Answers to Questions
1. A market is a means whereby buyers and sellers are brought together to aid in the
transfer of goods and/or services. While it generally has a physical location it need
not necessarily have one. Secondly, there is no requirement of ownership by those
who establish and administer the market--they need only provide a cheap, smooth
transfer of goods and/or services for a diverse clientele.
A good market should provide accurate information on the price and volume of past
transactions, and current supply and demand. Clearly, there should be rapid
dissemination of this information. Adequate liquidity is desirable so that participants
may buy and sell their goods and/or services rapidly, at a price reflecting the supply
and demand. The costs of transferring ownership and middleman commissions should
be low. Finally, the prevailing price should reflect all available information.
2.This is a good discussion question for class because you could explore with students
what are some of the alternatives that are used by investors with regards to other assets
such as art and antiques. Some possibilities are ads in the paper of your local
community or large cities. Another obvious alternative is an auction. With an ad you
would have to specify a price or be ready to negotiate with a buyer. With an auction
you would be very uncertain of what you would receive. In all cases, there would be a
substantial time problem.
3.Liquidity is the ability to sell an asset quickly at a price not substantially different
from the current market assuming no new information is available. A share of
Microsoft very liquid, while an antique would be a fairly illiquid asset. A share of
Microsoft is highly liquid since an investor could convert it into cash within one
penny of the current market price. An antique is illiquid since it is relatively difficult
to find a buyer and then you are uncertain as to what price the prospective buyer
would offer.
4.The primary market in securities is where new issues are sold by corporations to
acquire new capital via the sale of bonds, preferred stock or common stock. The sale
typically takes place through an investment banker.
The secondary market is simply trading in outstanding securities. It involves
transactions between owners after the issue has been sold to the public by the
company. Consequently, the proceeds from the sale do not go to the company as is
the case with a primary offering. Thus, the price of the security is important to the
buyer and seller.
The functioning of the primary market would be seriously hampered in the absence of
a good secondary market. A good secondary market provides liquidity to an investor
if he or she wants to alter the composition of his or her portfolio from securities to
other assets (i.e., house, etc.). Thus, investors would be reluctant to acquire securities
in the primary market if they felt they would not subsequently have the ability to sell
the securities quickly at a known price.5.An example of an initial public offering (IPO) would be a company selling company
stock to the public for the first time. An example of a recent IPO would be Google. By
contrast, a seasoned equity refers to an established company, such as IBM, offering a
new issue of common stock to an existing market for the stock. The IPO involves
greater risk for the buyer because there is yet not an established secondary market for
the company.
Exercise
6.Student
7.In competitive bid the issuer is responsible for specifying the type of security to be
offered, the timing, etc. and then soliciting competitive bids from investment banking
firms wishing to act as an underwriter. The high bids will be awarded the contracts.
Negotiated relationships are contractual arrangements between an underwriter and the
issuer wherein the underwriter helps the issuer prepare the bond issue with the
understanding that they have the exclusive right to sell the issue.
8.Membership prices for a set on the NYSE have steadily fallen over recent years. Some
reasons for this include: 1) The NYSE specializes in equities to the exclusion of other
products like derivatives, 2) it has been slow to introduce new products (like ETF’s
traded on the AMEX), 3) it still takes 14 seconds to clear a trade, largely due to the
fact that the NYSE does not clear and settle its own trades, 4) in general it has become
harder for specialists to make money one the exchange.
9.One reason for the existence of regional exchanges is that they provide trading
facilities for geographically local companies that do not qualify for listing on a
national exchange. Second, they list national firms thus providing small local
brokerage firms that are not members of a national exchange the opportunity to trade
in securities that are listed on a national exchange. The essential difference between
the national and regional exchanges is that the regional exchanges have less stringent
listing requirements, thus allowing small firms to obtain listing. In addition regional
exchanges can trade some stocks on the Nasdaq market under unlisted trading
privileges (UTP) granted by the SEC. Most trading on regional exchanges is due to
dual-listed and UTP stocks.
10.The Nasdaq market is larger than the listed exchanges in terms of the number of issues
traded, almost 5,000 issues are traded on the Nasdaq market compared to 3,000 stock
issues (common and preferred) for the NYSE and 600 issues listed on the AMEX. In
sharp contrast, the NYSE has a larger total value of trading - in 2000, NYSE value of
trading was about $13 billion and Nasdaq was about $9 billion.
