Chapter 03 - Securities Markets
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.
The underwriters do not capture the part of the costs corresponding to
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
In principle, potential losses are unbounded, growing directly with
increases in the price of IBM.
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.
The stock is purchased for: 300 x $40 = $12,000
The amount borrowed is $4,000.
Therefore, the investor put up
equity, or margin, of $8,000.
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
$4,000 x 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.
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%