Chapter 03 - Securities Markets
CHAPTER 03
SECURITIES MARKETS
1. An IPO is the first time a formerly privately-owned company sells stock to the
general public. A seasoned issue is the issuance of stock by a company that has
already undergone an IPO.
2. The effective price paid or received for a stock includes items such as bid-ask
spread, brokerage fees, commissions, and taxes (when applicable). These reduce
the amount received by a seller and increase the cost incurred by a buyer.
3. The primary market is the market where newly-issued securities are sold, while
the secondary market is the market for trading existing securities. After firms sell
their newly-issued stocks to investors in the primary market, new investors
purchase stocks from existing investors in the secondary market.
4. The primary source of income for a securities dealer is the bid-ask spread. This is
the difference between the price at which the dealer is willing to purchase a
security and the price at which they are willing to sell the same security.
5. When a firm is a willing buyer of securities and wishes to avoid the extensive
time and cost associated with preparing a public issue, it may issue shares
privately.
6. A stop order is a trade is not to be executed unless stock hits a price limit. The
stop-loss is used to limit losses when prices are falling. An order specifying a
price at which an investor is willing to buy or sell a security is a limit order, while
a market order directs the broker to buy or sell at whatever price is available in the
market.
7. Many large investors seek anonymity for fear that their intentions will become
known to other investors. Large block trades attract the attention of other traders.
By splitting large transactions into smaller trades, investors are better able to
retain a degree of anonymity.
8. Underwriters purchase securities from the issuing company and resell them. A
prospectus is a description of the firm and the security it is issuing.
9. Margin is a type of leverage that allows investors to post only a portion of the
value of the security they purchase. As such, when the price of the security rises
or falls, the gain or loss represents a much higher percentage, relative to the actual
money invested.
10. a. A market order has price uncertainty but not execution uncertainty.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
, Chapter 03 - Securities Markets
11. a. An illiquid security in a developing country is most likely to trade in broker
markets.
12.
a. In principle, potential losses are unbounded, growing directly with
increases in the price of IBX.
b. If the price of IBX shares goes above $210, then the stop-buy order would
be executed, limiting the losses from the short sale. If the stop-buy order
can be filled at $200, the maximum possible loss per share is $10. The
total loss is: $10 100 shares = $1000.
13. Answers to this problem will vary.
14.
a. In addition to the explicit fees of $60,000, we should also take into
account the implicit cost incurred to DRK from the underpricing in the
IPO. The underpricing is $4 per share, or a total of $400,000, implying
total costs of $460,000.
b. No. The underwriters do not capture the part of the costs corresponding to
the underpricing. However, the underpricing may be a rational marketing
strategy to attract and retain long-term relationships with their investors.
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.
15.
a. The stock is purchased for $40 300 shares = $12,000.
Given that the amount borrowed from the broker is $4,000, Dee’s margin
is the initial purchase price net borrowing: $12,000 – $4,000 = $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:
Principal (1 + Interest rate) = $4,000 (1 + 0.08) = $4,320.
The value of the stock falls to: $30 300 shares = $9,000.
The remaining margin in the investor’s account is:
Equity in a ccount
Margin on long position =
Value of s tock
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
CHAPTER 03
SECURITIES MARKETS
1. An IPO is the first time a formerly privately-owned company sells stock to the
general public. A seasoned issue is the issuance of stock by a company that has
already undergone an IPO.
2. The effective price paid or received for a stock includes items such as bid-ask
spread, brokerage fees, commissions, and taxes (when applicable). These reduce
the amount received by a seller and increase the cost incurred by a buyer.
3. The primary market is the market where newly-issued securities are sold, while
the secondary market is the market for trading existing securities. After firms sell
their newly-issued stocks to investors in the primary market, new investors
purchase stocks from existing investors in the secondary market.
4. The primary source of income for a securities dealer is the bid-ask spread. This is
the difference between the price at which the dealer is willing to purchase a
security and the price at which they are willing to sell the same security.
5. When a firm is a willing buyer of securities and wishes to avoid the extensive
time and cost associated with preparing a public issue, it may issue shares
privately.
6. A stop order is a trade is not to be executed unless stock hits a price limit. The
stop-loss is used to limit losses when prices are falling. An order specifying a
price at which an investor is willing to buy or sell a security is a limit order, while
a market order directs the broker to buy or sell at whatever price is available in the
market.
7. Many large investors seek anonymity for fear that their intentions will become
known to other investors. Large block trades attract the attention of other traders.
By splitting large transactions into smaller trades, investors are better able to
retain a degree of anonymity.
8. Underwriters purchase securities from the issuing company and resell them. A
prospectus is a description of the firm and the security it is issuing.
9. Margin is a type of leverage that allows investors to post only a portion of the
value of the security they purchase. As such, when the price of the security rises
or falls, the gain or loss represents a much higher percentage, relative to the actual
money invested.
10. a. A market order has price uncertainty but not execution uncertainty.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
, Chapter 03 - Securities Markets
11. a. An illiquid security in a developing country is most likely to trade in broker
markets.
12.
a. In principle, potential losses are unbounded, growing directly with
increases in the price of IBX.
b. If the price of IBX shares goes above $210, then the stop-buy order would
be executed, limiting the losses from the short sale. If the stop-buy order
can be filled at $200, the maximum possible loss per share is $10. The
total loss is: $10 100 shares = $1000.
13. Answers to this problem will vary.
14.
a. In addition to the explicit fees of $60,000, we should also take into
account the implicit cost incurred to DRK from the underpricing in the
IPO. The underpricing is $4 per share, or a total of $400,000, implying
total costs of $460,000.
b. No. The underwriters do not capture the part of the costs corresponding to
the underpricing. However, the underpricing may be a rational marketing
strategy to attract and retain long-term relationships with their investors.
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.
15.
a. The stock is purchased for $40 300 shares = $12,000.
Given that the amount borrowed from the broker is $4,000, Dee’s margin
is the initial purchase price net borrowing: $12,000 – $4,000 = $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:
Principal (1 + Interest rate) = $4,000 (1 + 0.08) = $4,320.
The value of the stock falls to: $30 300 shares = $9,000.
The remaining margin in the investor’s account is:
Equity in a ccount
Margin on long position =
Value of s tock
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior
written consent of McGraw-Hill Education.