11.Level 1 provides a quote on Nasdaq stocks for brokerage firms that are not regular. It
is a median quote that is representative of the quotes of the several market makers in
the particular security. Level 2 is provides instantaneous quotes on Nasdaq stocks
offered by all markets makers. This enables the broker to make a deal with the market
maker offering the best price. Level 3 is for markets makers. These investment firms
desire all the information provided in Level 2 but also need the ability to enter their
own quotes or change them relative to other market makers.
12.
(a) The third market is the trading of exchange listed securities away from their
exchanges. It enables the non members of the exchange to trade in exchange listedsecurities. Most of the large institutional favorites are traded on the third market- -
e.g., IBM, Ford, General Electric.
(b) The fourth market is the trading of exchange listed stocks on an Alternative Trading
System (ATS) such as Electronic Communication Systems (ECS) or Electronic
Communication Network (ECN). These electronic trading systems facilitate the
exchange of millions of shares every day.
13.
(a) A market order is an order to buy/sell a stock at the most profitable ask/bid prices
prevailing at the time the order hits the exchange floor. A market order implies the
investor wants the transaction completed quickly at the prevailing price. Example: I
read good reports about BM and I'm certain the stock will go up in value. When I call
my broker and submit a market buy order for 100 shares of IBM and the prevailing
asking price is 95. Total cost for my shares will be $9,500 + commission.
(b) A limit order specifies a maximum price that the individual will pay to purchase the
stock or the minimum he will accept to sell it. Example: IBM is selling for $95--I
could put in a limit buy order for one week to buy 100 shares at $90.
(c). A short sale is the sale of stock that is not currently owned by the seller with the intent
of purchasing it later at a lower price. This is done by borrowing the stock from
another investor through a broker. Example: I expect IBM to fall to $80--I could sell
it short at $95 and expect to repurchase the shares at $80, thereby netting a profit of
$15 per share before commissions.
(d) A stop-loss order is a conditional order whereby the investor indicates that he wants to
sell the stock if the price drops to a specified price, thus protecting himself from a
large and rapid decline in price. Example: I buy IBM at $95 and put in a stop loss at
$90 that protects me from a loss if prices fall to $90.
14.The specialist acts as a broker in handling limit orders placed with member brokers.
Being constantly in touch with current prices, he is in a better position to execute limit
orders since it is entered in his books and executed as soon as appropriate. Second, he
maintains a fair and orderly market by trading on his own account when there is
inadequate supply or demand. If the spread between the bid and ask is substantial, he
can place his own bid or ask in order to narrow the spread. This helps provide a
continuous market with orderly price changes.
The specialist obtains income from both his functions: commissions as a broker, and
outperforming the market in his dealer function using the monopolistic information he
has on limit orders.CHAPTER 6
Answers to Problems
1
(a). Assume you pay $80 cash for the stock:
(1) If the stock is later sold at $100 a share the rate of return from investing in the
stock is:
($100 - $80)/ $80 = 0.25 or 25.00%
(2) If stock is later sold at $40 a share the rate of return from investing in the stock
would be:
($40 - $80)/ $80 = -0.50 or -50.00%
(b) Assuming you use the maximum amount of leverage in buying the stock. On a per
share basis you borrow (0.4)(80) = $32 and thus pay out of pocket $48 per share.
(1) If the stock is later sold at $100 a share the rate of return from investing in the
stock is:
($100 - $80)/ $48 = 0.4167 or 41.67%
(2) If stock is later sold at $40 a share the rate of return from investing in the stock
would be:
($40 - $80)/ $48 = -0.8333 or -83.33%
2
(a) The margin deposit required is 40 percent and Lauren currently has $50,000 on
deposit in her margin account. If Lauren uses the maximum allowable margin the
number of shares she can purchase =
3571
=
(50,000)/[(0.4)(35)]
(b) Total Profit = Total Return - Total Investment
Note that the Total Investment = Borrowing + Your out of pocket investment.
On a per share basis Total Investment = $35 = (.6)(35) + (.4)(35)
(1) If stock rises to $45/share
Total profit = 3571(45 – 35) = $35,710
(2) If stock falls to $25/share.
