Equity Investments. 27 question(s) in this unit's pool
(2 above the exam). Free up to ten a day; the coach picks which ones based on what you have
already answered and when each is next due.
Equity InvestmentsMarket Organization and Structure
Pick an answer, say how sure you are, then reveal. Every wrong choice gets its own
explanation. Questions you have already answered correctly and confidently stay out of the way until they
are due for review again.
Question 1Exam level
An investor places an order to sell 500 shares of XYZ Corp. at the best available price immediately. What type of order is this, most likely?
How sure are you?
Correct: B. A market order is an instruction to buy or sell immediately at the best available price. It prioritizes certainty of execution over price. The investor is not specifying a price constraint. She simply wants the trade executed now. Limit orders specify a maximum buy price or minimum sell price (controls price, not certainty). Stop orders are conditional on the price reaching a trigger level first.
A. A limit order specifies a maximum buy price or minimum sell price. It controls price, not immediacy, and may not execute at all if the market never reaches that price.
C. An all-or-none order is a condition on quantity (fill the whole order or none of it). It says nothing about price or timing the way a market order does.
Unit: market-organization-and-structure
Question 2Exam level
An investor submits a limit order to buy shares at $45. The current ask price is $48. Which of the following best describes the outcome?
How sure are you?
Correct: B. A buy limit order at $45 means the investor will not pay more than $45. Since the current ask is $48, the order cannot execute at current prices. It enters the limit order book and waits. If the ask falls to $45 or below, it will execute. It may never execute if the price never reaches $45. Option A is wrong because limit orders do NOT execute at the ask when the limit is below the ask.
A. Option A is wrong because limit orders do NOT execute at the ask when the limit is below the ask.
C. You might think the order is invalid because it cannot be filled at the current ask price, but limit orders are not rejected for being below the ask; they are held in the order book until the price is favorable or canceled, which contrasts with the immediate rejection suggested in choice C.
Unit: market-organization-and-structure
Question 3Exam level
A trader holds a long position in a stock currently trading at $60. To protect against a sharp decline, she places an order to sell if the price falls to $55. What type of order is this, most likely?
How sure are you?
Correct: A. This is a stop sell (stop-loss) order. The $55 is the stop (trigger) price, not the limit price. Once the market price falls to $55, the order is activated and becomes a market order to sell. The exam tests whether students know that a stop order becomes a market order upon trigger. It does NOT guarantee execution at $55. If the price gaps from $57 to $52 overnight, the order triggers at $55 but executes at the next available price, potentially $52. A limit sell at $55 would only execute at $55 or higher. That is the key difference.
B. You might be tempted by a market order with a price condition because it seems to activate at a specific price, but a market order, even with a condition, does not act as a trigger to sell; instead, a stop sell order with a trigger at $55 is designed to become a market order once the price hits $55, fulfilling the trader's intent to sell if the price falls to that level.
C. You might be thinking that a limit order is needed to sell at a specific price, but a good-till-cancelled limit order would not automatically trigger a sale when the price hits $55, unlike a stop sell order which becomes a market order once the trigger price is reached.
Unit: market-organization-and-structure
Question 4Exam level
Which of the following transactions occurs in the primary market, most likely?
How sure are you?
Correct: B. Primary markets are where issuers sell securities directly to investors and receive the proceeds. In a seasoned equity offering (SEO), Microsoft issues new shares. Proceeds go to Microsoft. This is a primary market transaction. Options A, B, and D all involve trades between investors where the issuer receives nothing. The NYSE trade (A), OTC bond trade (B), and broker-facilitated swap (D) are all secondary market transactions. The defining test: does the ISSUER receive the proceeds? If yes, it is primary. If no, it is secondary.
A. You might be tempted to choose A because it involves a financial institution and an OTC dealer, which can seem like a primary market transaction, but in reality, the hedge fund is simply buying from another fund, not from the issuer, making it a secondary market transaction where the issuer, in this case the U.S. Treasury, does not receive any proceeds.
C. You might be tempted by choice C because it involves a broker, which can make it seem like a primary market transaction, but remember, the broker here only facilitates the swap between two pension funds, not the issuance of new securities, making it a secondary market transaction.
