Chapter 03 How Securities Are Traded Answer Key Part 3

Chapter 03 - How Securities Are Traded 44. You purchased 100 shares of common stock on margin at $40 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 $25? Ignore interest on margin. A. 0.33 B. 0.55 C. 0.20 D. 0.23 E. 0.25 100 shares * $40/share * 0.5 = $4,000 * 0.5 = $2,000 (loan amount); X = [100($25) − $2,000]/100($25); X = 0.20. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 45. You purchased 1000 shares of common stock on margin at $30 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 $24? Ignore interest on margin. A. 0.33 B. 0.375 C. 0.20 D. 0.23 E. 0.25 1000 shares * $30/share * 0.5 = $30,000 * 0.5 = $15,000 (loan amount); X = [1000($24) − $15,000]/1000($24); X = 0.375. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 3-21 Chapter 03 - How Securities Are Traded 46. You purchased 100 shares of common stock on margin for $50 per share. The initial margin is 50% and the stock pays no dividend. What would your rate of return be if you sell the stock at $56 per share? Ignore interest on margin. A. 28% B. 33% C. 14% D. 42% E. 24% 100($50)(0.50) = $2,500 investment; gain on stock sale = (5650)(100) − = $600; Return = ($600/$2,500) = 24%. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 47. You purchased 100 shares of common stock on margin for $35 per share. The initial margin is 50% and the stock pays no dividend. What would your rate of return be if you sell the stock at $42 per share? Ignore interest on margin. A. 28% B. 33% C. 14% D. 40% E. 24% 100($35)(0.50) = $1,750 investment; gain on stock sale = (4235)(100) − = $700; Return = ($700/$1,750) = 40%. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 3-22 Chapter 03 - How Securities Are Traded 48. Assume you sell short 1000 shares of common stock at $35 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $25/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. 20.47% B. 25.63% C. 57.14% D. 77.23% E. none of the above Profit on stock = ($35 −$25)(1,000) = $10,000; initial investment = ($35)(1,000)(.5) = $17,500; return =$10,000/$17,500 = 57.14%. AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Trading on Margin 49. Assume you sell short 100 shares of common stock at $30 per share, with initial margin at 50%. What would be your rate of return if you repurchase the stock at $35/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. -33.33% B. -25.63% C. -57.14% D. -77.23% E. none of the above Profit on stock = ($30 −$35)(100) = −500; initial investment = ($30)(100)(.5) = $1,500; return =−$500/$1,500 = −33.33%. AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Short Selling 3-23 Chapter 03 - How Securities Are Traded 50. You want to purchase GM stock at $40 from your broker using as little of your own money as possible. If initial margin is 50% and you have $4000 to invest, how many shares can you buy? A. 100 shares B. 200 shares C. 50 shares D. 500 shares E. 25 shares you can buy ($4000/$40) = 100 shares outright and you can borrow $4,000 to buy another 100 shares. AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Trading on Margin 51. You want to purchase IBM stock at $80 from your broker using as little of your own money as possible. If initial margin is 50% and you have $2000 to invest, how many shares can you buy? A. 100 shares B. 200 shares C. 50 shares D. 500 shares E. 25 shares You can buy ($2000/$80) = 25 shares outright and you can borrow $2,000 to buy another 25 shares. AACSB: Analytic Bloom's: Apply Difficulty: Moderate Topic: Trading on Margin 3-24 Chapter 03 - How Securities Are Traded 52. Assume you sold short 100 shares of common stock at $40 per share. The initial margin is 50%. What would be the maintenance margin if a margin call is made at a stock price of $50? A. 40% B. 20% C. 35% D. 25% E. none of the above $4,000 × 1.5 = $6,000; [$6,000 −100($50)]/100($50) = 20%. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Short Selling Topic: Trading on Margin 53. Assume you sold short 100 shares of common stock at $70 per share. The initial margin is 50%. What would be the maintenance margin if a margin call is made at a stock price of $85? A. 40.5% B. 20.5% C. 35.5% D. 23.5% E. none of the above $7,000 × 1.5 = $10,500; [$10,500 −100($85)]/100($85) = 23.5%. AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Short Selling Topic: Trading on Margin 3-25 Chapter 03 - How Securities Are Traded 54. You sold short 100 shares of common stock at $45 per share. The initial margin is 50%. At what stock price would you receive a margin call if the maintenance margin is 35%? A. $50 B. $65 C. $35 D. $40 E. none of the above Equity = 100($45) * 1.5 = $6,750; 0.35 = ($6,750 −100P)/100P; 35P = 6,750 −100P; 135P = 6,750; P = $50.00 AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Trading on Margin 55. You sold short 100 shares of common stock at $75 per share. The initial margin is 50%. At what stock price would you receive a margin call if the maintenance margin is 30%? A. $90.23 B. $88.52 C. $86.54 D. $87.12 E. none of the above Equity = 100($75) * 1.5 = $11,250; 0.30 = ($11,250 −100P)/100P; 30P = 11,250 −100P; 130P = 11,250; P = $86.54 AACSB: Analytic Bloom's: Apply Difficulty: Difficult Topic: Short Selling Topic: Trading on Margin 3-26 Chapter 03 - How Securities Are Traded 56. Despite large first-day IPO returns, average first-year returns in the US are approximately ____________ percent. A. 7.2 B. 18.2 C. 26.4 D. 4.8 E. 9.1 See Figure 3.3. AACSB: Analytic Bloom's: Remember Difficulty: Easy Topic: Stocks 57. Average second-year IPO returns in the US are approximately ____________ percent. A. 6.7 B. 18.2 