Question 1

The Internal Revenue Code defines short-term as a holding period of one year or less. If a capital gain is classified as a short-term capital gain, it is taxed as ordinary income at the investor's regular income tax rate.

Accepted Answer

The Internal Revenue Code defines short-term as a holding period of one year or less. If a capital gain is classified as a short-term capital gain, it is taxed as ordinary income at the investor's regular income tax rate.

Question 2

What do equity securities represent? Describe the two types of equity securities distinguishing between them.

Accepted Answer

The answer of What do equity securities represent? Describe the...

Question 3

There are two major components of transaction costs: explicit costs and implicit costs.

Accepted Answer

Transaction costs are the costs associated with making an economic transaction, and they can be classified into two types: explicit costs and implicit costs. Explicit costs refer to the actual out-of-pocket expenses incurred in the process of conducting a transaction, such as legal fees, commissions, transportation costs, and taxes. Implicit costs, on the other hand, are the opportunity costs or foregone benefits that arise from making a trade-off or engaging in a transaction, such as the time and effort spent searching for information, negotiating, monitoring, and enforcing contracts.

Question 4

The optimal strategy to pursue when the stock market is perceived to be price inefficient is indexing because it allows the investor to capture the efficiency of the market.

Accepted Answer

If the stock market is perceived to be price inefficient, then actively managed strategies may be more appropriate as they aim to identify mispricings in the market and take advantage of them. Indexing would not capture these potential opportunities and would simply mirror the inefficiencies of the market.

Question 5

The key to instituting circuit breakers is coordination and infrequency.

Accepted Answer

Circuit breakers are meant to be used infrequently and in a coordinated manner to avoid causing unnecessary disruptions or panic in the market. If circuit breakers were implemented too frequently or without coordination, they could potentially do more harm than good.

Question 6

Active investment strategies, consisting of efforts to time purchases and select stocks, are pursued by investors who believe that securities are mispriced enough that it is possible to capitalize on strategies that are designed to exploit the perceived inefficiency.

Accepted Answer

Active investment strategies involve trying to find mispriced securities and taking advantage of them, which suggests that investors believe there are inefficiencies in the market. Therefore, the statement is true.

Question 7

Short selling involves the sale of a security not owned by the investor at the time of sale. Investors can arrange to have their broker borrow the stock from someone else, and the borrowed stock is delivered to implement the sale. To cover their short position, investors must subsequently purchase the stock and return it to the party that lent the stock. Give an example of how this short selling is done.

Accepted Answer

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Question 8

An investor shorts (borrows and sells) 100 shares of a stock at $50 for a total stock value of $5,000. With an initial margin of 50%, the investor must deposit $2,500 (in addition to leaving the $5,000 from the sale in the account). This leaves the investor with a credit balance of $7,000 (which does not change with the stock price since it is in cash).

Accepted Answer

The initial transaction of short selling 100 shares at $50 each results in a credit of $5,000 to the investor's account. The initial margin requirement of 50% means the investor must have at least $2,500 in the account before the sale. This margin acts as a security deposit and does not add to the credit balance from the sale. Therefore, the investor's account would have a credit balance of $5,000 from the sale, not $7,000. The $2,500 is a requirement to ensure the investor can cover losses, not an additional credit.

Question 9

Discount brokers have been particularly ineffective in inducing retail investors to participate in the market for individual stocks.

Accepted Answer

Discount brokers have been successful in inducing retail investors to participate in the market for individual stocks by providing low-cost trading services and easy access to information and resources.

Question 10

The Wilshire 4500 includes all stocks in the Wilshire 5000 except for those in the Dow Jones 500.

Accepted Answer

The correct statement is that the Wilshire 4500 includes all stocks in the Wilshire 5000 except for the 500 stocks in the Dow Jones 500. The Dow Jones 500 is not a valid index, and it is likely that the statement in the question was meant to refer to the Dow Jones Industrial Average (DJIA), which includes only 30 stocks.

Question 11

Describe a "soft dollar" arrangement and how it differs from a "hard dollar" arrangement.

Accepted Answer

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Question 12

From a dealer's perspective, program trades can be conducted in two ways. Name and describe these two ways.

Accepted Answer

The answer of From a dealer's perspective, program trades can...

Question 13

The brokerage firm can also choose to execute the trade on an agency basis. In this case, the dealer would commit its own capital to buy or sell the portfolio and complete the investor's transaction immediately.

Accepted Answer

When executing a trade on an agency basis, the brokerage acts as an agent, meaning it does not use its own capital but instead finds another party to complete the transaction.

Question 14

Explicit trading costs include impact costs, timing costs, and opportunity costs.

