Chapter 03  How Securities are Traded
31
BA 4814 & BA 5814  INVESTMENTS
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 stopbuy 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 stopbuy 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
32
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 orderly market) can be replicated by a computer system.
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 Spring '09
 caglarsenel
 Financial Markets

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