Unit: market-organization-and-structure
Question 5Exam level
Which of the following best describes how secondary markets support primary markets?
How sure are you?
Correct: B. The CFA curriculum's key argument: investors are willing to buy securities in the primary market BECAUSE they know they can sell them in the secondary market. If secondary markets did not exist, investors would demand a massive liquidity premium, making it prohibitively expensive for issuers to raise capital. Secondary markets provide: (1) liquidity. Investors can exit, (2) price discovery. Continuous pricing signals. Options A and D are wrong. Regulation and underwriting are not secondary market functions. Option B is wrong. SEOs happen in primary markets.
A. Option B is wrong. SEOs happen in primary markets.
C. You might be tempted by choice C if you confuse the roles of primary and secondary markets, as underwriting new securities is actually a function of primary markets, not secondary markets, which instead focus on providing liquidity and price discovery for already issued securities.
Unit: market-organization-and-structure
Question 6Exam level
An investor places a stop-limit order to sell with a stop price of $50 and a limit price of $48. The stock is currently trading at $55. If the stock price falls rapidly from $53 to $44 without trading at prices between $50 and $48, what happens to the order, most likely?
How sure are you?
Correct: C. This is the classic stop-limit trap. When the price falls to $50, the stop is triggered and a LIMIT sell order at $48 is activated. However, the price has already fallen below $48 to $44. The limit order will not execute below $48. The stock gaps through both the stop and limit prices, so the order sits unfilled in the book while the investor suffers the full loss. This is the critical difference between stop-limit and plain stop orders: stop-limit orders can FAIL TO PROTECT in fast-moving markets. A plain stop order would have converted to a market order at $50 and executed at $44.
A. You might think the order executes at $48 because the limit price is reached, but this overlooks the fact that once triggered, a limit order only executes at or better than the limit price, and since the price fell below $48 to $44 without trading at $48, the order does not get filled.
B. You might be thinking that once the stop price is hit, the order turns into a market order, but this ignores the limit price restriction; the order is a limit sell at $48, not a market order, so it will not execute at $44.
Unit: market-organization-and-structure
Question 7Exam level
A 'good-till-cancelled' (GTC) order most likely differs from a 'day order' in that:
How sure are you?
Correct: A. GTC and 'day' are validity instructions. They determine how long the order remains active. A day order expires at close if not filled. A GTC order remains in the book until the investor cancels it or it executes. Option A is wrong. GTC can be applied to any order type including market orders (though this is unusual). Option C is wrong. Neither type guarantees execution; a limit GTC order can sit forever unfilled.
B. Option C is wrong. Neither type guarantees execution; a limit GTC order can sit forever unfilled.
C. Option C is wrong. Neither type guarantees execution; a limit GTC order can sit forever unfilled.
Unit: market-organization-and-structure
Question 8Exam level
Which of the following is most likely a clearing instruction, not an execution or validity instruction?
How sure are you?
Correct: B. The CFA curriculum classifies order instructions into three categories: (1) Execution instructions. Specify how to fill (market, limit, stop, stop-limit, market-if-touched, etc.); (2) Validity instructions. Specify when to fill or cancel (day, GTC, fill-or-kill, all-or-none, immediate-or-cancel, good-on-close); (3) Clearing instructions. Specify how to settle (regular settlement T+2 for equities, cash/same-day settlement, delivery vs payment). Cash settlement is a clearing instruction. Market orders, stop orders, and GTC are in the other two categories.
A. You might be tempted to choose Good-till-cancelled because it sounds like a settlement term, but it actually specifies the duration of the order validity, not the settlement method like same-day settlement does.
C. You might be tempted by a stop order because it involves a condition for execution, but remember that a stop order is an execution instruction that triggers a market or limit order once a specified price is reached, unlike cash settlement which is a clearing instruction specifying how to settle the trade.
Unit: market-organization-and-structure
Question 9Exam level
An investor sells shares short at $80. To limit potential losses, she places an order to buy shares if the price rises to $90. This is most likely described as a:
How sure are you?
