Question 1:
There are a wide variety of securities traded on the stock market. List the two (2) main types.
Answer
The two main types of securities traded on the stock market are Debt and Equities.
Question 2:
Name the two (2) main types of debt securities traded on the stock market. Who issues them?
Answer
The two main types of debt securities traded on the stock market are:
Question 3:
2,000 shares in XYZ were bought at $14.00 per share in September 1993 and sold in May 2000 at $17.00. The dividend received was $0.25 fully franked (sold before final dividend). CPI Sept ’93 109.8 Sept ’99 123.4
(a) Calculate the income tax on the dividend.
(b) Calculate the capital gain under both allowable methods.
(c) Choose what amount you would include in assessable income.
Answer
Dividends are paid by the company from the net profit that is available for equity shareholders. This net income is after adjusting for the income taxes to be paid. The dividends which are paid from the profit after tax of the company are called franked dividends and the receiver of the dividend receives a rebate on the tax to be paid by him. Thus, this eliminates double taxation on the dividend.
Proceeds on disposal (2000 * $17) 34,000
Less original cost (indexed for inflation)
2000 * $14 * 123.4/109.80 31,468
Taxable gain 2,532
Proceeds on disposal (2000 * $17) 34,000
Less original cost (2000 * $14) 28,000
Taxable gain 6,000
Thus, amount to be included in assessable income = 6,000 * 50% = $3,000
Question 4:
Your client holds 1000 shares in COD Ltd. The company announces a bonus issue on the basis of 1 for 3. What is your client’s entitlement?
Answer
Company announces bonus of 1 for every 3 shares hold. The client holds 1,000 shares, thus his entitlement will be (1,000/3 * 1) = 333 bonus shares.
Question 5:
Your client has a margin lending facility, and the margin lender has rung to say that they’re in margin. The client must restore the ratio of the loan to security to at least 1:1. List three ways the client can meet their obligations
Answer
The three ways in which the client can meet their obligations are:
Question 6:
Where would you find a current trading price for an exchange-traded option?
Answer
The current price of the exchange-traded option can be found under the Derivatives market on the ASX.
Question 7:
List the five basic elements of an option
Answer
The five basic elements of an option are:
Question 8:
Your client has bought a NCP DEC 1100 Put option for 74 cents while NCP is trading at $10.83. Calculate the intrinsic and time value of the option
Answer
Here in the above situation, my client has the right to exercise and sell the shares for $11.00, which is 17 cents higher than the current share price. This 17 cents is the intrinsic value of the share (Intrinsic value is the difference between the current share price $10.83 and the right to sell at $11.00).
The time value of option = Option Premium – Intrinsic Value
The time value of option = 74 cents – 17 cents
The time value of option = 57 cents.
Thus, for the NCP DEC put option, Intrinsic Value = 17 cents and Time value of option = 57 cents.
Question 9:
You see a BHP DEC 900 call option trading for 72 cents. At the same time, you see a BHP 900 call warrant with the same expiry date as the option trading for 36 ……? Calculate
Answer
In this case, the conversion ratio can be calculated as 2: 1, indicating that the owner of the warrant can purchase 2 options at the price of one warrant.
Question 10:
Your client has bought a DEC SPI 200 contract at 6867. What is the full face value of the contract?
Answer
SPI 200 introduced in 2000 is based on the ASX 200 index which is a weighted index of 200 companies listed on the stock exchange. It is a sort of balanced portfolio of underlying 200 companies and the underlying value of the index is equal to twenty-five times the S&P 200 index or $A25.
Thus, the full face value of the contract of DEC SPI 200 bought at 6867 = 6867 * $A25 = $A171,675.
Question 11:
Jim buys 5,000 Coles Myer Limited (CML) shares for $7.00 a share. He is expecting them to pay an unfranked dividend of $0.15c per share in one month. He has heard that he can increase his return by selling call options on the CML shares as well. He decides to sell five (5) call options expiring in exactly three months. The options have a strike price of $7.25 and sell for 16c. The delta of the option is 0.25
In answering the following questions, show all calculations and ignore fees and commissions.
A few days after Jim’s initial purchase of CML shares and sale of CML call options, the share price falls to $6.76.
If Jim had sold his shares for $7.05 after receiving the dividend, what would his potential loss now be?
At expiry, the share price leapt to $8.00. What is the intrinsic value of the options now?
What are the two (2) choices available to Jim on expiry and what will result from each choice Assume that Jim decides not to sell his call options. When the price of CML reached $8.00 per share, he sold the shares. What is the return on the total strategy in dollars?
