CFA Practice Question
Investors buy securities on margin ______
II. because they can earn returns higher than those possible with a cash purchase.
III. despite the fact that they may incur large losses.
I. because a leverage effect is created.
II. because they can earn returns higher than those possible with a cash purchase.
III. despite the fact that they may incur large losses.
Correct Answer: I, II and III
Buying on margin exposes the investor to larger possible gains and losses. This is the leverage effect. Thus all three answers are correct.
User Contributed Comments 6
| User | Comment |
|---|---|
| Khadria | Why II ? |
| jwebbs | because they are BORROWING money to invest.... its sorta like buying a house and getting a mortgage to do it because otherwise you might not have been able to do it. |
| Fotsta | because they are BORROWING money and they are able to buy more stocks. More stocks- Higher gains or losses |
| Bududeen | the return on your investment is calculated based on the profit/initial investment....if you use your own cash this would increase the denominator thus lower the return in relative terms (in absolute terms the returns remain the same though)....if you borrow the money you used the denominator becomes smaller but the numerator will be higher but the proportionate effect will be a return...for e.g. A used $10,000 to purchase stock now sold for $15,000 the return is 5000/10000 = 50% But say $4000 is borrowed @ 10% : the return is (5000-400)/6000= 76.67%. This is an increase of 26.67% just because some of the money used is on margin or borrowed money. I hope this helps! |
| johntan1979 | Read the example in the notes on Microsoft. Possibility of earning 51% instead of 30%, and losing 69%! |
| jonan203 | christ, anyone who asks a one word question at this point simply hasn't taken the time to read & understand the notes! |