Chapter 03 - CHAPTER 3: HOW SECURITIES ARE TRADED 1. a. In...

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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 stop-buy 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 stop-buy 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% 3-1
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4. 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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Chapter 03 - CHAPTER 3: HOW SECURITIES ARE TRADED 1. a. In...

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