CHAPTER3:SECURITIESMARKETS

1.

2.

a.

Inadditiontotheexplicitfeesof$70,000,FBNappearstohavepaidan
implicitpriceinunderpricingoftheIPO.Theunderpricingis$3per
share,oratotalof$300,000,implyingtotalcostsof$370,000.

b.

No.Theunderwritersdonotcapturethepartofthecostscorrespondingto
theunderpricing.Theunderpricingmaybearationalmarketingstrategy.
Withoutit,theunderwriterswouldneedtospendmoreresourcesinorderto
placetheissuewiththepublic.Theunderwriterswouldthenneedtocharge
higherexplicitfeestotheissuingfirm.Theissuingfirmmaybejustaswell
offpayingtheimplicitissuancecostrepresentedbytheunderpricing.

a.

Inprinciple,potentiallossesareunbounded,growingdirectlywith
increasesinthepriceofHarrierGroup

b.

Ifthestopbuyordercanbefilledat17.50,themaximumpossiblelossper
shareis1.50.IfthepriceofHarrierGroupsharesgoesabove17.50,then
thestopbuyorderwouldbeexecuted,limitingthelossesfromtheshortsale.

3.

ThebrokerisinstructedtoattempttosellyourMarks&Spencerstockassoonas
theMarks&Spencerstocktradesatabidpriceof353.50orless.Here,thebroker
willattempttoexecute,butmaynotbeabletosellat353.50,sincethebidpriceis
now353.00.Thepriceatwhichyousellmaybemoreorlessthan353.50
becausethestoplossbecomesamarketordertosellatcurrentmarketprices.

4.

a.

55.35

b.

55.25

c.

Thetradewillnotbeexecutedbecausethebidpriceislowerthantheprice
specifiedinthelimitsellorder.

d.

Thetradewillnotbeexecutedbecausetheaskedpriceisgreaterthantheprice
specifiedinthelimitbuyorder.

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5.

a.

Inanexchangemarket,therecanbepriceimprovementinthetwomarket
orders.Brokersforeachofthemarketorders(i.e.,thebuyandthesell
orders)canagreetoexecuteatradeinsidethequotedspread.Forexample,
theycantradeat55.30,thusimprovingthepriceforbothcustomersby
0.05relativetothequotedbidandaskedprices.Thebuyergetsthestock
for0.05lessthanthequotedaskedprice,andthesellerreceives0.05
moreforthestockthanthequotedbidprice.

b.

Whereasthelimitordertobuyat55.30wouldnotbeexecutedinadealer
market(sincetheaskedpriceis55.35),itcouldbeexecutedinan
exchangemarket.Abrokerforanothercustomerwithanordertosellat
marketwouldviewthelimitbuyorderasthebestbidprice;thetwo
brokerscouldagreetothetradeandbringittothespecialist,whowould
thenexecutethetrade.

6.

Thedealersetsthebidandaskedprice.Spreadsshouldbehigheroninactively
tradedstocksandloweronactivelytradedstocks.

7.

a.

Youbuy200sharesofTelecomfor8,000.Thesesharesincreasein
valueby10%,or800.Youpayinterestof:0.084,000=320
Therateofreturnwillbe:
800 320
=0.12=12%
4,000

b.

Thevalueofthe200sharesis200P.Equityis(200P4,000).Youwill
receiveamargincallwhen:
200P 4,000
=0.30whenP=28.57orlower
200P

8.

a.

Initialmarginis50%of4,000or2,000.

b.

Totalassetsare6,000(4,000fromthesaleofthestockand2,000putup
formargin).Liabilitiesare100P.Therefore,networthis(6,000100P).
Amargincallwillbeissuedwhen:
6,000 100P
=0.30whenP=46.15orhigher
100P

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9.

Thetotalcostofthepurchaseis:$40500=$20,000
Youborrow$5,000fromyourbroker,andinvest$15,000ofyourownfunds.
Yourmarginaccountstartsoutwithnetworthof$15,000.
a.

