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%
4.
a.
The initial margin was: (0.50
×
1,000
×
$40) = $20,000.
Old Economy
Traders loses ($10
×
1,000) = $10,000 as a result of the increase in the stock
price so 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
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