"Equity Investments":Option Markets and Contracts
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Questions 1:
A trader buys a stock at $30 and wants to limit downside risk. Which of the following orders will most likely guarantee that he can sell the stock at $25? (GTC means good till cancelled)
A 、Put option buy market order with a strike price of $25
B、 GTC, stop $25, limit $25 sell order
C、 GTC, stop $25, market sell order
Questions 2:
According to the industry life-cycle model, companies in a mature industry are most likely to experience:
A 、high barriers to entry.
B、 fierce competition.
C、 low dividend yields.
A is correct. Option contracts can be viewed as limit orders for which execution is guaranteed at the strike price. Therefore, a put buy order at a strike price of $25 will guarantee selling the stock at $25.
C is incorrect. A “GTC, stop $25, market sell” order becomes a market order when the price drops to or below $25 and is executed at the best price available in the market. Thus, the selling price of $25 is not guaranteed.
B is incorrect. A “GTC, stop $25, limit $25 sell” order limits the lower boundary to $25 but it does not guarantee execution at $25; in a fast-moving market prices may have dropped below the limit and the order will then not be executed.
A is correct. In the mature stage of the industry life-cycle model, brand loyalty and efficient cost structures will create barriers to entry. Fierce competition is a characteristic of the shakeout phase: Demand approaches market saturation levels because few new customers are left to enter the market. Because few growth opportunities are available in the mature phase, there is little need for capital investment, and thus greater amounts of earnings are paid out as dividends, increasing dividend yields.
B is incorrect. Fierce competition is a characteristic of the shakeout phase, not the mature stage. In the mature stage, the remaining companies in the industry aggressively fight for market share.
C is incorrect. Dividends increase in the mature stage, as there are little in the way of growth opportunities, and not much need for capital investment—a greater proportion of earnings are paid out as dividends, increasing dividend yields.
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