(i)

Networthincreasesto:($44500)$5,000=$17,000
Percentagegain=$2,000/$15,000=0.1333=13.33%

(ii)

Withpriceunchanged,networthisunchanged.
Percentagegain=zero

(iii) Networthfallsto($36500)$5,000=$13,000
Percentagegain=($2,000/$15,000)=0.1333=13.33%
Therelationshipbetweenthepercentagereturnandthepercentagechange
inthepriceofthestockisgivenby:
Total investment

%return=%changeinprice Investor's initial equity =%changeinprice1.333

Forexample,whenthestockpricerisesfrom$40to$44,thepercentage
changeinpriceis10%,whilethepercentagegainfortheinvestoris:
$20,000

%return=10% $15,000 =13.33%

b.

Thevalueofthe500sharesis500P.Equityis(500P$5,000).Youwill
receiveamargincallwhen:
500P $5,000
=0.25whenP=$13.33orlower
500P

c.

Thevalueofthe500sharesis500P.Butnowyouhaveborrowed$10,000
insteadof$5,000.Therefore,equityis(500P$10,000).Youwillreceive
amargincallwhen:
500P $10,000
=0.25whenP=$26.67orlower
500P

Withlessequityintheaccount,youarefarmorevulnerabletoa
margincall.

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d.

Bytheendoftheyear,theamountoftheloanowedtothebroker
growsto:
$5,0001.08=$5,400
Theequityinyouraccountis(500P$5,400).Initialequitywas$15,000.
Therefore,yourrateofreturnafteroneyearisasfollows:
(i)

(500 $44) $5,400 $15,000

=0.1067=10.67%
$15,000

(ii)

(500 $40) $5,400 $15,000

=0.0267=2.67%
$15,000

(iii)

(500 $36) $5,400 $15,000

=0.1600=16.00%
$15,000

Therelationshipbetweenthepercentagereturnandthepercentagechange
inthepriceofIntelisgivenby:

%return= % change in price

Total investment
Funds borrowed
8%

Investor' s initial equity

Investor' s initial equity

Forexample,whenthestockpricerisesfrom$40to$44,thepercentage
changeinpriceis10%,whilethepercentagegainfortheinvestoris:

10%

e.

$20,000
$5,000 =10.67%

8%

$15,000
$15,000

Thevalueofthe500sharesis500P.Equityis(500P$5,400).Youwill
receiveamargincallwhen:
500P $5,400
=0.25whenP=$14.40orlower
500P

10.

a.

Thegainorlossontheshortpositionis:(500P)
Investedfunds=$15,000
Therefore:rateofreturn=(500P)/15,000
Therateofreturnineachofthethreescenariosis:
(i)

rateofreturn=(500$)/$15,000=0.1333=13.33%

(ii)

rateofreturn=(500$)/$15,000=0%

(iii) rateofreturn=[500($4)]/$15,000=+0.1333=+13.33%

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b.

Totalassetsinthemarginaccountare:
$20,000(fromthesaleofthestock)+$15,000(theinitialmargin)=$35,000
Liabilitiesare500P.Amargincallwillbeissuedwhen:
$35,000 500P
=0.25whenP=$56orhigher
500P

c. Witha$1dividend,theshortpositionmustnowpayontheborrowedshares:
($1/share500shares)=$500.Rateofreturnisnow:
[(500P)500]/15,000
(i)

rateofreturn=[(500$4)$500]/$15,000=0.1667=16.67%

(ii)

rateofreturn=[(500$0) $500]/$15,000=0.0333=3.33%

(iii) rateofreturn=[(500)($4)$500]/$15,000=+0.1000=+10.00%
Totalassetsare$35,000,andliabilitiesare(500P+500).Amargincallwill
beissuedwhen:
35,000 500 P 500
=0.25whenP=$55.20orhigher
500P

11.

Muchofwhatthespecialistdoes(e.g.,crossingordersandmaintainingthelimit
orderbook)canbeaccomplishedbyacomputerizedsystem.Infact,some
exchangesuseanautomatedsystemfornighttrading.Amoredifficultissueto
resolveiswhetherthemorediscretionaryactivitiesofspecialistsinvolvingtrading
fortheirownaccounts(e.g.,maintaininganorderlymarket)canbereplicatedbya
computersystem.

12.

a.