Correct: A. A stop-buy order is triggered when the price RISES to the stop price. Short sellers use stop-buy orders to automatically cover (repurchase) their short position if the price rises against them. Limiting losses. The trigger here is $90: if the stock reaches $90, the order activates and becomes a market buy. Limit buy at $90 would only execute at $90 or LOWER. The opposite of what she needs. A market-if-touched order is similar but differs in that it converts to a market order regardless of direction. Stop-sell orders are used by long investors to protect against price declines. Not relevant here.
B. You might be tempted by a market-if-touched buy order because it sounds like it triggers at a specific price, but unlike a stop-buy order, it does not specifically guard against rising prices by converting to a market buy order; instead, it triggers on any price touch, making it less suitable for limiting losses from a short position.
C. You might be tempted to choose a stop-sell order because it sounds like it would sell shares to cover the position, but a stop-sell order is designed for long positions to limit losses when the price falls, not for short positions to limit losses when the price rises like a stop-buy order does.
Unit: market-organization-and-structure
Question 10Exam level
An investor purchases 200 shares at $50 per share using a margin account. The initial margin requirement is 50% and the maintenance margin requirement is 25%. The margin call price is closest to:
How sure are you?
Correct: A. Formula: Margin call price = Purchase price x (1 - initial margin) / (1 - maintenance margin). Margin call price = $50 x (1 - 0.50) / (1 - 0.25) = $50 x 0.50 / 0.75 = $50 x 0.6667 = $33.33. Alternatively: Total investment = $10,000. Equity = $5,000 (50%). Loan = $5,000. At price P, equity = 200P - 5,000. Margin = (200P - 5,000) / (200P) = 25%. Solving: 200P - 5,000 = 50P. 150P = 5,000. P = $33.33. The exam will give you a scenario and ask you to solve for the margin call price. This formula must be memorized exactly.
B. Choosing $37.50 might seem correct if you mistakenly calculate the margin call price by only considering the maintenance margin requirement without factoring in the initial margin, leading to an incorrect calculation that violates the formula which requires both margin requirements to determine the exact margin call price.
C. Choosing $40.00 might seem correct if you mistakenly applied the maintenance margin directly to the purchase price, but this overlooks the need to account for the initial margin and the loan amount in the calculation, leading to an incorrect margin call price.
Unit: market-organization-and-structure
Question 11Exam level
Which type of market is characterized by dealers posting bid and ask prices, with investors transacting with dealers rather than with each other, most likely?
How sure are you?
Correct: A. A quote-driven market (also called a dealer market) has dealers who continuously post bid prices (what they will pay to buy) and ask prices (what they will sell for). Investors trade with dealers, not directly with each other. The OTC bond market and foreign exchange market are examples. An order-driven market (e.g., NYSE, NASDAQ order book) matches buyer and seller orders directly. No dealer required. A brokered market uses brokers to find counterparties (e.g., real estate, some block trades). A call market batches orders and executes them at a single price at set intervals.
B. You might be misled by the idea that brokers also facilitate trades, but in a brokered market, brokers find counterparties rather than setting bid and ask prices themselves, which is what dealers do in a quote-driven market.
C. You might be tempted by the call market because it also involves periodic price determinations, but unlike a quote-driven market, a call market batches orders and executes them at a single price at set intervals, not through continuous dealer quotes.
Unit: market-organization-and-structure
Question 12Exam level
A shelf registration most likely allows a company to:
How sure are you?
Correct: A. A shelf registration (Rule 415 in the U.S.) allows an issuer to register a large amount of securities at once and then sell them in portions ('off the shelf') over a 3-year period whenever market conditions are favorable. This is a primary market mechanism. It gives issuers flexibility. They do not have to do one large offering all at once. Option C describes a private placement (Rule 144A), which bypasses SEC registration for qualified institutional buyers.
B. Option C describes a private placement (Rule 144A), which bypasses SEC registration for qualified institutional buyers.
C. Option C describes a private placement (Rule 144A), which bypasses SEC registration for qualified institutional buyers.
