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 IBX.
b.
If the stopbuy order can be filled at $78, the maximum possible loss per share
is $8.
If the price of IBX shares goes above $78, 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%
31
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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%
Therefore, there will be a margin call.
c.
The rate of return on the investment is:
(Ending equity in the account

Initial equity)/Initial equity
= ($8,000

$20,000)/$20,000 =

0.60 =

60.0%
5.
The stoploss order will be executed once the stock price decreases to the limit
price.
If the stock price later rebounds, the investor does not participate in the gains
because the investor no longer owns the stock.
In contrast, the put option need not
be exercised when the stock price falls below the exercise price.
An investor who
owns a share of stock and a put option can hold on to both securities.
If the stock
price never rebounds, the investor can eventually exercise the put by selling the
stock for the exercise price.
This provides the same downside protection as the
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 Spring '08
 Vizanko
 IBX

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