Total loss = 3571(25 -35) = -$35,710.(c)
Maintenance Margin = (Market Value – Initial Loan Value)/Market Value
where Market Value = Price per share x Number of shares.
Initial Loan Value = Total Investment - Initial Margin.
= $124,985 - $50,000 = $74,985
Therefore, if maintenance margin is 30 percent:
0.30 = [(3,571 x Price) - $74,985] / (3,571 x Price)
$30.00
=
Price
3. Profit = Ending Value - Beginning Value + Dividends - Transaction Costs - Interest
Beginning Value of Investment = $20 x 100 shares = $2,000
Your Investment = margin requirement + commission.
= (.55 x $2,000) + (.03 x $2,000)
= $1,100 + $60
= $1,160
Ending Value of Investment = $27 x 100 shares = $2,700
Dividends = $.50 x 100 shares = $50.00
Transaction Costs = (.03 x $2,000) + (.03 x $2,700) = $60 + $81 = $141
Interest = .10 x (.45 x $2,000) = $90.00
Therefore:
Profit = $2,700 - $2,000 + $50 - $141 - $90 = $519
The rate of return on your investment of $1,160 is:
44.74%
$519/$1,160
=
4. On a short sale profit is calculated as:
Profit = Beginning Value - Ending Value - Dividends - Transaction Costs - Interest
Beginning Value of Investment= $56.00 x 100 shares= $5,600
Your investment = margin requirement + commission
= (.45 x $5,600) + $155
$155
+
$2,520
=$2,675
=
Ending Value of Investment = $45.00 x 100 = $4,500
Dividends = $2.50 x 100 shares = $250.00
Transaction Costs = $155 + $145 = $300.00
Interest = .08 x (.55 x $5,600) = $246.40
Therefore:
Profit = $5,600 - $4,500 - $250 - $300 - $246.40 = $303.60
The rate of return on your investment of $2,675 is =
$303.60/$2,675 = 11.35%
5.
(a) I am satisfied with the profit resulting from the sale of the 200 shares at $40.
(b) With the stop loss: ($40 - $25)/$25 = 60%
Without the stop loss: ($30 - $25)/$25 = 20%
6.
(a) Assuming that you pay cash for the stock:
Rate of return = (45 – 30)/30 = 0.50 or 50%
(b) Assuming that you purchased shares using 60%
Rate of return = (45 – 30)/(0.6 x 30) = 0.8333 or 83.33%
7. Limit buy order at $24: When market declined to $20, your limit order was executed
$24 (buy), then the price went to $36.
Rate of return = ($36 - $24)/$24 = 50%.
Assuming market order at $28: Buy at $28, price goes to $36
Rate of return = ($36 - $28)/$28 = 28.57%.
Limit order at $18: Since the market did not decline to $18 (lowest price was $20) the
limit order was never executed.
Chapter 6
Answers to Spreadsheet Exercises
1.
Return on margin purchase
Input
Initial Price $50.00
Shares Purchased 1000
Initial Equity $25,000.00
Initial Margin 50%
Maintenance Margin 25%
Output
Percentage Change Ending Price Return
Margin Call Price 40% $70 80% $33.33 60% 80 120% 80% 90 160% 100% 100 200% 120% 110 240% 140% 120 280% 160% 130 320% 180% 140 360%
200% 150 400%
Return on margin purchase
Input
Initial Price $50.00
Shares Purchased1000
Initial Equity $25,000.00
Initial Margin 50%
Maintenance
Margin 25%
Holding Period 6 months
Annual Interest Rate8%
DPS $0.25
per
qtr
Output
Percentage Change Ending
Price Return
40% $70
78% 60% 80
118% 80% 90
158% 100% 100
198% 120% 110
238% 140% 120
278% 160% 130
318% 180% 140
358% 200% 150
398%
3.
Return on short sale
Input
Initial Price $56.00 Shares sold 100 Initial Equity $2,520.00 Initial Margin 45%
Holding Period 12
months Annual Interest Rate 8%
DPS $2.50 Commission (purchase)$155.00 Commission (sale) $145.00
Output
Percentage Change Ending
Price Return
45 11.35%-20% 44.8 12.10%-10% 50.4 -8.84%10% 61.6 -50.71%20% 67.2 -71.%30% 72.8 -92.58%40% 78.4 -113.51%50% 84 -134.44%60% .6 -155.38%下载本文