Accepted Answer

Explicit trading costs typically include commissions, taxes, and bid-ask spreads, while impact costs, timing costs, and opportunity costs are considered implicit trading costs.

Question 15

Implicit transaction costs are commissions, custodial fees, and transfer fees.

Accepted Answer

Implicit transaction costs refer to costs that are not directly visible or easily quantifiable, such as bid-ask spread, market impact, and slippage. Commissions, custodial fees, and transfer fees are considered explicit transaction costs.

Question 16

Some indexes represent a broad segment of the stock market while on a particular sector such as technology, oil and gas, and financial.

Accepted Answer

This is true. Examples of broad market indexes include the S&P 500 and the Dow Jones Industrial Average, while examples of sector-specific indexes include the Nasdaq Composite for technology, the NYSE Arca Oil Index for oil and gas, and the S&P Financial Select Sector Index for financials.

Question 17

To the investor, the disadvantage of the agency program trade is that, while commissions may be the lowest, the execution price may not be the best because of impact costs and the potential frontrunning by the brokerage firms that were solicited to submit a commission bid.

Accepted Answer

The statement accurately describes a disadvantage of the agency program trade.

Question 18

The institutional arrangement that has evolved to accommodate these needs is the upstairs market, which is a network of trading desks of the major securities firms and institutional investors that communicate with each other by means of electronic display systems and telephones.

Accepted Answer

The sentence accurately describes the concept of an upstairs market as a network of trading desks that use electronic displays and communication systems to facilitate trading among major securities firms and institutional investors.

Question 19

When an investor is calculating the return from holding common stock from the date of purchase to a given point in time and has sold the common stock, the return reflects an unrealized capital gain or unrealized capital loss.

Accepted Answer

A realized capital gain or loss is only recognized when the stock is sold, whereas an unrealized gain or loss is based on the current market value of the stock and has not yet been realized through a sale. Therefore, if the investor has sold the common stock, the gain or loss would be realized, not unrealized.

Question 20

Assume an investor buys 100 shares of a stock at $80 per share for $8,000 of stock on 50% margin and the maintenance margin is 30%. By purchasing $8,000 of a stock on 50% margin, the investor must put up $4,000 of cash (or other equity) and, thus, borrows $4,000 (referred to as the "debit balance").

Accepted Answer

This is correct. With a 50% margin, the investor must put up 50% of the purchase price ($80 per share x 100 shares = $8,000) as cash or other equity, which in this case is $4,000. This means that the investor is also borrowing $4,000 (the debit balance). The maintenance margin is the minimum amount of equity that must be maintained in the account, which is usually set at 30% of the total value of the securities held in the account.

Quiz 17: Markets for Common Stock: The Basic Characteristics

The Internal Revenue Code defines short-term as a holding period of one year or less. If a capital gain is classified as a short-term capital gain, it is taxed as ordinary income at the investor's regular income tax rate.

What do equity securities represent? Describe the two types of equity securities distinguishing between them.

There are two major components of transaction costs: explicit costs and implicit costs.

The optimal strategy to pursue when the stock market is perceived to be price inefficient is indexing because it allows the investor to capture the efficiency of the market.

The key to instituting circuit breakers is coordination and infrequency.

Active investment strategies, consisting of efforts to time purchases and select stocks, are pursued by investors who believe that securities are mispriced enough that it is possible to capitalize on strategies that are designed to exploit the perceived inefficiency.

Discount brokers have been particularly ineffective in inducing retail investors to participate in the market for individual stocks.

The Wilshire 4500 includes all stocks in the Wilshire 5000 except for those in the Dow Jones 500.

Describe a "soft dollar" arrangement and how it differs from a "hard dollar" arrangement.

From a dealer's perspective, program trades can be conducted in two ways. Name and describe these two ways.

The brokerage firm can also choose to execute the trade on an agency basis. In this case, the dealer would commit its own capital to buy or sell the portfolio and complete the investor's transaction immediately.

Explicit trading costs include impact costs, timing costs, and opportunity costs.

Implicit transaction costs are commissions, custodial fees, and transfer fees.

Some indexes represent a broad segment of the stock market while on a particular sector such as technology, oil and gas, and financial.

To the investor, the disadvantage of the agency program trade is that, while commissions may be the lowest, the execution price may not be the best because of impact costs and the potential frontrunning by the brokerage firms that were solicited to submit a commission bid.

The institutional arrangement that has evolved to accommodate these needs is the upstairs market, which is a network of trading desks of the major securities firms and institutional investors that communicate with each other by means of electronic display systems and telephones.

When an investor is calculating the return from holding common stock from the date of purchase to a given point in time and has sold the common stock, the return reflects an unrealized capital gain or unrealized capital loss.