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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
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
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
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
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
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
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%
Copyright © 2019 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
