Chapter 03 How Securities Are Traded Answer Key Part 1

Chapter 03 - How Securities Are Traded Chapter 03 How Securities Are Traded Answer Key Multiple Choice Questions 1. The trading of stock that was previously issued takes place A. in the secondary market. B. in the primary market. C. usually with the assistance of an investment banker. D. A and B. E. B and C. Secondary market transactions consist of trades between investors. AACSB: Analytic Bloom's: Remember Difficulty: Easy Topic: Stocks 2. A purchase of a new issue of stock takes place A. in the secondary market. B. in the primary market. C. usually with the assistance of an investment banker. D. A and B. E. B and C. Funds from the sale of new issues flow to the issuing corporation, making this a primary market transaction. Investment bankers usually assist by pricing the issue and finding buyers. AACSB: Analytic Bloom's: Remember Difficulty: Easy Topic: Stocks 3-1 Chapter 03 - How Securities Are Traded 3. Firms raise capital by issuing stock A. in the secondary market. B. in the primary market. C. to unwary investors. D. only on days when the market is up. E. C and D. Funds from the sale of new issues flow to the issuing corporation, making this a primary market transaction. AACSB: Analytic Bloom's: Remember Difficulty: Easy Topic: Stocks 4. The following statements regarding the specialist are true: A. Specialists maintain a book listing outstanding unexecuted limit orders. B. Specialists earn income from commissions and spreads in stock prices. C. Specialists stand ready to trade at quoted bid and ask prices. D. Specialists cannot trade in their own accounts. E. A, B, and C are all true. The specialists' functions are all of the items listed in A, B, and C. In addition, specialists trade in their own accounts. AACSB: Analytic Bloom's: Understand Difficulty: Moderate Topic: Stocks 3-2 Chapter 03 - How Securities Are Traded 5. Investment bankers A. act as intermediaries between issuers of stocks and investors. B. act as advisors to companies in helping them analyze their financial needs and find buyers for newly issued securities. C. accept deposits from savers and lend them out to companies. D. A and B. E. A, B, and C. The role of the investment banker is to assist the firm in issuing new securities, both in advisory and marketing capacities. The investment banker does not have a role comparable to a commercial bank, as indicated in C. AACSB: Analytic Bloom's: Remember Difficulty: Moderate Topic: Stock Trading 6. In a "firm commitment" A. the investment banker buys the stock from the company and resells the issue to the public. B. the investment banker agrees to help the firm sell the stock at a favorable price. C. the investment banker finds the best marketing arrangement for the investment banking firm. D. B and C. E. A and B. In a "firm commitment" the investment banker buys the stock from the company and resells the issue to the public. AACSB: Analytic Bloom's: Understand Difficulty: Moderate Topic: Stock Trading 3-3 Chapter 03 - How Securities Are Traded 7. The secondary market consists of A. transactions on the stock exchange. B. transactions in the OTC market. C. transactions through the investment banker. D. A and B. E. A, B, and C. The secondary market consists of transactions on the organized exchanges and in the OTC market. The investment banker is involved in the placement of new issues in the primary market. AACSB: Analytic Bloom's: Remember Difficulty: Moderate Topic: Stock Trading 8. Initial margin requirements in the U.S. are determined by A. the Securities and Exchange Commission. B. the Federal Reserve System. C. the New York Stock Exchange. D. B and C. E. A and B The Board of Governors of the Federal Reserve System determines initial margin requirements. AACSB: Analytic Bloom's: Understand Difficulty: Moderate Topic: Stocks 3-4 Chapter 03 - How Securities Are Traded 9. You purchased JNJ stock at $50 per share. The stock is currently selling at $65. Your gains may be protected by placing a __________ A. stop-buy order B. limit-buy order C. market order D. limit-sell order E. none of the above. With a limit-sell order, your stock will be sold only at a specified price, or better. Thus, such an order would protect your gains. None of the other orders are applicable to this situation. AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Stock Trading 10. You sold JCP stock short at $80 per share. Your losses could be minimized by placing a __________: A. limit-sell order B. limit-buy order C. stop-buy order D. day-order E. none of the above. With a stop-buy order, the stock would be purchased if the price increased to a specified level, thus limiting your loss. AACSB: Analytic Bloom's: Understand Difficulty: Moderate Topic: Stock Trading 3-5 Chapter 03 - How Securities Are Traded 11. Which one of the following statements regarding orders is false? A. A market order is simply an order to buy or sell a stock immediately at the prevailing