Answer
The premium that Jim earns by selling the call = 5 * 1000 * 0.16 = $800.
Now when the share price falls to $6.76
After receipt of dividend which is 15 cents on 5000 shares = $750, the loss would now be limited to $800 – $750 = $50.
At Expiry, Share price = $8.00
Intrinsic Value of the option is the premium paid which is 16 cents or .15 * 5000 = $750.
The two choices available to Jim at expiry are:
When price reaches $8.00, Jim sells the shares thereby generating return of ($8.00 – $7.00) * 5000 share = $5,000.
Question 12:
Adams Apple owns a substantial share portfolio consisting of blue chip stocks. He is concerned about the world economy and the possibility of another share market crash. He discusses his concerns with you, his stockbroker. You suggest he use the exchange-traded options market in order to hedge his portfolio completely. Discuss the strategy you would advise.
Answer
Exchange-traded funds are securities that consist of a stock index and all the assets therein rather than one single asset and tend to outperform them through continuous trading at the stock index.
Whereas Hedging is a risk management tool which is used by the investors to protect against potential losses and involves taking opposite and equal position in the market thus minimizing and preventing losses.
Here I would suggest the client to hedge his portfolio against ETF’s as his portfolio consists of only blue chip funds (which are more or less positively correlated and losses of one cannot be offset by income from other) whereas ETF’s track the entire index which is a combination of varied stocks thus giving him higher benefit of diversification and prevention against potential losses.
Question 13:
Explain the difference between the intrinsic value and the time value of an option. List four (4) factors that can affect the time value of an option.
Answer
Option premium consists of two portions:
The difference between intrinsic value and time value is that time value is the residual value of option after intrinsic value.
Four factors that can affect the time value of option are:
Question 14:
Balance of Payments figures have just been released and you notice that the SPI 200 spot month futures are falling in price, yet there has not been a relative fall in the S&P ASX 200 index. What accounts for this difference?
Answer
SPI 200 introduced in 2000 is based on the ASX 200 index which is a weighted index of 200 companies listed on the stock exchange. It is a sort of balanced portfolio of underlying 200 companies in the S&P ASX 200. SPI 200 is sold as one unit in the open market.
When the SPI 200 spot month future prices are falling this is speculation among market investors about the future price of S&P ASX 200 whereas S&P ASX reflects the speculation in all the 200 companies within it.
The difference between the two is attributable to the speculation in the market and the fact that SPI 200 reflects performance of one consolidated index and the S&P ASX 200 reflects the performance of all 200 companies within it.
Question 15:
Your client has a view that XYZ stock will rise strongly over the next three months and they would like to take advantage of that by entering the market. What are the four different strategies that you could employ? What are your considerations concerning the relative merits of each?
Answer
Four different strategies and consideration of merits that we could employ for entering the market are:
|
Sl No. |
Strategies |
Consideration |
|
1 |
Invest in the XYZ Shares |
High Transaction Cost and the risk as the entire amount is paid in full. |
|
2 |
Buy XYZ shares on Margin |
Interest rate risk as the total value of the shares is outstanding. |
|
3 |
Buy XYZ call option |
No dividends or voting rights |
|
4 |
Buy XYZ equity call warrant |
No dividends or voting rights |
Question 16:
You have two new clients. Client A is 23 years old, has just started a new job with an income of $78,000 per annum, and has $25,000 held in fixed interest term deposits. Client B is 57 years old, and planning to retire in 3 years, has a current annual income of $46,000, and assets of $73,000 spread across stocks and debentures. Both want to invest $25,000. What is the relative risk-carrying ability of each client? Why? What general strategies are appropriate for each client?
Answer
|
Sl No. |
Client – Description |
Risk Carrying Ability |
Reason |
General Strategy |
|
1 |
A – 23 years old, new job |
High |
The client is a young man with steady income source and a FD for contingencies. The client can take risk for higher returns. |
High Growth Stocks – These stocks reinvest the earnings in the business thus facilitating growth and expansion. |
|
2 |
B – 57 years old, Retired |
Low |
The client is a retired man who has no steady source of income and thus would not take high risks. |
Wealth Creation: Regular Income Stock – High Dividend Payout stocks as the retired person will need a steady stream of income for sustainability. |
Question 17:
One of your clients believes that NCP is going to rise strongly over the next three months, and they would like to use derivatives to trade their short-term view. They suggest buying either a NCP call option or a NCP share futures contract. Which strategy has the greatest risk/reward and why?
Answer
A NCP call option will give the client right to buy shares at a pre determined price at any time until the expiry of the option whereas a NCP share future contract will give the client financial exposure for 1,000 shares at a fixed price.
