CHAPTER 3: HOW SECURITIES ARE TRADED
1.
a.In addition to the explicit fees of $70,000, FBN appears to have paid an implicit
price in underpricing of the IPO.
The underpricing is $3 per share, or a total
of $300,000, implying total costs of $370,000.
b.
No.
The underwriters do not capture the part of the costs corresponding to the
underpricing.
The underpricing may be a rational marketing strategy.
Without it, the underwriters would need to spend more resources in order to
place the issue with the public.
The underwriters would then need to charge
higher explicit fees to the issuing firm.
The issuing firm may be just as well
off paying the implicit issuance cost represented by the underpricing.
2.
a.In principle, potential losses are unbounded, growing directly with increases in
the price of IBM.
b.
If the stopbuy order can be filled at $128, the maximum possible loss per
share is $8.
If the price of IBM shares go above $128, then the stopbuy order
would be executed, limiting the losses from the short sale.
3.
a.The stock is purchased for: 300
×
$40 = $12,000
The amount borrowed is $4,000.
Therefore, the investor put up equity, or
margin, of $8,000.
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:
$4,000
×
1.08 = $4,320
Therefore, the remaining margin in the investor’s account is:
$9,000

$4,320 = $4,680
The percentage margin is now: $4,680/$9,000 = 0.52 = 52%
Therefore, the investor will not receive a margin call.
c.
The rate of return on the investment over the year is:
(Ending equity in the account

Initial equity)/Initial equity
= ($4,680

$8,000)/$8,000 =

0.415 =

41.5%
31
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a.The initial margin was: 0.50
×
1,000
×
$40 = $20,000
As a result of the increase in the stock price Old Economy Traders loses:
$10
×
1,000 = $10,000
Therefore, margin decreases by $10,000.
Moreover, Old Economy Traders
must pay the dividend of $2 per share to the lender of the shares, so that the
margin in the account decreases by an additional $2,000.
Therefore, the
remaining margin is:
$20,000 – $10,000 – $2,000 = $8,000
b.
The percentage margin is: $8,000/$50,000 = 0.16 = 16%
So there will be a margin call.
c.The equity in the account decreased from $20,000 to $8,000 in one year, for a rate
of return of: (

$12,000/$20,000) =

0.60 =

60%
5.
Much of what the specialist does (e.g., crossing orders and maintaining the limit order
book) can be accomplished by a computerized system.
In fact, some exchanges use an
automated system for night trading.
A more difficult issue to resolve is whether the
more discretionary activities of specialists involving trading for their own accounts
(e.g., maintaining an orderly market) can be replicated by a computer system.
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 Spring '09
 Ettinger
 Pricing, Financial Markets

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