Chapter 12—Market Microstructure and Strategies
1. A ____ order to buy or sell a stock means to execute the transaction at the best possible price.
a.
market
b.
limit
c.
stop-loss
d.
stop-buy
2. With a ____ order, the investor specifies a purchase price that is above the current market price.
a.
market
b.
limit
c.
stop-loss
d.
stop-buy
3. When investors buy stock with borrowed funds, this is sometimes referred to as
a.
use of proxy.
b.
purchasing stock on margin.
c.
a margin call.
d.
a margin residual claim.
4. The maintenance margin is the minimum amount of the margin that investors must maintain as a
percentage of the stock’s initial purchase price.
a. True
b. False
5. Assume a stock is initially priced at $50, and pays an annual $2 dividend. An investor uses cash to pay
$25 a share and borrows the remaining funds at a 12 percent annual interest. What is the return if the
investor sells the stock for $55 at the end of one year?
a.
50 percent
b.
30 percent
c.
10 percent
d.
16 percent
e.
8 percent
6. When a brokerage firm demands more collateral from investors who have borrowed from the
brokerage firm to buy stocks, it is making a
a.
margin call.
b.
short sale.
c.
proxy fight.
d.
hedge.
7. Which of the following statements is incorrect?
a.
In a short sale, investors place an order to sell a stock that they do not own.
b.
Investors sell a stock short when they anticipate that its price will rise.
c.
When investors sell short, they will ultimately have to provide the stock back to the
investor from whom they borrowed it.
d.
Short-sellers must make payments to the investor from whom the stock was borrowed to
cover the dividend payments that the investor would have received of the stock had not
been borrowed.
8. Program trading
a.
is commonly used to reduce the susceptibility of a stock portfolio to stock market
movements.
b.
may involve the purchase of stocks that become “underpriced.”
c.
may involve the sale of stocks that become “overpriced.”
d.
can be combined with the trading of individual bonds to create portfolio insurance.
e.
none of the above
9. You purchase a stock with cash, and you earn a negative return on the stock. If you had purchased the
stock with 60 percent cash and 40 percent borrowed funds, your return on your investment would have
been
a.
positive.
b.
more negative than if you had covered the entire investment with cash.
c.
negative, but more favorable than if you had covered the entire investment with cash.
d.
zero.
10. Mark would like to purchase a stock priced at $70. Mark thinks he can sell the stock for $100 after one
year. If Mark does not borrow any money from his brokerage firm, what is the estimated return on the
stock?
a.
30.00 percent
b.
−42.86 percent
c.
−30.00 percent
d.
42.86 percent
e.
none of the above
11. Mark would like to purchase a stock priced at $70. The stock is not expected to pay any dividends in
the coming year. Mark can either put up the entire amount and purchase the stock, or borrow half of
the investment amount from his brokerage firm at an annual interest rate of 12 percent and put up the
remainder. Mark thinks he can sell the stock for $100 after one year. If Mark borrows from his
brokerage firm, his estimated return on the stock would be ____ percent.
a.
42.86
b.
85.71
c.
73.71
d.
30.00
12. Karen just purchased a stock costing $33 on margin, paying $23 and borrowing the remainder from a
brokerage firm at 15 percent annual interest. The stock pays an annual dividend of $2. If Karen sells
the stock after one year at a price of $50, what is the return on the stock?
a.
27.60 percent
b.
82.61 percent
c.
76.09 percent
d.
58.70 percent
e.
none of the above
13. The present margin requirement is that at least ____ percent of an investor’s invested funds must be
paid in cash.
a.
20
b.
30
c.
40
d.
50
e.
none of the above
14. An investor sold a stock short a year ago for $50 per share. The stock’s price is currently $52 per share.
If the investor is unwilling to accept a loss on the short sale of more than $5 per share on the
transaction, she could place a
a.
stop-loss order with a specified selling price of $55 per share.
b.
stop-buy order with a specified purchase price of $55 per share.
c.
stop-loss order with a specified selling price of $45 per share.
d.
stop-buy order with a specified purchase price of $45 per share.
