LOS f: Describe methods used by institutional investors in the bond market to finance the purchase of a security (i.e., margin buying and repurchase agreements).

Q1. Which of the following statements regarding financing bond purchases is TRUE?

A)   The rate the investor pays on the loan in a margin transaction is known as the call money rate.

B)   In margin transactions, the broker borrows from the bank at the call money rate plus a spread.

C)   Purchasing securities on margin allows investors to leverage assets and make larger purchases.

Q2. Which of the following statements regarding financing bond purchases with margin accounts is FALSE?

A)   In the U.S., margin accounts are regulated by the Federal Reserve.

B)   Individuals are more likely than institutions to use margin accounts to finance bond purchases.

C)   The required margin percentage changes daily.

LOS f: Describe methods used by institutional investors in the bond market to finance the purchase of a security (i.e., margin buying and repurchase agreements).fficeffice" />

Q1. Which of the following statements regarding financing bond purchases is TRUE?

A)   The rate the investor pays on the loan in a margin transaction is known as the call money rate.

B)   In margin transactions, the broker borrows from the bank at the call money rate plus a spread.

C)   Purchasing securities on margin allows investors to leverage assets and make larger purchases.

Correct answer is C)

Example: An investor has $5,000 cash, but wants to buy ten $1,000 face value bonds at par (for a total of $10,000). With cash only, he can only purchase five of the bonds. With a 50% margin account, he can buy all ten bonds ($5,000 cash equity contribution and $5,000 from the margin account). With the margin account, he will realize the gain or loss on all ten bonds rather than the five he could have purchased with cash only.
The statements about the rates paid by the parties to a margin transaction are reversed. The statement, “In margin transactions, the broker borrows from the bank at the call money rate plus a spread,” should read, “…borrows…at the call money rate.” The statement, “The rate the investor pays on the loan in a margin transaction is known as the call money rate.” should read, “…known as the call money rate plus a spread.” Remember that the broker needs to make profit, so the investor will pay a rate higher than the broker pays to the bank.

Q2. Which of the following statements regarding financing bond purchases with margin accounts is FALSE?

A)   In the ffice:smarttags" />U.S., margin accounts are regulated by the Federal Reserve.

B)   Individuals are more likely than institutions to use margin accounts to finance bond purchases.

C)   The required margin percentage changes daily.

Correct answer is C)

The margin percentage is fixed by contract. The required margin dollars may vary from day to day due to fluctuations in the underlying collateral.

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