The greatest risk/reward strategy between the two is buying NCP future contract as the return is $10 for every cent increase in the share but conversely for every cent decrease in the share price, the investors loses $10 and thus the loss cannot be limited as it can be in case of option.
Question 19:
You open a new account for a husband and wife with funds from the recent sale of their house. You fill in the client profile, and during the discussion, your clients inform you that their objective is to invest the funds short-term, until they find another house to buy. They stress that the funds cannot go into high risk investments, and you decide on a mix of short-term fixed interest investments and stock. A few weeks later the husband rings you and says he wants to allocate some of the funds to speculative options trading, because he has heard of the potential rewards. What do you do?
Answer
Every investor in the market must have a definite strategy to meet the defined objectives. All the investments by the investor must be aligned to the strategy adopted. Here the client wants to invest in short-term liquid fixed interest funds because he has the objective to buy a house in near future and will need cash for the same.
In this situation as an advisor, I will let the client know the potential risks of investing in the speculative options trading and how he might not meet his objective of saving for the house that he intends to buy. If the client still insists, I will have to go ahead with his plans as ultimately it is his money and he is the investor. I can provide guidance and let him know the potential risks involved.
Question 20:
Your manager calls you into his office and explains that there is a client dispute involving one of your clients. The client has suffered substantial losses as a result of options trading, and is claiming that they did not understand the risks involved with the strategies you advised them on. The client is insisting that the firm makes good the losses, or they will pursue legal action against you and the firm. How do you prove that you followed the ‘know your client requirements’? What documents/recorded history could you produce to prove you met your obligations to the client
Answer
As per the new regulatory regime released on 11 March 2002, every investor needs to know complete details of their client which includes basic personal details, references, cash flow, assets and liabilities, objectives, custody of securities, net worth, bank details, reason for short selling and other important details. These details will enable the advisor to form a “reasonable basis for advice”.
I can prove that I have followed the ‘know your client requirements’ by presenting the KYC form and the application form which the client have must filled in before investing. Further, the documents and history that I can produce to prove that I have met the obligations are the form, my advice, and client’s acceptance on the same, securities history showing the transactions that were carried out.
Question 21:
A new employee has just come on board. You overhear them with a client explaining that they will monitor their portfolio. What is the difference between monitoring and reviewing a portfolio? What could be the repercussions? Explain and discuss.
Answer
Monitoring is a continuous process which involves regular collection and analysis of a portfolio to ensure that the portfolio is moving in the direction of the set objective. It is continuous and involves gathering of information primarily.
Reviewing on the other hand is careful evaluation of the portfolio on the basis of the data collected while monitoring. While reviewing we decide whether or not to change the strategy for meeting the set objectives. The repercussions of review can be a complete change in the strategy of the portfolio.
Question 22:
Find a resource that will explain the difference between forward and lagging indicators
Here the authors have elaborately described what leading and lagging indicators are, their differences, examples and practical use in investment.
Question 23:
With the potential of the ASX merging with another exchange, what would be positives and potential negatives of a merger for the Australian investor?
Answer
Positives of ASX merging with another exchange for an Australian investor can be easy access to large pool of funds, indexation benefits, greater possibility of diversification of portfolio etc.
Potential negatives of ASX merging with another exchange for an Australian investor can be dilution in the level of control by the Australian exchange, possibilities of higher charges and/or commissions etc.
Question 24:
The traditional advice for retired investors is to seek and invest in dividend stocks. In regards to capital growth stocks why is this NOT a good idea?
Answer
Capital Growth Stocks are stocks which reinvest their earnings in the business to accumulate funds, for tapping larger available opportunities in the future. They do not pay regular dividends and reinvest them for growth and expansion. Thus, retired investors who needs regular stream of income should not opt for capital growth stocks as the dividend payment are not guaranteed.
Essay Questions
Question 3:
You have a new client. One of the mandatory aspects of advice is that your client ‘understand’ what it is you are advising to do. Explain to your new client-
What a managed fund is? How returns relate to risk?
Answer:
Investors invest in the share market for returns on their investment. This investment in the share market can be in the form of shares, bonds, other marketable securities available on the stock exchanges. Many times, investors have funds to deploy in the market but they do not have necessary skills and expertise of the market or they might have the necessary skills and expertise but do not have enough funds to buy full units of securities.