market price. B. A limit sell order is where investors specify prices at which they are willing to sell a security. C. If stock ABC is selling at $50, a limit-buy order may instruct the broker to buy the stock if and when the share price falls below $45. D. A market order is an order to buy or sell a stock on a specific exchange (market). E. None of the above. All of the order descriptions above are correct except D. AACSB: Reflective Thinking Bloom's: Apply Difficulty: Moderate Topic: Stock Trading 12. Restrictions on trading involving insider information apply to the following except A. corporate officers. B. corporate directors. C. major stockholders. D. All of the above are subject to insider trading restrictions. E. None of the above is subject to insider trading restrictions. A, B, and C are corporate insiders and are subject to restrictions on trading on inside information. Further, the Supreme Court held that traders may not trade on nonpublic information even if they are not insiders. AACSB: Analytic Bloom's: Remember Difficulty: Moderate Topic: Stock Trading 3-6 Chapter 03 - How Securities Are Traded 13. The cost of buying and selling a stock consists of __________. A. broker's commissions B. dealer's bid-asked spread C. a price concession an investor may be forced to make. D. A and B. E. A, B, and C. All of the above are possible costs of buying and selling a stock. AACSB: Analytic Bloom's: Understand Difficulty: Moderate Topic: Stock Trading 14. Assume you purchased 200 shares of GE common stock on margin at $70 per share from your broker. If the initial margin is 55%, how much did you borrow from the broker? A. $6,000 B. $4,000 C. $7,700 D. $7,000 E. $6,300 200 shares * $70/share * (10.55) − = $14,000 * (0.45) = $6,300. AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Stock Trading 15. You sold short 200 shares of common stock at $60 per share. The initial margin is 60%. Your initial investment was A. $4,800. B. $12,000. C. $5,600. D. $7,200. E. none of the above. 200 shares * $60/share * 0.60 = $12,000 * 0.60 = $7,200 AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Stock Trading 3-7 Chapter 03 - How Securities Are Traded 16. You purchased 100 shares of IBM common stock on margin at $70 per share. Assume the initial margin is 50% and the maintenance margin is 30%. Below what stock price level would you get a margin call? Assume the stock pays no dividend; ignore interest on margin. A. $21 B. $50 C. $49 D. $80 E. none of the above 100 shares * $70 * .5 = $7,000 * 0.5 = $3,500 (loan amount); 0.30 = (100P −$3,500)/100P; 30P = 100P −$3,500; −70P = −$3,500; P = $50. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 17. You purchased 100 shares of common stock on margin at $45 per share. Assume the initial margin is 50% and the stock pays no dividend. What would the maintenance margin be if a margin call is made at a stock price of $30? Ignore interest on margin. A. 0.33 B. 0.55 C. 0.43 D. 0.23 E. 0.25 100 shares * $45/share * 0.5 = $4,500 * 0.5 = $2,250 (loan amount); X = [100($30) − $2,250]/100($30); X = 0.25. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 3-8 Chapter 03 - How Securities Are Traded 18. You purchased 300 shares of common stock on margin for $60 per share. The initial margin is 60% and the stock pays no dividend. What would your rate of return be if you sell the stock at $45 per share? Ignore interest on margin. A. 25.00% B. -33.33% C. 44.31% D. -41.67% E. -54.22% 300($60)(0.60) = $10,800 investment; 300($60) = $18,000 X (0.40) = $7,200 loan; Proceeds after selling stock and repaying loan: $13,500 −$7,200 = $6,300; Return = ($6,300 − $10,800)/$10,800 = −41.67%. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 19. Assume you sell short 100 shares of common stock at $45 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $40/share? The stock paid no dividends during the period, and you did not remove any money from the account before making the offsetting transaction. A. 20.03% B. 25.67% C. 22.22% D. 77.46% E. none of the above Profit on stock = ($45 −$40) * 100 = $500, $500/$2,250 (initial investment) = 22.22%. AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Trading on Margin 3-9 Chapter 03 - How Securities Are Traded 20. You sold short 300 shares of common stock at $55 per share. The initial margin is 60%. At what stock price would you receive a margin call if the maintenance margin is 35%? A. $51.00 B. $65.18 C. $35.22 D. $40.36 E. none of the above Equity = 300($55) * 1.6 = $26,400; 0.35 = ($26,400 −300P)/300P; 105P = 26,400 −300P; 405P = 26,400; P = $65.18 AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 21. Assume you sold short 100 shares of common stock at $50 per share. The initial margin is 60%. What would be the maintenance margin if a margin call is made at a stock price of $60? A. 40% B. 33% C. 35% D. 25% E. none of the above $5,000 × 1.6 = $8,000; [$8,000 −100($60)]/100($60) = 33%. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 3-10