15. The short interest ratio is commonly measured as the number of shares shorted divided by the number
of shares that the firm has repurchased in the last quarter.
a. True
b. False
16. Investors can reduce their risk by purchasing a stock on margin instead of using all cash to buy the
stock.
a. True
b. False
17. A short seller
a.
anticipates that the price of the stock sold short will increase.
b.
earns the difference between what they initially paid for the stock versus what they later
sell the stock for.
c.
makes a profit equal to the difference between the original sell price and the price paid for
the stock, after subtracting any dividend payments made.
d.
is essentially lending the stock to another investor and will ultimately receive that stock
back from that investor.
e.
none of the above
18. ____ are enforced to restrict the amount of credit extended to customers by stockbrokers.
a.
Limit orders
b.
Margin requirements
c.
Maintenance margins
d.
Initial margins
19. Assume that a stock is priced at $50 and pays an annual dividend of $2 per share. An investor
purchases the stock on margin, paying $25 per share and borrowing the remainder from the brokerage
firm at 9 percent annual interest. If, after one year, the stock is sold at a price of $65.25 per share, the
return on the stock is
a.
60 percent.
b.
44 percent.
c.
30 percent.
d.
69 percent.
20. Assume that a stock is priced at $50 and pays an annual dividend of $2 per share. An investor
purchases the stock, using only personal funds and not borrowing from the brokerage firm. If, after one
year, the stock is sold at a price of $65.25 per share, the return on the stock is
a.
26.5 percent.
b.
28.5 percent.
c.
30.5 percent.
d.
34.5 percent.
21. The risk of a short sale is that the stock price
a.
may decrease over time.
b.
will remain the same.
c.
may increase over time.
d.
none of the above
22. ____ facilitate stock transactions by taking positions in specific stocks.
a.
Board members
b.
Capstone members
c.
Market makers
d.
None of the above
23. ____ facilitate transactions on a stock exchange by executing stock transactions for their clients.
a.
Board members
b.
Capstone members
c.
Floor brokers
d.
None of the above
24. The short interest represents the amount of interest that borrowers owe on loans used to purchase
stock.
a. True
b. False
25. Which of the following statements is incorrect?
a.
Market-makers take positions to capitalize on the discrepancy between the prevailing
stock price and their own valuation of a stock.
b.
Market-makers may take the opposite position of uninformed investors and therefore stand
to benefit if their expectations are correct.
c.
Market makers are required to purchase the stocks they are assigned for a price existing
when the market opened on any given day.
d.
The spread quoted for a given stock may vary among market-makers.
26. A short-interest ratio of 20 or more indicates that many investors
a.
believe that the stock price is currently overvalued.
b.
believe that the stock price is currently undervalued.
c.
are selling the stock short.
d.
both A and C
27. Lisa would like to purchase a stock priced at $70. The stock is not expected to pay any dividends in the
coming year. She can either put up the entire amount and purchase the stock, or borrow $35 from her
brokerage firm at an annual interest rate of 12 percent and put up the remainder. She thinks she can
sell the stock for $100 after one year. If she borrows from her brokerage firm, her estimated return on
the stock would be ____ percent.
a.
42.86
b.
85.71
c.
73.71
d.
30.00
28. Short-selling a stock refers to
a.
poor performance from purchasing an overvalued stock.
b.
the new issuance of low-priced stocks by firms.
c.
the new issuance of stocks by financially weak firms.
d.
the borrowing of stock owned by someone else and selling it in the market.
29. Trading halts are imposed by
a.
the SEC.
b.
brokers.
c.
stock exchanges.
d.
the Treasury.
30. The size of the spread on stocks that have relatively little trading is
a.
smaller to reflect the lower degree of uncertainty.
b.
the same as that of stocks with higher volumes of trading.
c.
wider to reflect the higher degree of uncertainty.
d.
not affected by trading volume.