C. 26.4 D. 7.0 E. 9.1 See Figure 3.3. AACSB: Analytic Bloom's: Remember Difficulty: Easy Topic: Stocks 58. Average third-year IPO returns in the US are approximately ____________ percent. A. 6.7 B. 18.2 C. 26.4 D. 5.3 E. 10.4 See Figure 3.3. AACSB: Analytic Bloom's: Remember Difficulty: Easy Topic: Stocks 3-27 Chapter 03 - How Securities Are Traded 59. The preliminary prospectus is referred to as a ____________. A. red herring B. indenture C. green mail D. tombstone E. headstone The preliminary prospectus is referred to as a red herring. AACSB: Analytic Bloom's: Remember Difficulty: Easy Topic: Stocks 60. The securities act of 1933 ____________. I) requires full disclosure of relevant information relating to the issue of new securities II) requires registration of new securities III) requires issuance of a prospectus detailing financial prospects of the firm IV) established the SEC V) requires periodic disclosure of relevant financial information VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers A. I, II and III B. I, II, III, IV, V, and VI C. I, II and V D. I, II and IV E. IV only The securities act of 1933 requires full disclosure of relevant information relating to the issue of new securities, requires registration of new securities, and requires issuance of a prospectus detailing financial prospects of the firm. AACSB: Analytic Bloom's: Understand Difficulty: Easy Topic: Regulation 3-28 Chapter 03 - How Securities Are Traded 61. The securities act of 1934 ____________. I) requires full disclosure of relevant information relating to the issue of new securities II) requires registration of new securities III) requires issuance of a prospectus detailing financial prospects of the firm IV) established the SEC V) requires periodic disclosure of relevant financial information VI) empowers SEC to regulate exchanges, OTC trading, brokers, and dealers A. I, II and III B. I, II, III, IV, V, and VI C. I, II and V D. I, II and IV E. IV, V, and VI The securities act of 1934 established the SEC, requires periodic disclosure of relevant financial information, and empowers SEC to regulate exchanges, OTC trading, brokers, and dealers. AACSB: Analytic Bloom's: Understand Difficulty: Easy Topic: Regulation 62. Which of the following is not required under the CFA Institute Standards of Professional Conduct? A. knowledge of all applicable laws, rules and regulations B. disclosure of all personal investments whether or not they may conflict with a client's investments C. disclosure of all conflicts to clients and prospects D. reasonable inquiry into a client's financial situation E. All of the above are required under the CFA Institute standards. See "Excerpts from CFA Institute Standards of Professional Conduct". Personal investments need not be disclosed unless they are in potential or actual conflict. AACSB: Analytic Bloom's: Understand Difficulty: Moderate Topic: Regulation 3-29 Chapter 03 - How Securities Are Traded 63. According to the CFA Institute Standards of Professional Conduct, CFA Institute members have responsibilities to all of the following except: A. the government B. the profession C. the public D. the employer E. clients and prospective clients See "Excerpts from CFA Institute Standards of Professional Conduct". AACSB: Analytic Bloom's: Understand Difficulty: Moderate Topic: Regulation 3-30 Chapter 03 - How Securities Are Traded Short Answer Questions 64. Discuss margin buying of common stocks. Include in your discussion the advantages and disadvantages, the types of margin requirements, how these requirements are met, and who determines these requirements. Buying stock on margin means buying stock with partially borrowed funds. These funds are borrowed from your broker, who has borrowed the funds from a commercial bank. The initial margin requirement is the percent of the funds that must be your own. The current initial margin requirement in the U.S. is 50% and is set by the Federal Reserve System. Margin is simply equity as a percent of the value of your account. Subsequent to opening the account, stock prices change and thus the margin of your account changes. The maintenance margin is the relevant margin after you open your account. A 25% maintenance margin is required for NYSE listed stocks; however, most brokers will require a maintenance margin above that amount. If the margin of your account falls below the maintenance margin requirement, you will receive a margin call. You can either send your broker more cash to reduce the amount of the original loan to get your account back to the required maintenance margin, or your broker can sell some of the shares for you, using the proceeds to reduce the amount of your original loan, thus getting your account back to the margin requirement. The advantage of margin is that of leverage. If the price of stock increases you own more shares than had you used only your own funds and your returns will be greater. The disadvantage of margin is that if the price of the stock declines you will own more shares and your losses will be greater than had you used only your own funds. AACSB: Reflective Thinking Bloom's: Understand Difficulty: Moderate Topic: Trading on Margin 65. List three listing requirements for the Singapore Exchange. Listing requirements include, but are not limited to, minimum pretax income and operating revenue in the last year, minimum number of independent directors on the board, minimum market value of publicly held stock, minimum percentage of shares publicly held, and a minimum number of shareholders. AACSB: Reflective Thinking Bloom's: Understand Difficulty: Moderate Topic: Exchanges 3-31