1. Margin buying is a method of purchasing stocks, in which the investor borrows a part of the stock’s purchase price from a broker. Basically, the margin is the portion contributed by the investor, while the broker contributes the rest. The broker on the other hand to finance these investments, borrows money from the bank at a call money rate and agrees to repay the bank on call immediately if the bank requests. Thus the investor is charged the bank rate + service charges for the loan.
The advantages of buying on margin are that it allows investors to invest a greater amount than they own money allows, thus allowing them to potentially magnify the return on investment.
The disadvantage is that if the investment loses value, the equity in the margin account falls below the required maintenance level; the investor is exposed to a loss because he/she must still pay back the loan. Consequently the investor will get a margin call from the broker.
The initial margin requirement is 50%; therefore this requirement is met by paying 50% in cash while the remaining part is borrowed. The Board of Governors of the Federal Reserve System determines the requirements to finance purchases using margin loans.
1. List and describe the more important types of mutual funds according to their investment policy and use.
2. The more important types of mutual funds according to their investment policy and use follow:
• Money Market Funds - invest in money market securities like: commercial paper, repurchase agreements, or certificates of deposits. The average maturity of money market funds is a little more than one month. The net asset value is fixed at $1 per share, making them exempt from tax implications like capital gains or capital losses associated with redemption of shares.
• Equity Funds - typically invest in stock, though they may also hold fixed income or other types of securities. They usually hold between 4%-5% of total assets in the money market securities in order to deliver liquidity.
Equity funds are classified into the following categories: income funds and growth funds. Income funds are focused on holding shares of firms with consistently high dividend yields whereas growth funds are focused on prospects for capital gains. The latter are usually riskier and respond more intensely to economic conditions.
• Sector Funds – are funds that invest in a specific industry such as: biotechnology, precious metals, telecommunications, etc., or specialize in securities of specific countries.
• Bond Funds – are specialized on corporate bonds, treasury bonds, mortgage backed securities, or municipal bonds. They may also specialize by maturity or credit risk of the issuer, thus from short-term to long term, or very safe to high yield, respectively.
• International Funds – unlike global funds, which have a global investment focus, including the United States, international funds invest in securities of firms located outside the United States only.
• Balanced Funds – are designed to hold an individual’s entire investment portfolio, both equities and fixed income securities in a balanced proportion.
• Asset Allocation and Flexible Funds – are similar to balanced funds as they hold both stocks and bonds, nevertheless asset allocation funds vary the proportions allocated to each market in accordance with the portfolio manager’s expectations of each of the relative sector performances.
• Index Funds – match the performance of a broad market index. Here shares are bought in securities that are included in a particular index in proportion with each of the security’s representation in that particular model. Investment in an index fund is a low cost way for small investors to pursue a passive investment strategy.…