Equity Securities - Equity Transactions

Question 1

What is the difference between cash and margin accounts?

Answer 1

• Clients with regular cash accounts are expected to make full payment for purchases or full delivery for sales on or before the settlement date
• In contrast, margin accounts are used by clients who wish to buy or sell securities on partial credit. In such cases, the client pays only a portion of the purchase price and the investment dealer lends the balance to the client, charging interest on the loan

Question 2

What is the difference between long and short positions, and how is a short position executed?

Answer 2

• Throughout this chapter, we refer to long and short positions. A long position represents actual ownership in a security. In contrast, a short position is created when an investor sells a security that the investor does not own.
• With short selling, the order of the transactions is reversed: the investor sells the security first, and then waits in the hope of eventually buying it back at a lower price. Because the seller does not own the securities sold, the seller in effect creates a short position, during which the seller still owes the securities. The subsequent purchase eventually compensates for this deficit.

Question 3

When putting an order to purchase or sell an equity security, define the following options, market orders, limit orders, day order, good til order, on-stop sell order, on-stop buy order

Answer 3

• A market order is an order to buy or sell a specified number of securities at the prevailing market price. All orders not bearing a specific price are considered market orders. The benefit of a market order is that the investor is certain that it will be executed. However, the price is not certain, particularly in shares (or units) that are less liquid.
• A limit order is an order to buy or sell securities at a specific price or better. The advantage to a limit order is that the order will be executed only if the market reaches that price or better. The downside to a limit order is that there is no certainty that the order will be filled.
• A day order is an order to buy or sell that expires at the end of the day, if it is not executed on the day it is entered. All orders are considered to be day orders unless otherwise specified.
• There are two good til order types that an investor can place: a good til date (GTD) order or a good til cancelled (GTC) order. * A GTD order expires on a date specified by the investor. * A GTC order expires 90 calendar days from entry on the TSX, unless the investor decides to cancel the trade sooner than the expiry date.
• An on-stop sell order, also known as a stop loss order, is an order that is specifically used in connection with a sell order where the limit price is below the existing market price. The order is triggered when the stock drops to the specified level. The purpose is to reduce the amount of loss that might be incurred or to protect at least part of a paper profit when a stock’s price declines.
• An on-stop buy order, also known as a stop buy order, is the opposite of an on-stop sell order – that is, an order to buy a stock at or above a certain price. On-stop buy orders are used for two reasons: * To protect a short position when the stock’s price is rising. * To ensure that a stock is purchased while its price is rising.