Table of Contents

Very Short Question Answer

1. Differentiate the price – weighted index from the value – weighted index.

 Price weighted index is calculated by assigning weights in an index in proportion to the stock price of the underlying corporation. It is given by total of the market prices of all stocks in the sample divided by number of stocks. On the other hand, for a value weighted index, corporations’ market capitalization regulates its weights in an index, irrespective of the share price. It is calculated as total market capitalization of all companies in sample in the current period divided by total market capitalization in the base period.

2. What do you mean by industry and company information?

 Industry and company information are important types and sources of investment information. They include the past and anticipated data on specific company and industry as a whole. The company specific information are used to analyze the past trend of movement in the performance of company’s securities and to identify the prospects of investing into them. Similarly, industry specific information are analyzed to identify the past trend and future prospects of a given industry as a whole.

3. How do you differentiate cash brokerage account from margin brokerage account?

Investors need to open brokerage account to execute securities transactions in stock market through the broker. The brokerage account may be a cash account or a margin account. With a cash brokerage account, the investors require to pay full value of stock purchased in cash. With a margin account, investors are allowed to borrow a part of funds they need to buy the securities. The investor needs to deposit initial margin money to buy shares of stock. The margin requirement varies from broker to broker. The broker uses the securities purchased by investors as collateral to secure the margin loan. If the value of investor portfolio falls below specified amount, the investor should add enough cash to maintain the margin in the account.

4. Assume that ABC stock is currently selling for Rs 150 a share. If you place a limit order to sell 100 shares of this stock with a limit price of Rs 250 per share, do you think that the order will be executed on the day?

SOLUTION

A time limit of one day is not likely to have the order executed because the limit sell price Rs 250 is well above the current price of Rs 150. Only if the current price becomes more favorable, that is, if the stock price rises by at least Rs 100 per share, the limit order will be executed.

5. If you place a stop loss order to sell 500 shares of stock at Rs 150 when the current price is Rs 170, how much will you receive for each share if price drops to Rs 145?

SOLUTION

The stop price specified for stop sell order is Rs 150. It implies that the stop sell order will be executed as soon as the price drops to Rs 150 or below. If price actually drops to Rs 145, the order will be executed at this price and we will receive Rs 145 per share.

Short Question Answer

1. What are the different types of order which an investor can make in stock market?

Investors can make different types of order to buy or sell the securities. The basic types of orders are as follows:

  • Market Order: A market order is the most common type of order. It is an order to buy or sell securities immediately. By placing a market order, the investor instructs the broker to buy or sell specified quantity of securities at the best attainable price. Market order can be a market buy order or market sell order. A market buy order is the order to buy securities at or near the current ask price. Similarly, a market sell order is the order to sell securities at or near the current bid price. Generally, this order is executed immediately as soon as it reaches the exchange floor. Thus the market order guarantees the execution of trade. However, it does not guarantee the price.
  • Limit Order: A limit order sets price limit to buy or sell the securities. By placing this order, an investor instructs the broker to buy or sell securities at a specified or better price. Limit order can be placed for both buy and sell order. A limit buy order specifies the maximum limit of purchase price at which the securities can be bought. It can only be executed at the specified limit price or lower. On the other hand, a limit sell order specifies the minimum limit of selling price. It can only be executed at the specified limit price or higher. A limit order prevents from unfavorable price change. However it does not guarantee the order execution because it can be executed only if specified limit condition of price is satisfied. Thus, with limit order, it is possible to miss the trading opportunity if price moves away from the limit price before it can be executed. It is also possible that the market can move to the limit price and the order still may not get executed if there are not enough buyers or sellers at that particular price level.
  • Stop Order: A stop order, also known as stop-loss order, is the order placed to buy or sell securities when the securities meet the specified price. The specified price level is called the stop price. When the stop price is reached, a stop order becomes a market order and executed immediately. Note that a stop order work in the opposite direction of a limit order. A stop order to buy securities is placed above the prevailing market price. Investors generally use this order to limit a loss on a stock that they have sold short. On the other hand, a stop order to sell is placed below the prevailing market price. Investors generally use this order to limit a loss on a stock that they currently own. The most common use of a stop order is to set a risk limit for a trade. A stop order is set at the price level beyond which an investor would not be willing to take any more risk on the trade. For stop buy order, the stop price is set below the trade entry, providing protection in the event that the market drops. For stop sell order, stop price is set above the trade entry in case the market rises.
  • Stop-Limit Order: A stop order may also contain the limit condition. If so, it is called stop-limit order. A stop-limit order specifies both stop price and limit price. The limit price for a stop-limit buy order is always at or above the stop price. For example, a stock is currently priced at Rs 500. We placed a stop-limit buy order for this stock specifying stop price at Rs 510 and limit price at Rs 520. As soon as the stock price rises to Rs 510, the order becomes market order and broker will buy the stock at Rs 510. However, the stock price may go up directly above Rs 510. In this case, the broker will execute the stop-limit buy order if the stock price is at or below Rs 520. Note that Rs 520 is the maximum limit of purchase price and the order remain unexecuted if price directly goes above Rs 520, the limit buy price of the stop-limit buy order. On the other hand, the limit price for a stop-limit sell order is always at or below the stop price. For example, we placed a stop-limit sell order for the stock currently priced at Rs 500. Our stop price is Rs 490 and limit price is Rs 480. As soon as the stock price declines to Rs 490, our order becomes market order and broker will sell the stock at Rs 490. However, the stock price may go down directly below Rs 490. In this case, the broker will execute the stop-limit sell order if the stock price is at or above Rs 480. The orders will not be executed if stock price directly goes down below Rs 480.
2. What are the different steps of executing purchasing order of securities? [5] The different steps of executing purchasing order of securities are as follows:
  • Selecting a stockbroker: An investor should select a competitive broker that best suits to her/his investment goal. The investor should consider reputation, quality of services, range of products offered, technology and easily accessibility and cost efficiency while selecting a right broker to buy securities.
  • Opening brokerage account: After selecting the right broker, the investors should open brokerage account with the broker. There are two basic types of accounts: cash account and the margin account. With cash account, investors should pay total purchase value in cash to buy the stocks. With margin account, investors should pay only certain percentage of purchase value of securities as initial margin deposit. The brokers will allow the rest of purchase value as margin loan to investors.
  • Placing the purchase order: After opening the brokerage account, the investor should place buy order for securities. Order must be disseminated in written form by filling up the required information on purchase order form.
  • Executing the order: The broker then transmits the investor’s purchase order to the exchange floor quoting the purchase price as directed by buyer. When the price condition satisfies, the order will be executed
  • Receipt of contract note: When the purchase orders are executed, a contract note is sent to the client specifying the number, rate, and date of purchase. Many brokers require their clients to pay the balance amount on receipt of contract note.
  • Settlement: When the broker receives the share certificate and transfer deed from the seller, the broker intimates the client to take those shares and make payment in cash. Finally the transfer of ownership to the buyer takes place.
3. What is market order? Describe how market orders are placed in stock exchanges.

A market order is the most common type of order. It is an order to buy or sell securities immediately. By placing a market order, the investor instructs the broker to buy or sell specified quantity of securities at the best attainable price. Market order can be a market buy order or market sell order. A market buy order is the order to buy securities at or near the current ask price. Similarly, a market sell order is the order to sell securities at or near the current bid price. Generally, this type of order is executed immediately as soon as it reaches the exchange floor. Thus the market order guarantees the execution of trade. However, it does not guarantee the price. It is worthwhile to note that the last closing price is not necessarily the price at which a market order is executed. Sometimes it is possible that the investor has to expose with costly buy or sell with the market order. For example, suppose an investor places a market order to buy 200 shares of common stocks. The stocks are currently priced at Rs 200 per share. If there are other orders in queue to buy the same shares of stock, this order may be executed at a price higher than Rs 200. However, it is also possible that parts of the order may be executed at the offer price and remaining parts at a higher price. Since the market orders are executed immediately, investors, however, can be sure that market order will be executed at a price closure to prevailing market price. Investors can place a market order in a number of ways. Generally there are four forms of market order. They are described below:

