ARE143_CHAP_5_KEY

ARE143_CHAP_5_KEY - 1 Managerial Economics (ARE) 143...

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1 Managerial Economics (ARE) 143 University of California, Davis Instructor: John H. Constantine KEY—Chapter 5 Problem 1: If you were to visit your local car retailer, there is both a primary and secondary market in action. Explain. Is the car retailer a dealer or broker? Why? The new car lot is a primary market; every new car sold is an IPO. The used car lot is a secondary market. The Chevy retailer is a dealer, buying and selling out of inventory. Problem 2: On the NYSE, does a specialist act as a dealer or broker? Both. When trading occurs in the crowd, the specialist acts as a broker. If necessary, the specialist will buy or sell out of inventory to fill an order. Problem 3: (a) What is the difference between a “market order” and a “limit order”? What is the potential downside to each type of order? A market order is an order to execute the trade at the current market price. A limit order specifies the highest (lowest) price at which you are willing to purchase (sell) the stock. The downside of a market order is that in a volatile market, the market price could change dramatically before your order is executed. The downside of a limit order is that the stock may never hit the limit price, meaning your trade will not be executed. (b) What is a “stop-loss order”? Why might it be used? Is it sure to stop a loss? A stop-loss order is an order to sell at market if the price declines to the stop price. As the name suggests, it is a tool to limit losses. As with any stop order, however, the price received may be worse than the stop price, so it may not work as well as the investor hopes. For example, suppose a stock is selling for $50. An investor has a stop loss on at $45, thereby limiting the potential loss to $5, or so the naive investor thinks. However, after the market closes, the company announces a disaster. Next morning, the stock opens at $30. The investor’s sell order will be executed, but the loss suffered will far exceed $5 per share. (c) Suppose ABC Corporation is currently trading at $100. You want to buy it if it reaches $120. Why type of order should you submit? You should submit a stop order; more specifically, a stop buy order with a stop price of $120. (d) Suppose XYZ Corporation is currently trading at $65. You think if it reaches $70, it will continue to climb, so you want to buy it if it gets there. Should you submit a limit order to buy at $70? No, you should submit a stop order to buy at $70, also called a stop buy. A limit buy would be executed immediately at the current price.
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2 Problem 4: (a) There are basically four factors that differentiate stock market indexes. What are they, and briefly comment on each.
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This note was uploaded on 01/13/2012 for the course ARE 143 taught by Professor Brinkley,g during the Spring '08 term at UC Davis.

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ARE143_CHAP_5_KEY - 1 Managerial Economics (ARE) 143...

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