Thebuyorderwillbefilledatthebestlimitsellorderprice:$50.25

b.

Thenextmarketbuyorderwillbefilledatthenextbestlimitsell
orderprice:$51.50

c.

Youwouldwanttoincreaseyourinventory.Thereisconsiderablebuying
demandatpricesjustbelow$50,indicatingthatdownsideriskislimited.In
contrast,limitsellordersaresparse,indicatingthatamoderatebuyorder
couldresultinasubstantialpriceincrease.

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13.

a.

Thestockispurchasedfor:3004,000=1,200,000
Theamountborrowedis400,000.Therefore,theinvestorputupequity,
ormargin,of800,000.

b.

Ifthesharepricefallsto3,000,thenthevalueofthestockfallsto
900,000.Bytheendoftheyear,theamountoftheloanowedtothe
brokergrowsto:
400,0001.08=432,000
Therefore,theremainingmarginintheinvestorsaccountis:
900,000432,000=468,000
Thepercentagemarginisnow:468,000/900,000=0.52=52%
Therefore,theinvestorwillnotreceiveamargincall.

c.Therateofreturnontheinvestmentovertheyearis:
(EndingequityintheaccountInitialequity)/Initialequity
=(468,000800,000)/800,000=0.415=41.5%

14.

a.

Theinitialmarginwas:0.501,0004,000=2,000,000
AsaresultoftheincreaseinthestockpriceOldEconomyTradersloses:
1,0001,000=1,000,000
Therefore,margindecreasesby1,000,000.Moreover,OldEconomy
Tradersmustpaythedividendof200persharetothelenderoftheshares,
sothatthemarginintheaccountdecreasesbyanadditional200,000.
Therefore,theremainingmarginis:
2,000,0001,000,000200,000=800,000

b.

Thepercentagemarginis:800,000/5,000,000=0.16=16%
Sotherewillbeamargincall.

c.

15.

Theequityintheaccountdecreasedfrom2,000,000to800,000inone
year,forarateofreturnof:(1,200,000/2,000,000)=0.60=60%

TheSuperDotsystemexpeditestheflowofordersfromexchangemembersto
thespecialists.Itallowsmemberstosendcomputerizedordersdirectlytothe
flooroftheexchange,whichallowsthenearlysimultaneoussaleofeachstock
inalargeportfolio.Thiscapabilityisnecessaryforprogramtrading.

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37

16.

a.

Overshortperiodsoftime,thepriceofanexchangemembershipgenerally
increaseswithincreasesintradingactivity.Thismakessensebecause
tradingcommissionsdependontradingvolume.

b.

Thepriceofanexchangemembershiphasrisenfarlessinpercentageterms
thantradingvolume.Thissuggeststhatthecommissionschargedtotraderson
"typical"tradeshavefallenovertime.

17.
18.

Answerstothisproblemwillvary.
a.

Youwillnotreceiveamargincall.Youborrowed$20,000andwithanother
$20,000ofyourownequityyoubought1,000sharesofDisneyat$40per
share.At$35pershare,themarketvalueofthestockis$35,000,your
equityis$15,000,andthepercentagemarginis:$15,000/$35,000=42.9%
Yourpercentagemarginexceedstherequiredmaintenancemargin.

b.

Youwillreceiveamargincallwhen:
1,000P $20,000
=0.35whenP=$30.77orlower
1,000P

19.

Theproceedsfromtheshortsale(netofcommission)were:
(C$14100)C$50=C$1,350
AdividendpaymentofC$200waswithdrawnfromtheaccount.Coveringtheshort
saleatC$9persharecostyou(includingcommission):C$900+C$50=C$950
Therefore,thevalueofyouraccountisequaltothenetprofitonthetransaction:
C$1350C$200C$950=C$200
Notethatyourprofit(C$200)equals(100sharesprofitpershareofC$2).
Yournetproceedspersharewas:
C$14
C$9
C$2
C$1
C$2

sellingpriceofstock
repurchasepriceofstock
dividendpershare
2tradesC$0.50commissionpershare

38

20.

(d)

21.

(b)

22.

(d)

Thebrokerwillsell,atcurrentmarketprice,afterthefirsttransaction
at$55orless.

39