financial assets.

(b) Agency problem can only be eliminated through a proxy contest.

A. both statements are true

B. both statements are false

C. only a is true

D. only a is false
5. Which of the following is true about mortgage-backed securities?
I) They aggregate individual home mortgages into homogeneous pools.
II) The purchaser receives monthly interest and principal payments received from payments
made on the pool.
III) The banks that originated the mortgages maintain ownership of them.
IV) The banks that originated the mortgages continue to service them.
A. II, III, and IV
B. I, II, and IV
C. II and IV
D. I, III, and IV
E. I, II, III, and IV

6. Which of the following is used extensively in foreign trade when the creditworthiness of one
trader is unknown to the trading partner?
A. Repos
B. Bankers' acceptances
C. Eurodollars
D. Federal funds
E. Reverse repos

7. Shelf registration
A. is a way of placing issues in the primary market.
B. allows firms to register securities for sale over a two-year period.
C. increases transaction costs to the issuing firm.
D. A and B.
E. A and C.

8. You sold short 100 shares of common stock at $75 per share. The initial margin is 50%. At
what stock price would you receive a margin call if the maintenance margin is 30%?
A. $90.23
B. $88.52
C. $86.54
D. $87.12
E. none of the above

Equity = 100($75) * 1.5 = $11,250; 0.30 = ($11,250 − 100P)/100P; 30P = 11,250 − 100P; 130P
= 11,250; P = $86.54

9. Which of the following contributes to fragmentation of markets?

A. Bond trading

B. Algorithmic trading
C. Dark pools

D. High frequency trading

E. Both B & D

10. The PTI government in its 23rd January mini budget abolished 0.02% advance tax on sale
and purchase of shares and allowed for carrying forward of capital losses up to 3 years.
True/False

11(a). Discuss securitization as it relates to the field of investments and list one advantage of
securitization. (2 marks)
Securitization refers to aggregating underlying financial assets, such as mortgages, into pools and then
offering a security that represents a claim on these underlying assets. 1 mark

Securitization allows investors to hold partial ownership in financial assets that would otherwise be
beyond their reach (e.g., mortgages). 1 mark

(b).The table below represents price information on Fintech stock. Fintech trades in a dealer
market. (3 marks)
Bid Asked
55.25 55.50

i. Suppose you have submitted an order to your broker to buy at market. At what price will
your trade be executed?
55.50
ii. Suppose you have submitted a limit order to buy at Rs 55.37. What will happen?

The trade will not be executed because the asked price is greater than the price
specified in the limit buy order.

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

The trade will not be executed because the bid price is lower than the price specified
in the limit sell order.
12. You’ve borrowed $ 20,000 on margin to buy shares in Disney, 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. (5 marks)
i. Will you receive a margin call?

You will not receive a margin call. You borrowed $20,000 and with another $20,000
of your own equity you bought 1,000 shares of Disney at $40 per share. At $35 per
share, the market value of the stock is $35,000, your equity is $15,000, and the
percentage margin is: $15,000/$35,000 = 42.9%
Your percentage margin exceeds the required maintenance margin.

ii. How low can the price of Disney shares fall before you receive a margin call?
You will receive a margin call when:
1,000P  $20,000
= 0.35  when P = $30.77 or lower
1,000P

13. Use the table below to answer the following questions: (5 marks)

Based on the information given for the three stocks, calculate the first-period rates of return
(from t = 0 to t = 1) on

a. a market-value-weighted index;
The total market value at time 0 is $70 * 200 + $85 * 500 + $105 * 300 = $88,000. The total market
value at time 1 is $72 * 200 + $81 * 500 + $98 * 300 = $84,300. The return is $84,300/$88,000 − 1 =
−4.20%.

b. an equally-weighted index.
The return on Stock A for the first period is $72/$70 − 1 = 2.86%. The return on Stock B for the first
period is $81/$85 − 1 = −4.71%. The return on Stock C for the first period is $98/$105 − 1 = −6.67%. The
return on an equally weighted index of the three stocks is (2.86% − 4.71% − 6.67%)/3 = −2.84%.

Version B

2. Define Electronic communication networks (ECNs) and list two advantages of ECNs. (2 marks)

Computer networks that allow direct trading without the need for market makers.

Advantages: Any 2

Cost savings, speed & anonymity