Chapter 03 – Securities Markets
CHAPTER 03
SECURITIES MARKETS
1. An IPO is the first time a formerly privately-owned company sells stock to the
2. The effective price paid or received for a stock includes items such as bid-ask
3. The primary market is the market where newly-issued securities are sold, while
4. The primary source of income for a securities dealer is the bid-ask spread. This is
5. When a firm is a willing buyer of securities and wishes to avoid the extensive
6. A stop order is a trade is not to be executed unless stock hits a price limit. The
stop-loss is used to limit losses when prices are falling. An order specifying a
7. Many large investors seek anonymity for fear that their intentions will become
8. Underwriters purchase securities from the issuing company and resell them. A
prospectus is a description of the firm and the security it is issuing.
9. Margin is a type of leverage that allows investors to post only a portion of the
10. a. A market order has price uncertainty but not execution uncertainty.
11. a. An illiquid security in a developing country is most likely to trade in broker
markets
12.
a. In principle, potential losses are unbounded, growing directly with
increases in the price of IBM.
13. Answers to this problem will vary.
14.
Chapter 03 – Securities Markets
15.
a. The stock is purchased for $40 300 shares = $12,000.
Given that the amount borrowed from the broker is $4,000, Dee’s margin
is the initial purchase price net borrowing: $12,000 – $4,000 = $8,000.
b. If the share price falls to $30, then the value of the stock falls to $9,000.
20. The broker is instructed to attempt to sell your Marriott stock as soon as the
Marriott stock trades at a bid price of $20 or less. Here, the broker will attempt to
21.
a. The trade will be executed at $55.50
b. The trade will be executed at $55.25.
22.
a. In an exchange market, there can be price improvement in the two market
orders. Brokers for each of the market orders (i.e., the buy and the sell
orders) can agree to execute a trade inside the quoted spread. For example,
23.
a. You will not receive a margin call. You invest in 1,000 shares of Disney at
$40 per share with $20,000 in equity and $20,000 from borrowing. At $35
per share, the value of the stock becomes $35,000. Therefore, the equity
decreases to $15,000:
lower.
24. The proceeds from the short sale (net of commission) were:
($21 100) – $50 = $2,050.
A dividend payment of $300 was withdrawn from the account. Covering the short
sale at $15 per share costs (including commission): $1500 + $50 = $1550.
25. The total cost of the purchase is: $40 500 = $20,000.
Investing $15,000 from your own funds and borrowing $5,000 from the broker,
you start the margin account with the net worth of $15,000.
a.
(i) Net worth increases to: ($44 500) – $5,000 = $17,000
Percentage gain = ($17,000 – $15,000)/$15,000 = 0.1333 = 13.33%
in the price of the stock is given by:
% return = % change in price
Total i nvestment
Investor ‘s i nitial e quity
= % change in price 1.3333
$15,000
b. The value of the 500 shares is 500P. Equity is (500P – $5,000). You will
receive a margin call when:
50 0 P
instead of $5,000. Therefore, equity is (500P – $10,000). You will receive
a margin call when:
500 P － $ 10 ,000
50 0 P
= 0.25 or 25% when P = $26.67.
Therefore, the rate of return after one year is as follows:
(i)
(500 $44)－ $5,400 － $15,000
$15,000
= 0.1067 = 10.67%
(500 $40)－ $5,400 － $15,000
$15,000
(500 $36)－ $5,400 － $15,000
$15,000
The relationship between the percentage return and the percentage change
in the price of Intel is given by:
% return =
(
% change in price Total investment
Investor’s initial equity
)
8% Funds borrowed
(
Investor’s initial equity
)
For example, when the stock price rises from $40 to $44, the percentage
change in price is 10% (0.10), while the percentage gain for the investor
is:
(
. 10 $20,000
$15 ,000
)
(
.0 8 $5,000
$1 5 ,000
)
e. The value of the 500 shares is 500P. Equity is (500P – $5,400). I will
receive a margin call when:
500 P －$5,400
50 0 P
26.
500 P －$5,000
Chapter 03 – Securities Markets
a. Given the $15,000 invested funds and assuming the gain or loss on the
(ii) Rate of return = (–500 $)/$15,000 = 0%
(iii) Rate of return = [–500 (–$4)]/$15,000 = 0.1333 = 13.33%
Total assets on margin are the sum of the initial margin and the proceeds
from the sale of the stock:
$20,000 + $15,000 = $35,000. Liabilities are 500P. A margin call will be
500 P
b. With a $1 dividend, the short position must now pay on the borrowed
shares: ($1/share 500 shares) = $500. Rate of return is now:
[(–500 P) – 500]/15,000
(i) Rate of return =[(–500 $4) – $500]/$15,000 = –0.1667 = –16.67%
(ii) Rate of return = [(–500 $0) – $500]/$15,000 = –0.0333 = –3.33%
(iii) Rate of return = [(–500) (–$4) – $500]/$15,000 = 0.1000 = 10.00%