31. The ____ the trading volume of a stock, the ____ the spread.
a.
higher; wider
b.
higher; narrower
c.
lower; narrower
d.
none of the above
32. Electronic communications networks are primarily intended to prevent executives from using inside
information when trading stocks.
a. True
b. False
33. A ____ is a trading platform on a computer web site that allows investors to trade stocks without the
use of a broker.
a.
direct access broker
b.
program trader
c.
market maker
d.
communication network
34. The NYSE defines ____as the simultaneous buying and selling of a portfolio of at least 15 different
stocks that are valued at more than $1 million.
a.
direct access brokering
b.
electronic communication networking
c.
program trading
d.
regulation of stock trading
35. Trading halts are intended to ensure that the market has complete information before trading on news.
a. True
b. False
36. The Division of ____ of the SEC regulates the fair and orderly disclosure trading by ensuring honest
practices by various organizations that facilitate the trading of securities.
a.
Corporate Finance
b.
Enforcement
c.
Administration
d.
Market Regulation
37. The Division of ____ of the SEC assesses possible violations of regulations imposed by the SEC, and
can take action against individuals or firms.
a.
Corporate Finance
b.
Enforcement
c.
Administration
d.
Market Regulation
38. Until recently, international trading of stocks was limited by
a.
transaction costs.
b.
information costs.
c.
exchange rate risk.
d.
all of the above
39. The transaction costs associated with international trading of stocks have been reduced by
a.
the consolidation of stock exchanges.
b.
extensive computerization.
c.
the Eurolist system.
d.
all of the above
40. The exchange rate risk associated with international trading of stock has been reduced by
a.
information available on the Internet.
b.
extensive computerization of stock exchanges.
c.
the conversion of many European countries to a single currency.
d.
the Eurolist system.
41. A market order is an order to buy or sell a stock at the best possible price.
a. True
b. False
42. A stop-loss order is a particular type of limit order whereby the investor specifies a selling price that is
below the current market price of the stock.
a. True
b. False
43. When investors place a limit order, they can place it for the day only.
a. True
b. False
44. The initial margin is the minimum amount of margin that investors must maintain as a percentage of
the stock’s value without receiving a margin call.
a. True
b. False
45. A margin call from a broker means that the investor is required to provide more collateral (cash or
stocks) or sell the stock.
a. True
b. False
46. When investors sell short, they are essentially lending the stock to another investor and will ultimately
receive that stock back from the investor to whom they lent it.
a. True
b. False
47. A relatively high percentage (such as 3 percent) of the ratio of the number of shares sold short divided
by the total number of shares outstanding suggests a large amount of short positions in the market,
which implies that a relatively large number of investors expect the stock’s price to decline.
a. True
b. False
48. Trading halts are intended to prevent insider trading.
a. True
b. False
49. A trading halt prevents a stock from experiencing a loss in response to news.
a. True
b. False
50. The SEC’s Division of Market Regulation assesses possible violations of the SEC’s regulations and can
take action against individuals or firms.
a. True
b. False
51. Regulation Fair Disclosure (FD) requires firms to disclose relevant information first to their most
important clients.
a. True
b. False
52. ____ offer advice to customers on stocks to buy or sell.
a.
Full-service brokers
b.
Discount brokers
c.
Floor brokers
d.
Specialists
e.
Market-makers
53. Which of the following statements is incorrect with respect to Regulation Fair Disclosure (FD)?
a.
It required firms to disclose relevant information broadly to investors at the same time.
b.
It restricts firms from providing analysts with information that they could use before the
market is aware of the information.
c.
It requires firms to announce a change in expected earnings to all investors and other
interested parties at the same time.
d.
It prohibits firms from communicating with analysts after a news announcement is made
to all investors.
e.
All of the above are correct with respect to Regulation FD.
