Chap003 - Chapter 03 - How Securities are Traded CHAPTER 3:...

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Chapter 03 - How Securities are Traded 3-1 CHAPTER 3: HOW SECURITIES ARE TRADED PROBLEM SETS 1. Answers to this problem will vary. 2. The SuperDot system expedites the flow of orders from exchange members to the specialists. It allows members to send computerized orders directly to the floor of the exchange, which allows the nearly simultaneous sale of each stock in a large portfolio. This capability is necessary for program trading. 3. The dealer sets the bid and asked price. Spreads should be higher on inactively traded stocks and lower on actively traded stocks. 4. 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 goes above $128, then the stop-buy order would be executed, limiting the losses from the short sale. 5. 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%
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Chapter 03 - How Securities are Traded 3-2 6. 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% 7. 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
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This note was uploaded on 03/25/2009 for the course FIN FIN508 taught by Professor Wilsonchoi during the Spring '09 term at Korea Advanced Institute of Science and Technology.

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Chap003 - Chapter 03 - How Securities are Traded CHAPTER 3:...

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