Question 1

The buyer of a contract for difference (CFD):

Accepted Answer

A buyer of a CFD is going long, which means they are expecting the price of the underlying asset to rise. They make a profit if the price increases and incur a loss if the price falls. Option A is the opposite scenario, where the buyer would be going short and expecting the price to fall. Option C describes a call option, which is a different financial instrument than a CFD. Option D is not a correct choice as there must be one correct option.

Question 2

An option:

Accepted Answer

An option is an agreement that gives the buyer (holder) of the option the right but not the obligation to buy or sell something in the future at a fixed price. This means that the holder can choose to either exercise the option, if it is profitable to do so, or let it expire if it is not. Options are commonly used in financial markets for hedging, speculation, and generating income through option premiums.

Question 3

Negative gearing arises where:

Accepted Answer

None of the options given correctly describe negative gearing. Negative gearing occurs when the expenses of an investment, such as mortgage interest, exceed the income it generates, resulting in a taxable loss. This loss can then be used to offset income from other sources, reducing the overall tax liability. Thus, the correct answer is D - none of the above.

Question 4

The buyer of a futures contract will prefer prices of the underlying asset in the future to:

Accepted Answer

The buyer of a futures contract benefits when the prices of the underlying asset increase in the future, as it allows them to purchase the asset at a lower price than the market rate.

Question 5

The general risk/reward trade-off associated with warrants shows that:

Accepted Answer

The statement in the question is incorrect. There is no general risk/reward trade-off associated with warrants. The risk and reward profiles of different types of warrants vary depending on a variety of factors such as the strike price, the expiration date, and the underlying asset. Therefore, it is not possible to make a blanket statement about which type of warrant is more or less risky than another type without considering these specific factors.

Question 6

Futures contracts:

Accepted Answer

Futures contracts rarely end with physical delivery because most traders use them to speculate or hedge rather than to acquire the underlying asset. To make sure traders fulfill their obligations, they require a deposit or initial margin, which is a percentage of the contract's value. This margin can be increased or decreased as the market fluctuates, and if the trader's account value drops below the maintenance margin, they may receive a margin call to replenish it. Futures contracts are typically reversed out prior to expiration because it avoids the need for physical delivery or cash settlement.

Question 7

A margin loan exposes the borrower to which source(s) of risk for interest repayments?

Accepted Answer

A margin loan exposes the borrower to both timing issues arising from the receipt of investment income and the repayment of loan interest and the loan servicing ability of the borrower to meet repayments from existing income. In addition, a margin loan also exposes the borrower to the risk of a margin call, which requires the borrower to provide additional security or repay the loan in full. Therefore, both choices A and C are correct. Choice B is also a risk associated with margin loans, but it pertains to the risk of a margin call rather than interest repayments.

Question 8

If an investor believes that the price of an asset is going to decrease in the future they would:

Accepted Answer

If an investor believes the price of an asset will decrease, they would prefer not to own the asset, especially if they are a long-term investor, and would likely sell the asset if they currently hold it to avoid potential losses.

Question 9

Over time, an investor making principal and interest loan repayments on an investment using borrowed funds which is increasing in value would expect their gearing ratio to:

Accepted Answer

As the investment is increasing in value, the investor is effectively making a profit. By using borrowed funds to make repayments, they are increasing their gearing ratio. However, as the investment value continues to increase, the gearing ratio will decrease as the value of the investment outweighs the outstanding loan amount. Therefore, the gearing ratio would decrease over time.

Question 10

The benefits arising from margin lending over traditional principal and interest mortgage loans typically include:

Accepted Answer

Margin lending offers both liquidity and investment diversification opportunities compared to traditional mortgage loans. However, it is important to note that while the interest rate on margin loans may be lower, the risk associated with margin lending is higher, as it involves borrowing against investments and leaves the borrower vulnerable to market volatility.

Question 11

The presence of rising asset prices and concessional tax rates on capital gains in a stable interest rate environment is more preferable for a negatively geared share investment than which of the following economic conditions?

Accepted Answer

Negatively geared share investments benefit from rising asset prices and concessional tax rates because the investor can gain from the increased value of the asset and lower taxes on any profits. Stable interest rates also help by keeping borrowing costs predictable. All the other conditions listed (A, B, C) are less preferable because they involve either stable or decreasing asset prices, rising interest rates, or higher taxes on capital gains, all of which can reduce the profitability or increase the cost of a negatively geared investment.

Question 12

The estimated percentage of options exercised on the ASX Options Market is:

Accepted Answer

The answer of The estimated percentage of options exercised on...

Question 13

Some variations of standard interest and principal mortgages available to investors include:

Accepted Answer

All of the above options are variations of standard interest and principal mortgages available to investors.

A) Equity release loans allow the investor to withdraw surplus equity above agreed levels, providing them with additional funds if needed.

B) Interest-only loans with the entire principal payable at the end of the loan can be beneficial for investors who anticipate a large payout or gain at the end of the loan term.

C) Reverse mortgages are designed for older homeowners, allowing them to borrow against the equity in their home while still retaining ownership.

Question 14

Loan-to-valuation ratios (LVRs) are set by:

Accepted Answer

Lenders set the loan-to-valuation ratios (LVRs) based on their own risk appetite and lending policies. The Reserve Bank of Australia does not directly set LVRs. Borrowers can negotiate a lower LVR with the lender, but ultimately it is up to the lender to decide the LVR they are willing to offer.

Question 15

When an investor invests in an income producing asset:

Accepted Answer

Interest on loans associated with income-producing assets is typically tax deductible, as it is considered a business expense.

Question 16

In Australia, index options can be exercised:

Accepted Answer

The answer of In Australia, index options can be exercised:
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Question 17

Investment products or instruments that derive their value from underlying assets include:

Accepted Answer

All of the above choices are investment products or instruments that derive their value from underlying assets. Contracts for difference (CFDs), options, and warrants all involve a contract between a buyer and a seller, in which the value of the product is tied to the value of an underlying asset, such as a stock or a commodity.

Question 18

The strike price of an option is:

Accepted Answer

The strike price of an option is the price at which an option contract will be transacted if the option is exercised. It is not the price paid for the option premium or the trading price of the option at the inception of the option contract. Therefore, option C is the correct choice.

Question 19

Where the value of secured assets falls below an agreed debt-to-asset ratio for a margin loan, what action will be required to be taken?

Accepted Answer

When the value of secured assets falls below an agreed debt-to-asset ratio for a margin loan, the borrower must meet a margin call on the loan, which means they must either provide more collateral or pay down the loan balance. If the borrower fails to meet the margin call, the lender may have the right to sell the securities in the account to repay the loan.

Question 20

The lender in a mortgage contract is referred to as the:

Accepted Answer

The lender in a mortgage contract is referred to as the mortgagee. The mortgagor is the borrower who pledges their property as collateral for the loan.

Quiz 8: Leveraged Investments

The buyer of a contract for difference (CFD) :