  • Day order: Most of the market orders are a day order. This type of order remains in effect for a trading day. This order automatically expires at the end of the trading day if not executed.
  • Good till cancelled order: A day order remains in effect until the end of the day the order was placed. However, a good-till-canceled order is active until the trade is executed or the trader cancels the order. Brokers typically cancel this order automatically if they cannot be executed from 30 to 90 days of order placed.
  • Fill-or-kill order: Fill-or-kill orders must be executed immediately. If not executed, they will be canceled automatically. In case of this order, partial executions are not accepted.
  • Immediate or cancel order: Immediate or cancel order requires that the orders should be executed in full or part immediately. If not executed they will be cancelled.
4. Discuss the advantages and disadvantages of using a market order and a limit order.

Market order: A market order is an order to buy or sell securities immediately. By placing a market order, the investor instructs the broker to buy or sell specified quantity of securities at the best attainable price. Market order can be a market buy order or market sell order. A market buy order is the order to buy securities at or near the current ask price. Similarly, a market sell order is the order to sell securities at or near the current bid price. Generally, this type of order is executed immediately as soon as it reaches the exchange floor

The basic advantage of a market order is that it guarantees the execution of trade. However, it does not guarantee the price. It is worthwhile to note that the last closing price is not necessarily the price at which a market order is executed. Sometimes it is possible that the investor has to expose with costly buy or sell with the market order. For example, suppose an investor places a market order to buy 200 shares of common stocks. The stock, are currently priced at Rs 200 per share. If there are other orders in queue to buy the same shares of stock, this order may be executed at a price higher than Rs 200. However, it is also possible that parts of the order may be executed at the offer price and remaining parts at a higher price. Since the market orders are executed immediately, investors, however, can be sure that market order will be executed at a price closure to prevailing market price.

Limit order: A limit order sets price limit to buy or sell the securities. By placing this order, an investor instructs the broker to buy or sell securities at a specified or better price. Limit order also can be placed for both buy and sell order. A limit buy order specifies the maximum limit of purchase price at which the securities can be bought. It can only be executed at the specified limit price or lower. On the other hand, a limit sell order specifies the minimum limit of selling price. It can only be executed at the specified limit price or higher.

The basic advantage of a limit order is that it prevents from unfavorable price change. However it does not guarantee the order execution because it can be executed only if specified limit condition of price is satisfied. For example, suppose we placed a limit buy order for certain shares of common stock at limit price of Rs 200. Current selling price per share of this stock is Rs 210. So, the order will be executed only if the price drops to Rs 200 or below. But, unfortunately, if price rises from its current level of Rs 210 to Rs 220, the order will not be executed and we will miss the opportunity to make a profit of Rs 10 (that is, Rs 220 – Rs 210), which otherwise would have locked in if the shares were bought at Rs 210. Thus, with limit order, it is possible to miss the trading opportunity if price moves away from the limit price before it can be executed. It is also possible that the market can move to the limit price and the order still may not get executed if there are not enough buyers or sellers at that particular price level.

5. What is market order? Explain with illustration the different types of order a customer may place to his/her broker?

A market order is an order that instructs the broker to buy or sell specified quantity of securities at the best attainable price as soon as it reaches the trading floor. Market order can be a market buy order or market sell order. A market buy order is the order to buy securities at or near the current ask price. Similarly, a market sell order is the order to sell securities at or near the current bid price. The market order guarantees the execution of trade. However, it does not guarantee the price. For example, suppose an investor places a market order to buy 200 shares of common stocks. The stock are currently priced at Rs 200 per share. If there are other orders in queue to buy the same shares of stock, this order may be executed at a price higher than Rs 200.

A market order is the most common types of order. There are other types of order that a customer may place to her/his broker. They are: limit order, stop order, and stop-limit order.

A limit order sets price limit to buy or sell the securities. By placing this order, an investor instructs the broker to buy or sell securities at a specified or better price. For example, suppose an investor posts a limit sell order to sell certain shares of common stock for not less than Rs 300. This order will be executed. only if the price of this stock is Rs 300 or above. A limit order prevents from unfavorable price change. However it does not guarantee the order execution because it can be executed only if specified limit condition of price is satisfied.

