cfp mod 2 chpt 1

Card Set Information

cfp mod 2 chpt 1
2014-01-21 12:38:47
cfp module chapter

fundamentals of investment for financial planning
Show Answers:

  1.  The primary and secondary markets are both critical to economic growth anddevelopment, but each in a different way. Explain why each is important.
    The primary market is where companies raise new capital via the sale of new securities.Without the primary market, corporations would be greatly restricted in the amount ofcash they could raise for new projects, and, as such, economic growth would be stymied.Although corporations do not participate in the secondary market, except on the rareoccasion that they buy back their own securities, the secondary market is nonethelesscrucial to the corporations for raising money. Without the ability to resell securities in thesecondary market, few would be interested in investing in the primary market; hence, awell-functioning secondary market is critical for a healthy primary market.
  2. Investment bankers facilitate new-issue sales of debt and equity securities.Describe the two underwriting approaches they use to accomplish thisobjective
    The investment banker may choose to act as an agent for the issuing firm, in whichcase the job is taken on a best-efforts basis. In this case, the firm itself bears the risk ofnot raising all of the cash it desires if the offering does not sell out. Most underwriting,however, is done on a firm-commitment basis, which means the investment banker buysthe securities from the issuer and then resells them to the public. In this case, if theoffering fails to sell out, the investment banker takes a loss by being forced to hold thesecurities or sell them at a lower than anticipated price.
  3. Although the distinction is becoming blurry, identify the two major categoriesof stock brokers and how their services differ from each other
    The two categories of brokers are full service and discount. In a full-service brokeragefirm, a client works with a specific broker. Benefits such as research on particularsecurities are generously provided. Commissions are on the high side. In a discountbrokerage firm, the account is with the firm, not a specific broker. Benefits like stock research may be minimal. Commissions, particularly for Internet-based brokers, maybe extremely low.
  4. Identify the four activities of a specialist
    The specialist manages the auction process by providing the best bid and ask pricesduring the trading day; executes orders for floor brokers; serves as a catalyst; and provides capital to accommodate temporary imbalances between buy and sell orders.
  5. Define the third and fourth markets and describe the benefits each providesto investors.
    The third market is the trading of listed stocks in the over-the-counter (OTC) market. Itallows investors the opportunity to seek better prices. The fourth market refers to directtrading between institutions. The benefit of this method is that institutional investorseliminate the bid-ask spread, commissions, and reduce the consequences of price impact.
  6. What is the key difference between the NYSE andany other market?
    The NYSE generally has the highest listing requirements. Its listing requirements includeeither $10 million in pre-tax earnings over the last 3 years, or $2 million in pre-tax earningsfor each of the last 2 years combined with a positive earnings number for the third year;1.1 million of a company’s shares to be publicly held; the market value of the publicly heldshares to be at least $100 million; there be at least 2,000 round-lot holders; and the priceof the stock to not be less than one dollar.
  7. List the three components that make up the potential cost of a trade, andidentify which are implicit and which are explicit.
    The three are commissions (explicit), bid-ask spreads (implicit), and price impact.
  8. Explain the difference between the following four buy orders: market, limit,stop-buy, and stop-limit buy
    A market order to buy requires an immediate purchase at the best available price. A limitorder to buy stipulates the maximum (buy) price acceptable for a trade to take place. Atthe time the order is placed, the market price of the stock is usually above the limit price.A stop-buy order becomes a market order when the stop price is reached. It is usuallyused in conjunction with short sales and the buy price is normally above the currentmarket price when the order is placed. A stop-limit buy order becomes a limit order oncethe stop price is reached. The order requires the investor to designate both the stopprice and the limit price.
  9. . You have inherited an extremely large position in the Family HeirloomCorporation. You would like to liquidate this position. A traditional sell orderwill be ineffective due to the size of the holding. What are some methods fordisposing of this stock? [4]
    The three common methods are a block trade, a special offering, or a secondarydistribution. The best method depends on the actual size of the holding.
  10. You have $600,000 in stock and $50,000 in cash sitting in your stock accountwith the Shaky Standard Brokerage Firm. Should you be concerned aboutyour holdings if the brokerage firm files for bankruptcy, assuming the firmis covered by the SIPC? [7]
    In terms of the inconvenience, you should be concerned. With respect to financial loss,the answer is that it depends. The SIPC protects brokerage customers against lossesthat would otherwise result from the failure of their brokerage firm. Customers are insuredup to $500,000, not more than $100,000 of which may be in cash. Any claims abovethose sums are applied against the firm’s available assets during liquidation. Mostbrokerage firms, however, have purchased additional insurance. Thus, if Shaky Standardhas additional insurance coverage, there is little risk of financial loss with respect to thesecurities. However, SIPC insurance covers the cash only if it is in the account incidentalto trading activities. If it is there to earn interest income, then there is no insuranceprotection for the cash.
  11. Investment bankers generally agree to sell a new issue on a best-effort basis torf
    False. Investment bankers generally agree to sell a new issue on a firm-commitmentbasis when acting as agents, which means that they buy the securities from the issuerand then sell them to the public.
  12. The most basic function that brokers and their firms perform is to link investors to the securities markets tof