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CHAPTER 3: HOW SECURITIES ARE TRADED
CHAPTER 3: HOW SECURITIES ARE TRADED
PROBLEM SETS
1. Stop-loss order: allows a stock to be sold if the price falls below a predetermined
2. In response to the potential negative reaction to large [block] trades, trades will be split
3. The use of leverage necessarily magnifies returns to investors. Leveraging
borrowed money allows for greater return on investment if the stock price increases.
However, if the stock price declines, the investor must repay the loan, regardless of
4. (a) A market order is an order to execute the trade immediately at the best possible
price. The emphasis in a market order is the speed of execution (the reduction
5. (a) A broker market consists of intermediaries who have the discretion to trade for
their clients. A large block trade in an illiquid security would most likely trade
The advantage of an electronic communication network (ECN) is that it can
Electronic limit-order markets (ELOM) transact securities with high trading
volume. This illiquid security is unlikely to be traded on an ELOM.
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CHAPTER 3: HOW SECURITIES ARE TRADED
b. 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:
Therefore, the remaining margin in the investor’s account is:
c. The rate of return on the investment over the year is:
Alternatively, divide the initial equity investments into the change in value
plus the interest payment:
Therefore, margin decreases by $10,000. Moreover, Old Economy Traders
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CHAPTER 3: HOW SECURITIES ARE TRADED
c. You would want to increase your inventory. There is considerable buying
9. a. You buy 200 shares of Telecom for $10,000. These shares increase in value by
The rate of return will be:
$1, 000 $400 0.12 12%
$5,000
-= =
receive a margin call when:
P
P
200
000,5$200
= 0.30 when P= $35.71 or lower
10. a. Initial margin is 50% of $5,000, or $2,500.
b. Total assets are $7,500 ($5,000 from the sale of the stock and $2,500 put up for
CHAPTER 3: HOW SECURITIES ARE TRADED
The relationship between the percentage return and the percentage change in
the price of the stock is given by:
% return = % change in price
equity initial sInvestor'
investment Total
= % change in price 1.333
For example, when the stock price rises from $20 to $22, the percentage change in
price is 10%, while the percentage gain for the investor is:
CHAPTER 3: HOW SECURITIES ARE TRADED
(ii)
000,15$
000,15$400,5$)20$000,1(
= –0.0267, or –2.67%
(iii)
000,15$
000,15$400,5$)18$000,1(
= –0.1600, or –16.00%
The relationship between the percentage return and the percentage change in
the price of Xtel is given by:
% return =
equity initial sInvestor'
investment Total
pricein change %
equity initial sInvestor'
borrowed Funds
%8
For example, when the stock price rises from $40 to $44, the percentage
change in price is 10%, while the percentage gain for the investor is:
000,15$
000,20$
%10
000,15$
000,5$
%8
=10.67%
e. The value of the 1000 shares is 1,000P. Equity is (1,000P – $5,400). You will
receive a margin call when:
P
P
000,1
400,5$000,1
= 0.25 when P = $7.20 or lower
12. a. The gain or loss on the short position is: (–1,000 ΔP)
Invested funds = $15,000
Therefore: rate of return = (–1,000 ΔP)/15,000
The rate of return in each of the three scenarios is:
b. Total assets in the margin account equal:
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CHAPTER 3: HOW SECURITIES ARE TRADED
P
P
000,1
000,1000,35$
= 0.25 when P = $28 or higher
c. With a $1 dividend, the short position must now pay on the borrowed shares:
($1/share 1000 shares) = $1000. Rate of return is now:
[(–1,000 ΔP) – 1,000]/15,000
Total assets are $35,000, and liabilities are (1,000P + 1,000). A margin call will
be issued when:
P
P
000,1
000,1000,1000,35
= 0.25 when P = $27.2 or higher
13. The broker is instructed to attempt to sell your Marriott stock as soon as the
Marriott stock trades at a bid price of $70 or less. Here, the broker will attempt to
14. a. $55.50
15. a. You will not receive a margin call. You borrowed $20,000 and with another
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CHAPTER 3: HOW SECURITIES ARE TRADED
b. You will receive a margin call when:
P
P
000,1
000,20$000,1
= 0.35 when P = $30.77 or lower
16. The proceeds from the short sale (net of commission) were: ($21 100) – $50 = $2,050
A dividend payment of $200 was withdrawn from the account.
Therefore, the value of your account is equal to the net profit on the transaction:
Note that your profit ($300) equals (100 shares profit per share of $3). Your net
proceeds per share were:
CFA PROBLEMS
1. a. In addition to the explicit fees of $70,000, FBN appears to have paid an
b. No. The underwriters do not capture the part of the costs corresponding to
the underpricing. The underpricing may be a rational marketing strategy.
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CHAPTER 3: HOW SECURITIES ARE TRADED
3. (d)
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