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account pays no interest.) A year later, the price of Internet Dreams has risen from $40
to $50, and the stock has paid a dividend of $2 per share.
a. What is the remaining margin in the account?
b. If the maintenance margin requirement is 30%, will Old Economy receive a
margin call?
c. What is the rate of return on the investment?
5. Do you think it is possible to replace market-making specialists with a fully automated,
computerized trade-matching system?
6. Consider the following limit order book of a specialist. The last trade in the stock
occurred at a price of $50.
Bodie’Kane’Marcus: I. Elements of Investments 3. How Securities Are © The McGraw’Hill
Essentials of Investments, Traded Companies, 2003
Fifth Edition




94 Part ONE Elements of Investments


Limit Buy Orders Limit Sell Orders

Price Shares Price Shares
$49.75 500 $50.25 100
49.50 800 51.50 100
49.25 500 54.75 300
49.00 200 58.25 100
48.50 600


a. If a market buy order for 100 shares comes in, at what price will it be filled?
b. At what price would the next market buy order be filled?
c. If you were the specialist, would you want to increase or decrease your inventory of
this stock?
7. You are bullish on Telecom stock. The current market price is $50 per share, and you
have $5,000 of your own to invest. You borrow an additional $5,000 from your broker
at an interest rate of 8% per year and invest $10,000 in the stock.
a. What will be your rate of return if the price of Telecom stock goes up by 10% during
the next year? (Ignore the expected dividend.)
b. How far does the price of Telecom stock have to fall for you to get a margin call if
the maintenance margin is 30%? Assume the price fall happens immediately.
8. You are bearish on Telecom and decide to sell short 100 shares at the current market
price of $50 per share.
a. How much in cash or securities must you put into your brokerage account if the
broker™s initial margin requirement is 50% of the value of the short position?
b. How high can the price of the stock go before you get a margin call if the
maintenance margin is 30% of the value of the short position?
9. Suppose that Intel currently is selling at $40 per share. You buy 500 shares using
$15,000 of your own money and borrowing the remainder of the purchase price from
your broker. The rate on the margin loan is 8%.
a. What is the percentage increase in the net worth of your brokerage account if the price
of Intel immediately changes to: (i) $44; (ii) $40; (iii) $36? What is the relationship
between your percentage return and the percentage change in the price of Intel?
b. If the maintenance margin is 25%, how low can Intel™s price fall before you get a
margin call?
c. How would your answer to (b) change if you had financed the initial purchase with
only $10,000 of your own money?
d. What is the rate of return on your margined position (assuming again that you
invest $15,000 of your own money) if Intel is selling after one year at: (i) $44;
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(ii) $40; (iii) $36? What is the relationship between your percentage return and
the percentage change in the price of Intel? Assume that Intel pays no dividends.
e. Continue to assume that a year has passed. How low can Intel™s price fall before you
get a margin call?
10. Suppose that you sell short 500 shares of Intel, currently selling for $40 per share, and
give your broker $15,000 to establish your margin account.
a. If you earn no interest on the funds in your margin account, what will be your rate of
return after one year if Intel stock is selling at: (i) $44; (ii) $40; (iii) $36? Assume
that Intel pays no dividends.
b. If the maintenance margin is 25%, how high can Intel™s price rise before you get a
margin call?
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Fifth Edition




95
3 How Securities Are Traded


c. Redo parts (a) and (b), but now assume that Intel also has paid a year-end dividend
of $1 per share. The prices in part (a) should be interpreted as ex-dividend, that is,
prices after the dividend has been paid.
11. Call one full-service broker and one discount broker and find out the transaction costs
of implementing the following strategies:
a. Buying 100 shares of IBM now and selling them six months from now.
b. Investing an equivalent amount in six-month at-the-money call options on IBM stock
now and selling them six months from now.
12. Here is some price information on Marriott:
Bid Asked
Marriott 37.25 38.12

You have placed a stop-loss order to sell at $38. What are you telling your broker?
Given market prices, will your order be executed?
13. Here is some price information on Fincorp stock. Suppose first that Fincorp trades in a
dealer market such as Nasdaq.
Bid Asked
55.25 55.50

