Chapter 03 – Securities Markets
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Chapter 03 – Securities Markets
CHAPTER 03
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Chapter 03 – Securities Markets
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. 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
6. Many large investors seek anonymity for fear that their intentions will become
known to other investors. Large block trades attract the attention of other traders.
7. Underwriters purchase securities from the issuing company and resell them. A
8. Margin is a type of leverage that allows investors to post only a portion of the
9. a. A market order has price uncertainty but not execution uncertainty.
10. a. An illiquid security in a developing country is most likely to trade in broker
markets.
11.
a. In principle, potential losses are unbounded, growing directly with
b. If the price of IBM shares goes above $200, then the stop-buy order would
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Chapter 03 – Securities Markets
12. Answers to this problem will vary.
13.
a. In addition to the explicit fees of $60,000, we should also take into
account the implicit cost incurred to DRK from the underpricing in the
b. No. The underwriters do not capture the part of the costs corresponding to
the underpricing. However, the underpricing may be a rational marketing
strategy to attract and retain long-term relationships with their investors.
c. 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.
d. If the share price falls to $30, then the value of the stock falls to $9,000.
By the end of the year, the amount of the loan owed to the broker grows
to:
e. Rate of return =
Ending e quity in a ccount － Initial equity in account
Initial e quity in a ccount
=
$ 4 ,680 － $ 8 , 00 0
$ 8 ,000
= – 0.4150 = – 41.50%
14.
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Chapter 03 – Securities Markets
a. The initial margin was: $40 x 1,000 0.50 = $20,000.
As a result of the $10 increase in the stock price, Old Economy Traders
loses: $10 1,000 shares = $10,000.
b. Margin on short position =
Equity
Value of s hares o wed
=
$ 8,000
$ 50 1,000 shares
= 0.16 = 16%
c. The rate of return =
Ending e quity － Initial equity
Initial e quity
=
= – 0.60 = – 60%
15.
a. The market-buy order will be filled at $50.25, the best price of limit-sell
b. The next market-buy order will be filled at $51.50, the next-best limit-sell
c. As a security dealer, you would want to increase your inventory. There is
16.
a. Your initial investment is the sum of $5,000 in equity and $5,000 from
borrowing, which enables you to buy 200 shares of Telecom stock:
Initial i nvestment
Stock price
=
$10,000
$50
= 200 shares
The shares increase in value by 10%: $10,000 0.10 = $1,000.
You pay interest of = $5,000 0.08 = $400.
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website, in whole or part.
Chapter 03 – Securities Markets
$5,000
b. The value of the 200 shares is 200P. Equity is (200P – $5,000), and the
required margin is 30%.
200 P － $5,000
17.
a. Initial margin is 50% of $5,000, which is $2,500.
b. Total assets are $7,500 ($5,000 from the sale of the stock and $2,500 put
up for margin). Liabilities are 100P. Therefore, net worth is ($7,500 –
100P).
$7,50 0 －100 P
18. 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
19.
a. The trade will be executed at $55.50.
20.
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website, in whole or part.
Chapter 03 – Securities Markets
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
b. Whereas the limit order to buy at $55.37 would not be executed in a dealer
market (since the asked price is $55.50), it could be executed in an exchange
21.
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 $15,000:
b. Solving
1,00 0 P －$ 20,000
1,000 P
= 0.35 or 35%, we get P = $30.77
22. The proceeds from the short sale (net of commission) were:
($21 100) – $50 = $2,050.
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website, in whole or part.
Chapter 03 – Securities Markets
23. 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%
$15,000
b. The value of the 500 shares is 500P. Equity is (500P – $5,000). You will
receive a margin call when:
500P －$5,000
50 0 P
= 0.25 or 25%, when P = $13.33 or lower.
c. The value of the 500 shares is 500P. But now you have borrowed $10,000
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.
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Chapter 03 – Securities Markets
d. By the end of the year, the amount of the loan owed to the broker grows
to:
$5,000 (1 + 0.08) = $5,400
The equity in your account is (500P – $5,400). Initial equity was $15,000.
Therefore, the rate of return after one year is as follows:
(i)
(500 $44)－ $5,400 － $15,000
$15,000
= 0.1067 = 10.67%
(ii)
(500 $40)－ $5,400 － $15,000
$15,000
= –0.0267 = –2.67%
(iii)
(500 $36)－ $5,400 － $15,000
$15,000
= –0.1600 = –16.00%
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:
(
$15 ,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
= 0.25 or 25% when P = $14.40 or lower.
24.
a. Given the $15,000 invested funds and assuming the gain or loss on the
short position is (–500 P), we can calculate the rate of return using the
following formula:
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 03 – Securities Markets
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%
Total assets are $35,000, and liabilities are (500P + 500). A margin call
will be issued when:
$35,000 －500 P － 500
500 P
= 0.25 or 25% when P = $55.20 or higher.
CFA 1
c. Cannot tell from the information given.
CFA 2
d. Act as odd-lot dealers.
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$35,000 －500 P