A stop order is the order placed to buy or sell securities when the securities meet the specified price. The specified price level is called the stop price. When the stop price is reached, a stop order becomes a market order and executed immediately. Investors generally use this order to limit a loss on a stock that they currently own. For example, suppose the current market price per share is Rs 300. We placed a stop sell order for 200 shares of common stock at Rs 290 per share because we fear that there will be a significant drop in the market price. As soon as stock price declines to Rs 290 or below, the broker will execute the order. However, it should be noted that this stop sell order remains unexecuted if stock price is above Rs 290.

A stop order may also contain the limit condition. If so, it is called stop-limit order. A stop-limit order specifies both stop price and limit price. The limit price for a stop-limit buy order is always at or above the stop price. For example, a stock is currently priced at Rs 300. We placed a stop-limit buy order for this stock specifying stop price at Rs 310 and limit price at Rs 320. As soon as the stock price rises to Rs 310, the order becomes market order and broker will buy the stock at Rs 310. However, the stock price may go up directly above Rs 310. In this case, the broker will execute the stop-limit buy order if the stock price is at or below Rs 320. In this case, Rs 320 is the maximum limit of purchase price and the order remains unexecuted if price directly goes above Rs 320.

Long Question Answer

1. Discuss the advantages and disadvantages of using a market order and a limit order.

Market order

 A market order is an order to buy or sell securities immediately. By placing a market order, the investor instructs the broker to buy or sell specified quantity of securities at the best attainable price. Market order can be a market buy order or market sell order. A market buy order is the order to buy securities at or near the current ask price. Similarly, a market sell order is the order to sell securities at or near the current bid price. Generally, this type of order is executed immediately as soon as it reaches the exchange floor

The basic advantage of a market order is that it guarantees the execution of trade. However, it does not guarantee the price. It is worthwhile to note that the last closing price is not necessarily the price at which a market order is executed. Sometimes it is possible that the investor has to expose with costly buy or sell with the market order. For example, suppose an investor places a market order to buy 200 shares of common stocks. The stock, are currently priced at Rs 200 per share. If there are other orders in queue to buy the same shares of stock, this order may be executed at a price higher than Rs 200. However, it is also possible that parts of the order may be executed at the offer price and remaining parts at a higher price. Since the market orders are executed immediately, investors, however, can be sure that market order will be executed at a price closure to prevailing market price.

Limit order

A limit order sets price limit to buy or sell the securities. By placing this order, an investor instructs the broker to buy or sell securities at a specified or better price. Limit order also can be placed for both buy and sell order. A limit buy order specifies the maximum limit of purchase price at which the securities can be bought. It can only be executed at the specified limit price or lower. On the other hand, a limit sell order specifies the minimum limit of selling price. It can only be executed at the specified limit price or higher.

The basic advantage of a limit order is that it prevents from unfavorable price change. However it does not guarantee the order execution because it can be executed only if specified limit condition of price is satisfied. For example, suppose we placed a limit buy order for certain shares of common stock at limit price of Rs 200. Current selling price per share of this stock is Rs 210. So, the order will be executed only if the price drops to Rs 200 or below. But, unfortunately, if price rises from its current level of Rs 210 to Rs 220, the order will not be executed and we will miss the opportunity to make a profit of Rs 10 (that is, Rs 220 – Rs 210), which otherwise would have locked in if the shares were bought at Rs 210. Thus, with limit order, it is possible to miss the trading opportunity if price moves away from the limit price before it can be executed. It is also possible that the market can move to the limit price and the order still may not get executed if there are not enough buyers or sellers at that particular price level.

2.You are given number of shares outstanding and market price of the share of  Stock A Stock B and Stock C.

3. Suppose that a price weighted stock market average is based on the closing price of five stocks. The divisor used in the calculation of stock market average is currently 0.8. The closing prices for each of the five stocks in the stock market average today and exactly a year ago, when the divisor was 0.7, are as follows:

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