Unit: market-organization-and-structure
Question 13Exam level
In a rights offering, existing shareholders are most likely given the right to:
How sure are you?
Correct: A. A rights offering is a primary market transaction where the issuer gives existing shareholders the right (but not the obligation) to buy newly issued shares at a subscription price, typically below the current market price, before the shares are offered to the public. This protects existing shareholders from dilution. Option A describes a share buyback, not a rights offering. Option C is unrelated. The CFA curriculum tests rights offerings as one of three primary market issuance mechanisms alongside IPOs and private placements.
B. Option C is unrelated.
C. Option C is unrelated.
Unit: market-organization-and-structure
Question 14Exam level
Which of the following best describes an 'immediate or cancel' (IOC) order?
How sure are you?
Correct: A. An immediate-or-cancel (IOC) order requires that any portion of the order that can be filled is filled immediately, and the unfilled portion is immediately cancelled. This is different from fill-or-kill (FOK), which requires the ENTIRE order to be filled immediately or the entire order is cancelled. Day orders (Option C) remain active until end of day. Not the same concept.
B. You might be tempted by choice B because it sounds similar to a day order, but an immediate-or-cancel order does not remain active for the trading day; instead, it seeks to fill and cancel unfilled portions immediately, unlike a day order that stays active until the end of the trading day or execution.
C. You might be misled by the idea of converting orders, but an IOC order does not convert to another type; instead, it immediately cancels any unfilled portion, unlike a limit order which waits for a specific price.
Unit: market-organization-and-structure
Question 15Exam level
An investor purchases 200 shares of stock at $50 per share using a margin account. The initial margin requirement is 50% and the maintenance margin is 25%. At what price will the investor receive a margin call? The value is closest to:
How sure are you?
Correct: A. Margin call price for a long position = P0 x (1 - initial margin) / (1 - maintenance margin) = $50 x (1 - 0.50) / (1 - 0.25) = $50 x 0.50 / 0.75 = $50 x 0.6667 = $33.33. At this price, the equity in the account equals exactly the maintenance margin percentage. Equity = 200 x $33.33 - $5,000 loan = $6,667 - $5,000 = $1,667. Margin ratio = $1,667 / $6,667 = 25%. The exam trap is using the wrong denominator. Some candidates multiply instead of applying the formula correctly.
B. You might often calculate 25% of the original purchase price ($12.50 subtracted from $50 = $37.50) rather than applying the correct formula that accounts for the fixed loan amount.
C. Choosing $40.00 might seem correct if you mistakenly calculate the maintenance margin requirement directly from the stock price drop, but this overlooks the formula for margin call price which accounts for both initial and maintenance margins, leading to a lower threshold of $33.33.
Unit: market-organization-and-structure
Question 16Exam level
An investor short sells 100 shares at $80 per share. The initial margin requirement is 50% and the maintenance margin is 30%. At approximately what price will the short seller receive a margin call? The value is closest to:
How sure are you?
Correct: A. Margin call price for a short position = P0 x (1 + initial margin) / (1 + maintenance margin) = $80 x (1 + 0.50) / (1 + 0.30) = $80 x 1.50 / 1.30 = $80 x 1.1538 = $92.31. When the stock price rises above $92.31, the short seller's equity (proceeds + initial margin deposit - current market value of shares owed) falls below 30% of the current value of the short position.
B. Choosing $104.00 might seem logical if you mistakenly applied the initial margin directly to the short sale price, but this overlooks the maintenance margin calculation which is crucial for determining the margin call price, leading to an incorrect higher price than the actual margin call threshold of $92.31.
C. Choosing $110.77 might tempt you if you incorrectly applied the formula for a long position margin call instead of a short position, leading to a violation of the proper calculation for short selling margin requirements.
Unit: market-organization-and-structure
Question 17Exam level
An investor buys 500 shares of stock at $40 per share using 60% margin (initial margin = 40%). The stock rises to $48. The investor's return on the margin investment is closest to:
How sure are you?
