CFA Pop Quiz #158: Level I: Equity- Market Organization, Market Indices, and Market Efficiency
Joel Sandow, an investor, wants to go short on a stock that is currently priced at $40. However, he anticipates the prices to rise during this period. To protect against the adverse price movements, Sandow will most likely enter into a:
- Good-on-close order.
- Stop order.
- Good-till-canceled order.
Correct Answer B.
Stop orders, often referred to as stop-loss orders, are placed by investors to protect themselves from adverse price movements. A stop-loss buy order is placed by short sellers above the market price. If the price of the asset moves against the short seller’s expectations, the stop buy order will ensure that her losses do not exceed a particular limit.
A trader is comparing being long a forward contract at $90 and being long a call option contract with a strike price of $90. Both contracts have the same underlying common stock. The trader should understand that both contracts:
- generally, benefit as the underlying asset rises in value.
- involve a commitment to buy the underlying asset at $90.
- require the payment of an initial premium in order to establish the position.
Correct Answer A.
Both positions do have exposure to the underlying asset. For a forward contract, being long entails taking on both the upside and downside risk related to the underlying. In contrast, being long a call option provides upside exposure and limits the downside risk. Hence, both long positions do have the upside exposure.
A long forward is a commitment to buy the asset at $90. A long option means the trader does not have to exercise the option unless the underlying asset’s price is greater than $90. But, the option buyer does have to pay a premium in order to obtain this single-sided exposure.
There are three types of equity shares outstanding for Allen Shoe Company. If an investor desires to own equity with the highest claim on net assets in case of a liquidation, which type of shares would they purchase?
- Common shares.
- Preferred shares.
Correct Answer C.
Preferred shareholders have the highest claim on assets among the three types of equity investors.
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