54. A(n) ____ from a broker requires the investor to put up additional collateral.
a.
maintenance margin
b.
initial margin
c.
margin call
d.
trading halt
55. The short-interest ratio is the shares sold short divided by the
a.
average shares purchased over a recent period.
b.
average daily trading volume over a recent period.
c.
interest rate paid on the short sale.
d.
average daily trading volume on other stocks from the same industry.
56. A short seller
a.
anticipates that the price of the stock sold short will increase.
b.
earns the difference between what he initially paid for the stock versus what he later sell
the stock for.
c.
makes a profit equal to the difference between the original selling price and the price paid
for the stock, after subtracting any dividend payments made.
d.
is essentially lending the stock to another investor and will ultimately receive that stock
back from that investor.
e.
none of the above
57. The bid-ask spread is negatively related to
a.
order costs.
b.
inventory costs.
c.
risk
d.
trading volume.
58. Marziano Co. stock is quoted by a broker as bid $21.20, ask $21.40. The bid-ask spread is ____
percent.
a.
0.94
b.
0.93
c.
0.20
d.
none of the above
59. Which of the following statements is incorrect with respect to the structure of the SEC?
a.
It is composed of seven commissioners appointed by the president of the United States.
b.
The president selects one commissioner to chair the commission.
c.
Each commissioner serves a five-year term.
d.
Commissioners’ terms are staggered.
e.
Commissioners meet to assess whether existing regulations are successfully preventing
abuses and to revise the regulations as needed.
60. The SEC’s ____ requires the orderly disclosure of securities trades by various organizations that
facilitate the trading of securities.
a.
Division of Corporate Finance
b.
Division of Market Regulation
c.
Division of Enforcement
d.
none of the above
61. The SEC’s ____ reviews the registration statement files when a firm goes public, corporate filings for
annual and quarterly reports, and proxy statements that involve voting for board members or other
corporate issues.
a.
Division of Corporate Finance
b.
Division of Market Regulation
c.
Division of Enforcement
d.
none of the above
62. Under the SEC’s uptick rule, speculators are prohibited from taking a short position in stocks that have
experienced a decline of at least 10 percent for the day, unless the most recent trade resulted in a
decrease in the stock price
a. True
b. False
63. In naked short selling, short-sellers sell a stock short that they presently own.
a. True
b. False
64. Dark pools:
a.
are private stock markets used by institutional investors.
b.
are stocks issued by firms that have disclosed very limited financial information.
c.
are stock option contracts that cover positions in stocks.
d.
are contracts used to bet against the default of a debt instrument.
65. It is not illegal for investors to take positions in a stock based on inside information that they received
from an insider at the company, although it would be illegal for the insider to take a position based on
that information.
a. True
b. False
66. When the price of a company’s stock increases or decreases significantly in advance of a public
announcement of an event affecting the company, there are suspicions
that __________ may have occurred.
a.
bid rigging
b.
default inversion
c.
insider trading
d.
an increase in margin requirements
67. An advantage of trading in dark pools is that:
a.
the bid or ask prices offered can be more favorable than those available in the public stock
exchanges.
b.
an investor can accumulate a large number of shares of a particular stock without putting
excessive upward pressure on the stock price.
c.
they are convenient for high-frequency traders using computer algorithms to catch price
discrepancies.
d.
all of the above
68. A criticism of dark pools is that they:
a.
reduce transparency.
b.
are more expensive than the public stock exchanges.
c.
are not accessible to institutional investors.
d.
cannot be used to trade large blocks of stock.
69. Expert networks consisting of managers or executives of a publicly traded company who are hired as
consultants (“experts”) by a hedge fund to provide insight about the company:
a.
are illegal under Regulation FD.
b.
are legitimate if the consultants divulge only information that is already public.
c.
have raised concerns that the consultants provide inside information.
d.
B and C
70. To prosecute defendants connected with the Galleon Fund for __________, the government effectively
used wiretap evidence.
a.
dark pool trading
b.
naked short selling
c.
insider trading
d.
accounting fraud