978-1260013924 Chapter 3 Solution Manual

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

time and cost associated with preparing a public issue, it may issue shares

privately.

6. An order that specifies price at which an investor is willing to buy or sell 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

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.

Chapter 03 – Securities Markets

11. a. An illiquid security in a developing country is most likely to trade in broker

markets.

12. a. An investor who wishes to sell shares immediately should ask his or her

broker to enter a market order.

14. 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

IPO. The underpricing is $4 per share, or a total of $400,000, implying

15. a. The stock is purchased for $40  300 shares = $12,000.

Chapter 03 – Securities Markets

written consent of McGraw-Hill Education.

c. Margin on long position = Equity in account

Value of stock

= $9,000 － $4,320

$9,000 = 0.52 = 52%

Therefore, the investor will not receive a margin call.

d. Rate of return = Ending equity in account － Initial equity in account

Initial equity in account

= $4,680 － $8,000

$8,000 = – 0.4150 = – 41.50%

16. 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.

Because the percentage margin falls below the maintenance level of 30%,

there will be a margin call.

17. a. The market-buy order will be filled at $50.25, the best price of limit-sell

orders in the book.

Chapter 03 – Securities Markets

written consent of McGraw-Hill Education.

c. As a security dealer, you would want to increase your inventory. There is

considerable buying demand at prices just below $50, indicating that

downside risk is limited. In contrast, limit-sell orders are sparse,

indicating that a moderate buy order could result in a substantial price

increase.

18. 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 investment

Stock price = $10,000

$50 = 200 shares

19. 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

20. The broker is instructed to attempt to sell your Marriott stock as soon as the

Marriott stock trades at a bid price of $68 or less. Here, the broker will attempt to

21. a. The trade will be executed at $55.50.

Chapter 03 – Securities Markets

written consent of McGraw-Hill Education.

b. The trade will be executed at $55.25.

c. The trade will not be executed because the bid price is lower than the price

specified in the limit-sell order.

d. The trade will not be executed because the asked price is higher than the

price specified in the limit-buy order.

22. a. You will not receive a margin call. You invest in 1,000 shares of Ixnay 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:

23. 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.

24. 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%

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:

receive a margin call when:

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%

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) – (.08  $5,000

$15,000) = .1067 or 10.67%

e. The value of the 500 shares is 500P. Equity is (500P – $5,400). I will

receive a margin call when:

25. 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:

Rate of return = (–500  P)/15,000

Thus, the rate of return in each of the three scenarios is:

(i) Rate of return = (–500  $)/$15,000 = –0.1333 = –13.33%

written consent of McGraw-Hill Education.