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Unformatted text preview: 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/share or $300,000 total, 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 to place the issue with the public. They 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 IBM shares go above $128, the stop-buy order is executed, limiting the losses from the short sale. 3. a. The stock is purchased for 300 × $40 = $12,000. Borrowed funds are $4,000. Therefore, the investor put up equity or margin of $8,000. b. If the shares fall to $30, the value of the stock falls to $4,000. The amount of the loan owed to the broker grows to $4,000 × 1.08 = $4,320. Therefore, remaining margin is 9,000 - 4,320 = $4,680. The percentage margin is now 4,680/9,000 = .52, so there will not yet be a margin call. c. The rate of return on investment over the years is (Ending value of account - initial equity)/Initial equity = (4,680 - 8,000)/8,000 = - .415 = - 41.5. 4. a. The initial margin was .50 × 1,000 × $40 = $20,000. The firm loses $10 × 1,000 = $10,000 due to the increase in the stock price so margin falls by $10,000. Moreover, the firm must pay the dividend of $2 per share, which means the margin account falls by an additional $2,000. So remaining margin is $8,000 b. The percentage margin is $8,000/$50,000 = .16, so there will be a margin call. c. The margin account fell from $20,000 to $8,000 in one year, for a rate of return of - $12,000/$20,000 = - .60 = - 60%....
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This note was uploaded on 10/28/2009 for the course MBA MBA608 taught by Professor Martin during the Spring '09 term at Beirut Arab University.

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