Investing Chapter 2

What is the primary market?

• New securities are sold by the issuer to investors

• the issuer receives the money

What is the secondary market?

• Existing securities are traded between investors

• issuer normally receives no money

What is the money market?

A market for short-term debt securities with maturities under 1 year.

What is the capital market?

A market for:

• stocks

• longer-term debt securities

What does it mean to take a long position?

1. Buy a security first

2. expecting its price to rise

3. then sell for a profit

What does buying on margin mean?

Borrowing part of the purchase price from a broker to buy securities.

What is a short sale?

1. Borrow shares

2. sell them

3. buy them back later at a lower price

4. return the shares

The short seller profits if the price falls.

What is the major risk of short selling?

Losses can be theoretically unlimited.

What is a margin call?

A demand to add funds when account equity falls below the maintenance requirement.

What is the margin percentage formula?

Margin percentage = Equity ÷ Market Value.

What happens after a margin call?

Add money or sell/reduce the position.

What is the bid price?

The price at which a dealer is willing to buy.

What is the ask price?

The price a dealer is willing to sell at.

What is the bid-ask spread?

Ask price − Bid price.

What is an IPO?

Initial Public Offering; a company's first public sale of shares.

Is an IPO a primary or secondary market transaction?

Primary market.

What is "money left on the table" in an IPO?

The difference between the IPO offer price and the first-day closing price, multiplied by shares offered.

What is the formula for money left on the table?

(Closing price − IPO offer price) × Number of shares.

What are the four dimensions of liquidity?

1. Tightness

2. depth

3. immediacy

4. resiliency

Why is extended-hours trading riskier?

• Fewer participants

• lower liquidity

• wider spreads

• more price uncertainty

What is a broker's role?

Matches buyers and sellers.

What is a dealer's role?

Trades from its own inventory and quotes bid/ask prices.

When buying a stock immediately, which price do you pay?

The ask price.

What is the stock profit formula?

Profit = (Selling price − Purchase price) × Number of shares.

How does margin affect gains and losses?

Borrowing money increases the potential return and the potential loss on your own money

• Magnifies both potential loss and return

What is the OSC's role?

Regulates Ontario's capital markets and protects investors.

What is the CSA's role?

Coordinates Canada's provincial and territorial securities regulators.

What is CIRO?

Canada's national self-regulatory organization overseeing investment dealers and trading activity.

What is a crossing market?

A market that matches buy and sell orders without a traditional dealer.

Why are extended-hours markets less liquid?

They have fewer participants and wider bid-ask spreads.

What is an ECN?

An electronic system that matches buyers and sellers.

What is a dark pool?

A private trading venue where orders are not publicly displayed.

Why might an underwriter underprice an IPO?

To increase demand and reduce the risk of an unsuccessful offering.

How can institutional investors affect IPO pricing?

Their large orders can influence demand and pricing.

Why might a company accept a lower IPO price?

To build relationships with institutional investors and ensure a successful launch.

What is the gross IPO proceeds formula?

IPO offer price × Number of shares offered.

What if the first-day closing price is below the IPO offer price?

There is no positive money left on the table.

What happens to dividends when you short a stock?

• The short seller pays the dividend to the stock lender.

You borrow 10 shares of a company from your friend and short-sell them.

Then the company announces a $2 dividend per share.

• 10 shares × $2 = $20 dividend

• Normally, your friend (the person who owns the shares) would get that $20.

• But you borrowed their shares and sold them.

• So you have to give your friend the $20.

What is initial margin?

The minimum amount of your own money required to buy securities on margin.

What is maintenance margin?

The minimum equity percentage that must be maintained in a margin account.

What is global diversification?

• Investing internationally to spread investments across different industries, markets, and currencies

• potentially reducing portfolio risk

What is indirect international investing?

• Getting international exposure through Canadian companies

• with foreign operations or through foreign mutual funds/ETFs

What is direct international investing?

Investing directly in foreign securities

• buying securities on foreign exchanges

• investing in foreign companies

What are some risks of international investing?

• P — Politics

  • Political instability

  • Trade-policy changes

  R — Rules

  • Foreign-investment restrictions

  • Different regulations, tax laws, accounting standards

  M — Money

  • Taxes

  • Difficulty repatriating funds

  C — Currency

  • Currency risk

  T — Time

  • Different market hours

What is pyramiding?

Using unrealized gains in a margin account to purchase additional securities.

What are trade notes?

Records documenting the rationale behind a trade and the future strategy.

What is the formula for equity in a margin account?

Equity = Market Value − Loan

What are the three key components of a margin account?

1. Market Value = value of securities

2. Loan = amount borrowed

3. Equity = Market Value − Loan