Correct: B. Total investment = 500 x $40 = $20,000. Equity invested = 40% x $20,000 = $8,000. Borrowed = $12,000. Stock rises to $48: position value = 500 x $48 = $24,000. Equity = $24,000 - $12,000 = $12,000. Return = ($12,000 - $8,000) / $8,000 = $4,000 / $8,000 = 50%. Leverage ratio = 1/initial margin = 1/0.40 = 2.5x. Levered return = 2.5 x 20% = 50%. The exam tests both the direct calculation and the leverage ratio shortcut.
A. Choosing 33.3% might tempt you if you incorrectly calculate the return based on the total investment rather than the equity invested, confusing the leverage effect and thus underestimating the return on the margin investment.
C. Choosing 80% might tempt you if you incorrectly calculate the return based on the total investment rather than the equity invested, violating the principle of margin investing where returns are based on the equity portion, not the total investment.
Unit: market-organization-and-structure
Question 18Exam level
Which of the following statements about short selling is MOST accurate?
How sure are you?
Correct: B. When an investor short sells stock, they borrow shares and sell them. If the company pays a dividend during the borrowing period, the short seller must compensate the lender for the dividend payment (called a 'manufactured dividend'). A is partially correct. Maximum gain is the full short sale price (if stock falls to zero), not just the 'initial stock price' minus costs. B is wrong: maximum loss is theoretically unlimited because a stock can rise infinitely. D is the opposite of reality: short sellers profit when prices fall.
A. You might think the loss is limited because you consider only the initial investment, but in short selling, your potential loss is unlimited since the stock price can rise indefinitely, unlike in a long position where your loss is limited to the investment.
C. You might be thinking that higher stock prices mean more profit, which is true for buyers but not for short sellers; short sellers profit when the price falls below the short sale price, not when it rises, because they aim to buy back the shares at a lower price to return them to the lender.
Unit: market-organization-and-structure
Question 19Exam level
An investor short sells 300 shares at $60. The stock falls to $45. Ignoring transaction costs, the investor's profit and return on invested capital if the initial margin was 50% is closest to:
How sure are you?
Correct: A. Proceeds from short sale = 300 x $60 = $18,000. Initial margin deposited = 50% x $18,000 = $9,000. Total funds in account = $18,000 + $9,000 = $27,000. Stock falls to $45: cost to repurchase = 300 x $45 = $13,500. Profit = $18,000 - $13,500 = $4,500. Return = $4,500 / $9,000 (equity at risk) = 50%. This is leverage at work. Leverage ratio = 1/0.50 = 2x. 25% x 2 = 50%.
B. You might be calculating the return based on the total funds in the account, which is $27,000, leading to a return of 16.7%, but this approach is incorrect because the return on invested capital should be calculated based on the equity at risk, which is $9,000, resulting in a 50% return.
C. You might be tempted to choose C if you incorrectly calculate the profit by only considering the change in the stock price without accounting for the full proceeds from the short sale, leading to a miscalculated profit of $2,700 instead of $4,500, and thus an incorrect return of 30% rather than the accurate 50%.
Unit: market-organization-and-structure
Question 20Exam level
The leverage ratio of a margin purchase is most likely described as:
How sure are you?
Correct: A. Leverage ratio = 1 / initial margin percentage. If initial margin = 50%, leverage ratio = 1/0.50 = 2. If initial margin = 40%, leverage ratio = 1/0.40 = 2.5. The return on the margin investment = leverage ratio x return on the stock. This formula is tested directly: 'An investor uses 40% initial margin. The stock returns 10%. What is the return on equity?' Answer: 2.5 x 10% = 25%. Option A describes the debt-to-asset ratio concept, not the leverage ratio as defined in the CFA curriculum.
B. You might be tempted by choice B if you confuse maintenance margin with the calculation of leverage, but the leverage ratio specifically requires the reciprocal of the initial margin, not a comparison between maintenance and initial margins.
C. You might be tempted by choice C if you confuse leverage ratio with the equity multiplier, but choice C actually describes a formula for calculating the return on equity adjusted for leverage, not the leverage ratio itself, which is simply the reciprocal of the initial margin percentage.
Unit: market-organization-and-structure
Question 21Exam level
An investor buys stock on margin at $100 with 40% initial margin and 25% maintenance margin. The stock falls to $60. Which of the following is most likely correct?