a. Suppose you have submitted an order to your broker to buy at market. At what price
will your trade be executed?
b. Suppose you have submitted an order to sell at market. At what price will your trade
be executed?
c. Suppose you have submitted a limit order to sell at $55.62. What will happen?
d. Suppose you have submitted a limit order to buy at $55.37. What will happen?
14. Now reconsider problem 13 assuming that Fincorp sells in an exchange market like the
NYSE.
a. Is there any chance for price improvement in the market orders considered in parts
(a) and (b)?
b. Is there any chance of an immediate trade at $55.37 for the limit buy order in
part (d)?
15. What purpose does the SuperDot system serve on the New York Stock Exchange?
16. Who sets the bid and asked price for a stock traded over the counter? Would you expect
the spread to be higher on actively or inactively traded stocks?
17. Consider the following data concerning the NYSE:
Average Daily Trading Volume Annual High Price of an
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Year (thousands of shares) Exchange Membership
1985 109,169 $ 480,000
1987 188,938 1,150,000
1989 165,470 675,000
1991 178,917 440,000
1993 264,519 775,000
1995 346,101 1,050,000
1997 526,925 1,750,000


a. What do you conclude about the short-run relationship between trading activity and
the value of a seat?
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Essentials of Investments, Traded Companies, 2003
Fifth Edition




96 Part ONE Elements of Investments


b. Based on these data, what do you think has happened to the average commission
charged to traders in the last decade?
18. On January 1, you sold short one round lot (that is, 100 shares) of Zenith stock at $14
per share. On March 1, a dividend of $2 per share was paid. On April 1, you covered the
short sale by buying the stock at a price of $9 per share. You paid 50 cents per share in
commissions for each transaction. What is the value of your account on April 1?
The following questions are from past CFA examinations.
19. If you place a stop-loss order to sell 100 shares of stock at $55 when the current price is
$62, how much will you receive for each share if the price drops to $50?
a. $50.
b. $55.
c. $54.87.
d. Cannot tell from the information given.
20. You wish to sell short 100 shares of XYZ Corporation stock. If the last two transactions
were at $34.12 followed by $34.25, you can sell short on the next transaction only at a
price of
a. 34.12 or higher
b. 34.25 or higher
c. 34.25 or lower
d. 34.12 or lower
21. Specialists on the New York Stock Exchange do all of the following except:
a. Act as dealers for their own accounts.
b. Execute limit orders.
c. Help provide liquidity to the marketplace.
d. Act as odd-lot dealers.



WEBMA STER
Short Sales
Go to the website for Nasdaq at http://www.nasdaq.com. When you enter the site, a
dialog box appears that allows you to get quotes for up to 10 stocks. Request quotes
for the following companies as identified by their ticker: Noble Drilling (NE), Diamond
Offshore (DO), and Haliburton (HAL). Once you have entered the tickers for each
company, click the item called info quotes that appears directly below the dialog box
for quotes.
1. On which market or exchange do these stocks trade? Identify the high and low
price based on the current day™s trading.
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Below each of the info quotes another dialog box is present. Click the item labeled
fundamentals for the first stock. Some basic information on the company will appear
along with an additional submenu. One of the items is labeled short interest. When you
select that item a 12-month history of short interest will appear. You will need to
complete the above process for each of the stocks.
2. Describe the trend, if any, for short sales over the last year.
3. What is meant by the term Days to Cover that appears on the history for each
company?
4. Which of the companies has the largest relative number of shares that have
been sold short?
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Essentials of Investments, Traded Companies, 2003
Fifth Edition




97
3 How Securities Are Traded


SOLUTIONS TO
1. Limited time shelf registration was introduced because of its favorable trade-off of saving issue cost
against mandated disclosure. Allowing unlimited shelf registration would circumvent “blue sky”
< Concept
laws that ensure proper disclosure as the financial circumstances of the firm change over time.
CHECKS
2. The advent of negotiated commissions reduced the prices that brokers charged to execute trades on
the NYSE. This reduced the profitability of a seat on the exchange, which in turn resulted in the
lower seat prices in 1975 that is evident in Table 3.1. Eventually, however, trading volume
increased dramatically, which more than made up for lower commissions per trade, and the value of
a seat on the exchange rapidly increased after 1975.
3. Solving

100P $4,000
.4
100P
yields P $66.67 per share.
4. The investor will purchase 150 shares, with a rate of return as follows:

Repayment of
Year-End Year-End Principal Investor™s
Change in Price Value of Shares and Interest Rate of Return
30% $19,500 $5,450 40.5%
No change 15,000 5,450 4.5
30% 10,500 5,450 49.5


5. a. Once Dot Bomb stock goes up to $110, your balance sheet will be:

Assets Liabilities and Owner™s Equity
Cash $100,000 Short position in Dot Bomb $110,000
T-bills 50,000 Equity 40,000


b. Solving

$150,000 1,000P
.4
1,000P
yields P $107.14 per share.
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Essentials of Investments, Investment Companies Companies, 2003
Fifth Edition




4
MUTUAL FUNDS AND
OTHER INVESTMENT
COMPANIES

AFTER STUDYING THIS CHAPTER


>
YOU SHOULD BE ABLE TO:

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