FINC3017 · Investments And Portfolio Management
Asset Classes, Instruments & Market Mechanics
Asset Classes, Instruments & Market Mechanics (Week 2) maps the investable universe and the plumbing of trading it. You separate real from financial assets and debt from equity from derivatives, learn how indices are weighted (price-weighted, value/free-float-weighted, equal-weighted), and work through order types and the bid-ask spread. The quantitative core is margin: the initial and maintenance margin on a long position, the margin-call price, and the mirror-image mechanics of a short sale — plus how futures use daily mark-to-market and a clearinghouse to remove the counterparty risk that an OTC forward leaves open.
What this chapter covers
- 01Real vs financial assets; debt vs equity (common = residual claim + vote, preferred = fixed dividend, priority) vs derivatives
- 02Credit spread = corporate yield − treasury yield
- 03Index weighting: price-weighted (DJIA), value/free-float-weighted (S&P 500, ASX 200), equal-weighted (1/N)
- 04Bid-ask spread = ask − bid; market, limit and stop orders
- 05Long margin = equity/value = (value − loan)/value; margin call when below the maintenance level
- 06Margin-call price for a long position
- 07Short-sale margin and the short margin-call price
- 08Futures (daily mark-to-market, clearinghouse) vs forwards (OTC, settled at maturity)
Initial margin and the margin-call price on a long position
- 2 marks(a) Equity = value − loan = $10,000 − $4,000 = $6,000. Initial margin = equity/value = 6,000/10,000 = 60%.
- 2 marks(b) At $35 the position value is 200 × $35 = $7,000. Equity = 7,000 − 4,000 = $3,000, so margin = 3,000/7,000 = 42.86% — still above the 30% maintenance level.
- 2 marks(c) Set the margin equal to maintenance: (200P − 4,000)/(200P) = 0.30, which rearranges to 4,000/(200P) = 0.70.
- 1 mark(c cont.) Solve: 200P = 4,000/0.70 = 5,714.29, so P = $28.57. (Check: value $5,714.29, equity $1,714.29, ratio = 30%.)
Key terms
- Margin (long position)
- The investor's own equity as a fraction of position value: margin = equity/value = (value − loan)/value. A margin call is triggered when this ratio drops below the broker's maintenance margin, forcing the investor to add cash or close out.
- Short sale
- Selling borrowed shares hoping to buy them back cheaper. The investor profits if the price falls and loses if it rises; because losses are theoretically unlimited, the margin-call price sits above the entry price, the opposite of a long position.
- Index weighting schemes
- Price-weighted indices (DJIA) weight by share price; value/free-float-weighted indices (S&P 500, ASX 200) weight by market capitalisation; equal-weighted indices give every constituent the same 1/N weight, tilting toward smaller stocks.
- Bid-ask spread
- The gap between the best ask (lowest price a seller will accept) and the best bid (highest price a buyer will pay), ask − bid. It is a round-trip transaction cost and a measure of liquidity — wider spreads signal less liquid securities.
- Futures vs forwards
- Both lock a price for future delivery, but futures are exchange-traded, standardised and marked to market daily with a clearinghouse removing counterparty risk, while forwards are OTC, customisable and settled only at maturity — carrying counterparty default risk.
Asset Classes, Instruments & Market Mechanics FAQ
Why is a short sale's margin call triggered by a price rise rather than a fall?
When you short, you owe shares, so your liability grows as the price climbs. Your equity is the account balance minus the cost to buy the shares back, and a rising price shrinks that equity. The margin-call price is therefore above your entry price, the mirror image of a long position where the call comes from the price falling.
What is the difference between value-weighting and price-weighting an index?
A price-weighted index (like the DJIA) simply adds up share prices, so a high-priced stock dominates regardless of company size. A value-weighted index (S&P 500, ASX 200) weights by market capitalisation, so the largest companies move it most. Equal-weighting gives each stock the same influence and so tilts toward smaller names.
How does a clearinghouse make futures safer than forwards?
A futures clearinghouse becomes the counterparty to both sides and requires daily mark-to-market settlement of gains and losses through margin accounts, so unrealised losses cannot build up. A forward is a private OTC contract settled only at maturity, leaving each side exposed to the other defaulting in the meantime.
Exam move
Drill the margin arithmetic both directions — compute a current margin ratio, and solve for the margin-call price — and rehearse the short-sale version where the trigger is a price rise. Keep a one-line summary of each index-weighting scheme and the futures-versus-forwards contrast, because these are quick conceptual MCQ points.