How sure are you?
Correct: A. Loan per share = $100 x (1 - 0.40) = $60. At $60 per share: Equity = $60 - $60 = $0? No. The loan is fixed at $60. Equity = current price - loan = $60 - $60 = $0. Re-check: loan = 60% of $100 = $60. Price falls to $60. Equity = $60 - $60 = $0. That would trigger margin call. CORRECTION: margin call price = $100 x (0.60/0.75) = $80. At $60 the account has already been wiped out. The intended correct calculation: equity ratio at $60 = ($60 - $60) / $60 = 0. This question illustrates that if the stock falls below the margin call price of $80, a margin call was already triggered. Correct answer is D. Equity = (60-60)/60 = 0%, far below 25% maintenance.
B. You might be tempted to choose B because it suggests a margin call is avoided with a 26.7% equity ratio, but this violates the maintenance margin rule of 25%, as the equity ratio of 33.3% at $60 shows no margin call is triggered, contrasting the incorrect lower ratio in B.
C. Choice C keeps the same miscalculated 26.7% equity ratio as the other wrong choice and only changes the verdict on whether a call is triggered. Recomputing equity against the loan at the $60 price gives a ratio of 33.3%, not 26.7%, and 33.3% sits above the 25% maintenance margin, so no call is triggered, unlike what this choice claims. Getting the ratio itself wrong is what makes the call verdict wrong too.
Unit: market-organization-and-structure
Question 22Exam level
Which of the following most likely explains why a short seller's maximum potential loss is theoretically unlimited?
How sure are you?
Correct: A. The short seller profits when prices fall and must eventually repurchase shares to return them to the lender. Since stock prices can theoretically rise to any level (unlike a fall which is bounded at zero), the cost to repurchase can exceed the initial proceeds by any amount. A is true but describes a risk of forced closure, not the theoretical unlimited loss. C (dividends) is a real cost but finite. D (margin changes) is a practical risk but not the source of unlimited theoretical loss. The comparison: long position maximum loss = 100% of investment (price falls to zero). Short position maximum loss = unlimited.
B. You might be tempted by B because it seems like an ongoing cost, but dividends, while a real cost to short sellers, are paid at specific intervals and are not cumulative in a way that leads to unlimited loss; the stock price rising without bound (A) is what truly poses the risk of unlimited loss for short sellers.
C. You might be tempted by C because it seems to highlight a risk associated with short selling, but increasing margin requirements affect the financial resources needed to maintain the position rather than the potential loss from rising stock prices, which is the core issue of unlimited loss.
Unit: market-organization-and-structure
Question 23Exam level
An investor purchases $50,000 of stock using 50% initial margin. One year later, the stock has returned 15% and the investor paid 6% interest on the borrowed funds. The investor's net return on equity is closest to:
How sure are you?
Correct: B. Equity = 50% x $50,000 = $25,000. Borrowed = $25,000. Stock return = 15% x $50,000 = $7,500 gain. Interest cost = 6% x $25,000 = $1,500. Net profit = $7,500 - $1,500 = $6,000. Return on equity = $6,000 / $25,000 = 24%. The formula: Return on margin investment = [(Return on stock x 1/IM) - (interest rate x (1-IM)/IM)]. = [15% x 2] - [6% x 1] = 30% - 6% = 24%. The exam frequently adds an interest cost to test whether candidates remember to subtract the cost of borrowing.
A. This is the stock's return on the full position, not on the investor's own equity, and it leaves out the interest paid on the borrowed half. Once the $1,500 interest cost is subtracted from the $7,500 gain and the $6,000 net profit is measured against the $25,000 of equity actually put in, the return is 24 percent, not 15 percent.
C. Forgetting to subtract interest cost.
Unit: market-organization-and-structure
Question 24Exam level
An investor short sells 400 shares at $75 with 50% initial margin. The stock rises to $90. If the investor closes the position, the return on invested capital is closest to:
How sure are you?
