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32 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
Suggested Answers to Critical Thinking Question
Hello, I am Tim, an Insider Trader
Suppose you are on an airplane and you overhear two executives of a company talking about a
merger that is about to take place. If you buy stock based on what you overheard, are you
committing insider trading?
Answer:
No, the information was unsolicited, acquired passively, and there is no guarantee that you are interpreting
Suggested Answers to Discussion Questions
Questions 1 to 4 and 6 will have answers that will vary depending on the choices made by the student.
3.5 You should ask a broker about how much experience they have and whether they have been involved
3.7 a. Market orders are used when investors want to buy or sell a security quickly and are
3.8 Answers will vary with each student’s research.
3.9 The advice given by the large investment brokerages such as Prudential Securities and Morgan
Stanley is backed by a back office of analysts and a full line of services for the investor. For the
©2017 Pearson Education, Inc.
33 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
Solutions to Problems
3.1 a. Cost of research: Five hours at $20 per hour $100
Research data 75
Total $175
3.2 Mini-Dow Average (MDA)
=LClosing price of Stock 1 + + Closing price of Stock 5
MDA divisor
a. MDA—Today
=$74 +$39 +$112 +$71+$97
0.765 =393
0.765 =513.72
MDA—1 year ago
=$65+$34 +$95+$72 +$88
0.78 =354
0.78 =453.85
b. The value of the MDA today is 59.88 points higher than one year ago (513.72-453.85); this
general upward trend indicates a bull (rising) market.
3.3 SP-6 Index
+ +
=
+ +
L
L
Current closing market Current closing market
value of Stock 1 value of Stock 5
Base period closing market Base period closing market
value of Stock 1 value of Stock 5
a. SP-6 Index $460 $1120 $990 $420 $700 $320 $4,010
Jan. 1, 2016 $240 $630 $450 $150 $320 $80 $1,870
2.144 100 214.4
b. The SP-6 Index has moved from 100 in the base year to 214.4 on January 1, 2016, and 206.4 on
3.4 Market average
+ +
. . .
Closing price of Stock A Closing price of Stock F
Divisor
a.
1987
$50 $10 $7 $26 $45 $32
MarketAverage 170
1.00
+ + + + +
= =
©2017 Pearson Education, Inc.
35 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
3.7 The minimum loss that you would experience in this case is $3.50 per share, or $175, on the total
investment (50 shares at $3.50 per share). It is important to realize that this is a minimum loss. This is
3.8 Because you have sold the stock short, you make money if the stock price falls and you lose money
if the stock price goes above $60. Specifically, with 200 shares sold short, you lose $200 for each $1
that the stock price rises above $60. You want to place an order that will cover your short position by
purchasing 200 shares if the stock price rises to $67. At that point, you will have lost $1,400. The
correct order is a stop buy order with a stop price of $67.
3.9 Since the stock never fell to the limit order buy price, you never purchased it. However, you sold it at
3.10 A stop limit order to sell 500 shares at $40 initiates the sale of the stock once the price hits $40.
However, the sale will occur only if the stock price is $40 or better. If the price dips below $40, no
3.11 Probably nothing will happen. You placed a limit order to buy the stock, and the limit price was hit,
Solutions to Case Problems
Case 3.1 The Perezes’ Good Fortune
This case allows the student to choose sources of information for an investor who has no time or budget
constraints. This case should provide a good discussion and review of all the information sources.
a. Since Angel wants to concentrate exclusively on stocks and bonds, both the Wall Street Journal and
Barron’s would be excellent sources of information. The Wall Street Journal is published daily and
provides price quotations on many securities and provides world, national, regional, and corporate news.
In addition, it has special articles on different financial topics. Barron’s is published weekly and also
b. Since there are no budget constraints for Angel, and he is willing to spend a substantial amount on
getting information, he should consider the S&P Financial Reports and Services. The S&P Stock
©2017 Pearson Education, Inc.
Chapter 3 Investment Information and Securities Transactions 36
articles that Angel might find to have great educational value. Mergent also publishes a variety of
material that could be useful to Angel. Mergent’s Manuals, which are available online by subscription,
Perhaps the best of these services for Angel is the Value Line Investment Survey. Value Line seems
best because Angel does not currently possess the technical expertise needed to interpret all the
c. Financial portals, such as Yahoo! and Google Finance are among the more popular services that give
investors access to a wide range of information. MSN MoneyCentral provides more editorial analysis
than most sites and good interactive analytical tools. A comprehensive and entertaining site is the
d. While the basic role of the stockbroker would be to buy and sell securities on Angel’s behalf,
stockbrokers also provide additional services. For example, stockbrokers often advise clients and
e. Angel can obtain investment advice from a variety of sources: stockbrokers, bankers, subscription
services, and individual advisers and advisory firms. At this point, it is very difficult to advise him as
In this case, it seems that Angel could become more proficient at managing his own portfolio. He will
Case 3.2 Paul and Deborah’s Choices of Brokers and Advisors
a. Paul would best be served by online services such as Ameritrade because they give him the access to
information he may want but the freedom to execute his trades over the Internet.
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37 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
b. Both of them should go with the brokerage that answers their needs. While Paul gets the speed,
d. Day trading is a highly risky strategy that is meant for those who have the ability to focus 100% of
e. Many sources of information and advice are available to Paul and Deborah, from stockbrokers and
investment advisers to investment clubs and online investment education sites. Paul may consider sites
such as The Motley Fool, Zacks Investment Research, and the Wall Street Journal online. Deborah, on
©2017 Pearson Education, Inc.