In both these situations, managed fund comes to the rescue. Simply put, a Managed fund is pooled funds managed by an expert with the distribution of dividends and gains to the unitholders. It involves pooling together money from different investors into one fund that is invested and controlled by a professional investment manager (Ryan, 2017). Investors have the option to invest in a single class of available assets be it shares, bonds etc. or choose a mix of assets including shares, bonds, balanced funds, growth funds etc.
Investment in a managed fund will give you the units of the funds which is calculated on a daily basis and generally known as NAV (Net Asset Value). The more units to have, more you can reap the benefit of higher NAV as true in the case of share prices.
Managed funds can give you various advantages over traditional investment which are:
Also be to kept in mind is the risks associated with it which are common to risks of investing in any stock market security including the risk of loss, liquidity risk, payment of management fees to the fund manager etc.
Another important aspect of investing which you should know and be aware about is RISK & RETURN. They are the two sides of the same coin and every investment in the market must be done after a careful evaluation of both the risks and returns associated with it.
Returns are the gain from the investment whereas the risk is the probability or chance that you might not get the return that you expected from your investment. Every investment must trade-off this risk and return to gain maximum return over the optimal level of return (Encyclopaedia, 2018).
Generally, the higher the risks you take higher will be the returns that you will generate from your investment, however, this is not guaranteed. For example, generally, government securities offer a very low rate of interest ranging from 3% to 5% as they have virtually no risk. Further, start-up companies at times offer return to the tune of 35-40% but they have also very high chances of loss thus very high risk.
Risk and return generally have a directly proportional relationship where greater the risk you take, greater the return that you can expect.
Question 4:
You have just been asked by a new client
What fundamental and technical share analysis? Explain in simple terms and give some simple examples of them.
Answer:
Fundamental and technical share analysis is the two distinct views of the analysis of the financial markets. Very broadly and simply, we can differentiate between them on the fact that Technical analysis uses the price movement of the stock to predict future prices and the fundamental analysis uses the financial statements to analyze the health of the company and value it based on economic and financial factors (Investopedia, 2018)
Technical Analysis: Analysts using this technique uses the historical prices and the current price movement of the stock to predict the future prices of stocks based on trends of the movements. This analysis is purely based on the available share prices and the analyst’s here view that the share prices of the stock represents all the relevant financial information of the company. They start with the charts of the market prices of the share and then break them into quarters, month, week, days and even minutes prices of the share to depict and decode the trend of the share price movement.
It is generally suitable for investors having short term to medium term trading goals. (Bhatia, 2018)
A simple example of it can be by assuming you are a technical analyst and is interested in buying the stocks of Amazon Inc. You will first plot the overall trend in the market by moving averages per day of the benchmark (let say S&P 500). We will then plot the average daily prices of the intended stock and if the line is above the trend line of the benchmark, we can say that the stock is a bullish stock.
Fundamental Analysis: This school of thought uses the available financial statements of the company to analyze its performance and future prices. The analyst using this approach will use the financial statement to value the firm based on the intrinsic value per share which he calculates using the discounted cash flow method of future projected cash flows for the company. It evaluates both the internal and external forces of the company and predicts the potential earnings, growth and share prices.
They have long-term horizons and look at investment rather than trading. (Bhatia, 2018)
A simple example is evaluation of the health of the company based on its internal factors (strengths and weaknesses) in light of the external forces (opportunities and threats). It calculates the intrinsic value of the share based purely on available financial data.
Question 5:
Explain the different types of equity capital, their advantages and disadvantages
Answer:
Issuance of equity capital by the firm brings in the necessary fund for the company required for its expansion and growth plans. They provide the company, long-term funds for their major capital expenditure including building of factories, setting up of plant and equipment, new acquisitions etc.
Generally companies have authorised share capital (the maximum share capital that they can raise) and issued capital (the share capital which today stands outstanding). (Corplaw, 2013)
There are various types of equity capital which the firm can issue and some of them are as below:
Advantages: No obligation to pay fixed return unlike preference shares.
Disadvantages: Dilutes the ownership of the company. (White, 2017).
Advantages: Pro-rata voting and return rights based on payment
Disadvantages: Shareholders might not pay when called for the balance amount leaving the company no choice but to forfeit the shares.
Advantages: Fixed rate of dividend.
Disadvantages: Preferential rights in the property of the company.
Advantages: Fixed rate of interest for a specified time.
Disadvantages: Dilution of ownership when converted to ordinary shares.
Advantages: Potential future source of capital for expansion needs.
Disadvantages: Uncertainty attached with shareholders exercising their options.
Advantages: Both shares and trust are dealt together.
Disadvantages: Need to understand the taxation status and governing laws strictly.
