TRUE OR FALSE 1. Buying a derivative on an exchange, through a clearing house, eliminates all...

TRUE OR FALSE

1. Buying a derivative on an exchange, through a clearing house, eliminates all of the risk of owning that derivative.

2. You have an investment fund with $100,000,000 and would like to take a controlling interest in one or more publicly traded companies. The best way to figure out what companies you can afford to buy is by sorting them according to their stock price. It will be cheaper for you to take a controlling interest in companies with a lower stock price.

Expert Solution

1. FALSE. Clearing houses are kept as centralised institutions which deal with the buying and selling centrally so that all long and short positions are covered. However, these houses just reduce the risk and do not eliminate it completely. As these operate as monopoly of a duopoly, the losses which are too big for these houses to absorb are absorbed by the members most of which are banks. So if out of 100 participating members, 1 defaults, the rest 99 absorb those risks. So the risk is reduced but not completely eliminated. If the house actually falter, they become a new source of risk which they were specifically meant to eliminate.

2. FALSE. Lower stock price does not necessarily mean that it easier to take controlling interest in companies. It depends on the market capital which is a product of the stock price and the number of shares in the market.

For example if there is a company with 1 billion shares and cost of each share is $20, then with $100,000,000 it will be possible to buy 5 million shares and that is 0.5% of the company.

However if there is another company with 1 hundred thousand shares each priced at $1000, then with 100,000,000 it will be possible to buy all 1 hundred thousand shares. So in spite of having a higher stock price, the second company can be aquired but not the first. So market cap is the determinant which can help us identify whether 100,000,000 will be enough to get a controlling stake in the company or not.

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Rahul Sunny answered 8 months ago

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