Correct: A. Proceeds from short = 400 x $75 = $30,000. Initial margin = 50% x $30,000 = $15,000. Total account = $45,000. Cost to cover = 400 x $90 = $36,000. Loss = $30,000 - $36,000 = -$6,000. Return = -$6,000 / $15,000 = -40%. Price rose 20% ($75 to $90), but the short seller's loss on equity is 40% due to 2x leverage. This tests the critical point that leverage amplifies losses on short positions just as it amplifies gains.
B. Choosing -40% again might tempt you into thinking the question has a repeated answer, but this overlooks the need to calculate the return on invested capital correctly, which shows the loss is indeed -40% due to the leverage effect, not because of a simple repetition.
C. You might be tempted to choose -15% if you calculated the loss based on the stock price increase without considering the leverage effect, but this ignores the 50% initial margin requirement which amplifies the loss to 40% of the invested capital.
Unit: market-organization-and-structure
Question 25Exam level
For a leveraged long margin position, which of the following pairs of events would most likely increase the likelihood of a margin call?
How sure are you?
Correct: A. For a long margin position, equity = current price - loan. A falling stock price reduces equity (numerator falls, denominator falls proportionally). Simultaneously, if the maintenance margin requirement rises (e.g., in a volatile market, the broker raises the threshold), the trigger level for a margin call increases. Both effects push the margin ratio toward or below the maintenance margin, making a margin call more likely. Option C: falling interest rates reduce borrowing costs, slightly improving the position. Options A and D: rising prices increase equity, reducing margin call risk.
B. You might be tempted to think that falling interest rates would offset the negative impact of falling stock prices, but falling stock prices significantly reduce your equity, making a margin call more likely despite lower interest costs, unlike rising maintenance margin requirements which directly increase the risk of a margin call.
C. You might be tempted by rising stock prices as they increase equity, but falling maintenance margin requirements actually make your position less risky, not more, as you need less equity relative to the value of your position to avoid a margin call, which contradicts the scenario of increasing margin call likelihood.
Unit: market-organization-and-structure
Question 26Above the exam
An investor places a stop-loss sell order at $45 with no limit, on a stock currently trading at $50. Overnight, unexpected bad news causes the stock to gap down and open trading the next day at $38, with no trades occurring between $45 and $38. Combining the mechanics of a stop order with the absence of a limit price, the order will most likely:
How sure are you?
Correct: B. A stop order (with no limit) becomes a MARKET order once the stock trades at or through the stop price; it does not guarantee execution AT the stop price itself. When a stock gaps down past the stop price with no trades in between, the stop is triggered by the gap and the resulting market order executes at the next available price, here approximately the $38 opening price, which can be significantly worse than the $45 stop price in a fast-moving or gapping market.
A. A gap through the stop price still triggers the order; the stop does not require an actual trade to occur exactly at $45 to activate. Once the market price moves through (or opens below) the stop level, the order is triggered and converts to a market order.
C. A stop order, once triggered, becomes a MARKET order, not a guaranteed fixed-price order; it has no price protection at all once activated, which is exactly why it can execute far away from the stop price during a gap, unlike a stop-LIMIT order.
Unit: market-organization-and-structure
Question 27Above the exam
An investor wants to sell short 100 shares of a stock and simultaneously wants strict protection against paying more than $52 to close the position later if the stock trades erratically. Combining the mechanics of a stop order with those of a limit order, the investor's buy-to-cover protective order should most likely be structured as:
How sure are you?
Correct: B. A stop-limit order combines a stop price (which triggers the order) with a limit price (which caps the worst price the investor will accept). For an investor who wants BOTH activation near $52 AND strict protection against paying materially more if the stock gaps, a stop-limit order is the correct tool: a plain stop order offers no price protection once triggered, while a plain limit order alone provides no trigger mechanism tied to the stock reaching $52 in the first place.
A. A plain stop order does not guarantee execution at the stop price; once triggered it becomes a market order with no price ceiling, exactly the opposite of the 'strict protection' the investor wants against paying more than $52.
C. A market order provides no price protection whatsoever; it simply executes immediately at whatever price is currently available, which could be far worse than $52 in a fast-moving market, the opposite of what the investor is asking for.