HW #2

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School

Mt San Antonio College *

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101

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Finance

Date

Jan 9, 2024

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Uploaded by ChancellorMusic5325

HW #2 3. How does buying on margin magnify both the upside potential and the downside risk of an investment position?  Buying on margin can earn a higher return if the stock price increases. However, if the stock price decreases, there will be a negative return. 4. Are the following statements true or false? If false, correct them. a. An investor who wishes to sell shares immediately should ask his or her broker to enter a limit order.  False, an investor who wishes to sell shares immediately should ask his or her broker to enter a market order. b. The ask price is less than the bid price.  False, the ask price is higher than the bid price. c. An issue of additional shares of stock to the public by Microsoft would be called an IPO.  False, an issue of additional share of stock to the public by Microsoft would not be called an IPO. d. An ECN (electronic communications network) is a computer link used by security dealers primarily to advertise prices at which they are willing to buy or sell shares.  True. 5. Are the following statements true or false? If false, correct them. a. Market orders entail greater price uncertainty than limit orders.  True b. Market orders entail greater time-of-execution uncertainty than limit orders.  False, market orders entail less time-of-execution uncertainty than limit orders. 6. Dée Trader opens a brokerage account and purchases 300 shares of Internet Dreams at $40 per share. She borrows $4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%. a. What is the margin in Dée’s account when she first purchases the stock?  Stock purchase cost: $40 x 300 = $12,000 Margin = $12,000 - $4,000 = $8,000 b. If the share price falls to $30 per share by the end of the year, what is the remaining margin in her account?  Interest = $4,000 x 8% = $320 Changes in share price: $40 - $30 = $10 Remaining margin: $8,000 - $320 – ($10 x 300) = $4,680 c. If the maintenance margin requirement is 30%, will she receive a margin call?

 Percentage margin = $4,680 / ($30 x 300) = 0.52 = 52% 52% > 30% Since the percentage margin is greater than maintenance margin requirement, she will not receive a margin call. d. What is the rate of return on her investment?  Rate of return: ($4,680 - $,8000) / $8,000 = -0.415 = -41.5% 7. Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams from the previous problem. The initial margin requirement was 50%. (The margin 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?  The initial margin was: $40 x 1,000 x 50% = $20,000  $10 increases in stock price: $10 x 1,000 = $10,000  Dividends: $2 x 1,000 = $2,000  The remaining margin in the account: $20,000 - $10,000 - $2,000 = $8,000 b. If the maintenance margin requirement is 30%, will Old Economy receive a margin call?  Percentage margin = $8,000 / ($50 x 1,000) = 0.16 = 16% Because percent margin is lower than maintenance margin requirement, 16% < 30%, Old Economy will receive a margin call. c. What is the rate of return on the short position (treating the initial margin as the amount invested)?  Rate of return = ($8,000 - $20,000) / $20,000 = -0.6 = -60% 14. Here is some price information on FinCorp stock. Suppose that FinCorp trades in a dealer market. Bid $55.25 Ask $55.50 a. Suppose you have submitted an order to your broker to buy at market. At what price will your trade be executed?  The price that my trade will be executed is $55.50. b. Suppose you have submitted an order to sell at market. At what price will your trade be executed?  The price of selling my order at market is $55.25. c. Suppose you have submitted a limit order to sell at $55.62. What will happen?  The trade will be executed until the bid price raised to $55.62 or above. d. Suppose you have submitted a limit order to buy at $55.37. What will happen?  The trade will be executed when the ask price is dropped to $55.37 or below.

15. You’ve borrowed $20,000 on margin to buy shares in Ixnay, which is now selling at $40 per share. Your account starts at the initial margin requirement of 50%. The maintenance margin is 35%. Two days later, the stock price falls to $35 per share. a. Will you receive a margin call? 1000 P − $ 20000 1000 P = 35% 1000 P − $ 20000 = 350 P 650 P = $ 20000 P = $ 30.77  The stock price after two days of purchase is $35, which is higher than the price of margin call. Therefore, I will not receive a margin call. b. How low can the price of Ixnay shares fall before you receive a margin call?  I will receive a margin call when the price falls to $30.77 or below. CFA 2. If you place a limit 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?  The answer is b. $55.

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