Apart from the ones mentioned above, there are other kinds of equity capital which will be a hybrid of two or more of the above types of capital. Other shares will include bonus shares (does not raise any capital for the firm, issued for free to the existing shareholder), rights issue (additional shares at a discount, raises capital for the firm)
Question 7:
ETF’s are now in vogue after the so called GFC. Explain the ETF paradigm, the benefits and the potential disadvantages.
Answer:
Today ETF is a name known to everyone in the market and has grown by 500% in value since 2008 to a total value of $4 trillion (Martin, 2017). ETF’s or the Exchange Traded Funds since its introduction in the late 1990’s and have made investing easier. For ease of understanding, ETF’s are securities that consist of a stock index and all the assets therein rather than one single asset and tend to outperform them through continuous trading at the stock index.
ASX launched an active market for Exchange-Traded-Funds in the year 2001 and since then it has grown exponentially. ETFs have features of both shares and managed funds within them.
ETF paradigm is similar to mutual fund which are also amalgamation of various shares and are managed by a fund manager, but the major difference between the two is the fact that in case of mutual fund individual shares/stocks/bonds forming part of the fund is traded separately in the active market whereas in case of ETF, the entire ETF as a whole is offered for trade to the general public.
ETF’s are listed as a whole on the exchanges, they are traded throughout the day and thus have various prices at each point of time on a trade date, follows the T+3 rule and have a small management fee for the managers.
The benefits of the ETF are as below:
The potential disadvantages of the ETF’s can be as below:
References
Admin, C. (2013). An Introduction To Authorised & Issued Share Capital. [Blog] Corplaw Blog. Retrieved December 15, 2018 from https://www.corplaw.ie/blog/bid/342012/An-Introduction-To-Authorised-Issued-Share-Capital
Bhatia, N. (2018). Fundamental vs Technical Analysis of a Stock. [online] nitinbhatia.in. Retrieved December 15, 2018 from https://www.nitinbhatia.in/stocks/fundamental-vs-technical-analysis-of-a-stock/
Investopedia. (2018). What is the difference between fundamental and technical analysis?. [online] Retrieved December 15, 2018 from https://www.investopedia.com/ask/answers/difference-between-fundamental-and-technical-analysis/
Martin, W. (2017). ‘A huge risk of contagion’: Everything you need to know about ETFs — the hot investment area that some think will cause the next financial crisis | Markets Insider. [online] markets.businessinsider.com. Retrieved December 15, 2018 from https://markets.businessinsider.com/news/etf/what-is-an-etf-risk-global-financial-crisis-2017-10-1004580211
Perkins, C. (2018). What Is An ETF Or Exchange Traded Fund? – Paradigm oil inc. [online] Paradigm oil inc. Retrieved December 15, 2018 from https://www.paradigmoilinc.com/what-is-an-etf-or-exchange-traded-fund/
Risk-Return Tradeoff. (2018). In: International Encyclopedia of the Social Sciences.. Retrieved December 15, 2018 from https://www.encyclopedia.com/social-sciences/applied-and-social-sciences-magazines/risk-return-tradeoff
Ryan, T. (2017). What Are Managed Funds? – CANSTAR. [online] Canstar. Retrieved December 15, 2018 from https://www.canstar.com.au/managed-funds/what-are-managed-investments/
White, C. (2017). What are the advantages of ordinary shares?. [online] Investopedia. Retrieved December 15, 2018 from https://www.investopedia.com/ask/answers/050615/what-are-some-advantages-ordinary-shares.asp
Essay Writing Service Features
Our Experience
No matter how complex your assignment is, we can find the right professional for your specific task. Contact Essay is an essay writing company that hires only the smartest minds to help you with your projects. Our expertise allows us to provide students with high-quality academic writing, editing & proofreading services.
Free Features
Free revision policy
$10Free bibliography & reference
$8Free title page
$8Free formatting
$8How Our Essay Writing Service Works
First, you will need to complete an order form. It's not difficult but, in case there is anything you find not to be clear, you may always call us so that we can guide you through it. On the order form, you will need to include some basic information concerning your order: subject, topic, number of pages, etc. We also encourage our clients to upload any relevant information or sources that will help.
Complete the order form
Once we have all the information and instructions that we need, we select the most suitable writer for your assignment. While everything seems to be clear, the writer, who has complete knowledge of the subject, may need clarification from you. It is at that point that you would receive a call or email from us.
Writer’s assignment
As soon as the writer has finished, it will be delivered both to the website and to your email address so that you will not miss it. If your deadline is close at hand, we will place a call to you to make sure that you receive the paper on time.
Completing the order and download