ARE143_CHAP_2_KEY - 1 Managerial Economics (ARE) 143...

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1 Managerial Economics (ARE) 143 University of California, Davis Instructor: John H. Constantine KEY—Chapter 2 Problem 1: (a) What does it mean to purchase a security on margin? Why might you do it? Purchasing on margin means borrowing some of the money used to buy securities. You do it because you desire a larger position than you can afford to pay for, recognizing that using margin is a form of financial leverage. As such, your gains and losses will be magnified. Of course, you hope you only experience the gains. (b) What does it mean to sell a security short? Why might you do it? Shorting a security means borrowing it and selling it, with the understanding that at some future date you will buy the security and return it, thereby “covering” the short. You do it because you believe the security’s value will decline, so you hope to sell high now, then buy low later. (c) What is the reason margin requirements exist? Margin requirements amount to security deposits. They exist to protect your broker against losses. (d) What is the difference between asset allocation and security allocation? Asset allocation means choosing among broad categories such as stocks and bonds. Security selection means picking individual assets within a particular category, such as shares of stock in particular companies. (e) Are market timing and active asset allocation similar? Explain. They can be. Market timing amounts to active asset allocation, moving money in and out of certain broad classes (such as stocks) in anticipation of future market direction. Of course, market timing and passive asset allocation are not the same. (f) Why is street name registration advantageous to investors? Under what circumstances is it required? Some benefits from street name registration include: (i) The broker holds the security, so there is no danger of theft or other loss of the security. This is important because a stolen or lost security cannot be easily or cheaply replaced. (ii) Any dividends or interest payments are automatically credited, and they are often credited more quickly (and conveniently) than they would be if you received the check in the mail. (iii) The broker provides regular account statements showing the value of securities held in the account and any payments received. Also, for tax purposes, the broker will provide all the needed information on a single form at the end of the year, greatly reducing your record- keeping requirements. (iv) Street name registration will probably be required for anything other than a straight cash purchase, so, with a margin purchase for example, it will be required.
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2 Problem 2: (a) The XYZ Corporation stock sells for $83 per share, and you have decided to purchase as many shares as you possibly can. You have $13,000 available to invest. What is the maximum number of shares you can buy if the initial margin is 50%?
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This note was uploaded on 01/13/2012 for the course ARE 143 taught by Professor Brinkley,g during the Spring '08 term at UC Davis.

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ARE143_CHAP_2_KEY - 1 Managerial Economics (ARE) 143...

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