CHAPER 1:

1. Financial engineering has been disparaged as nothing more than paper shuffling. Critics
argue that resources used for rearranging wealth (i.e. bundling and unbundling financial assets)
might be better spent on creating wealth. Evaluate this criticism. Are any benefits realized by
creating an array of derivative securities from various primary securities?
While it is ultimately true that real assets determine the material well-being of an
economy, financial innovation in the form of bundling and unbundling securities creates
opportunities for investors to form more efficient portfolios. Both institutional and individual
investors can benefit when financial engineering creates new products that allow them to manage
their portfolios of financial assets more efficiently. Bundling and unbundling create financial
products with new properties and sensitivities to various sources of risk that allows investors to
reduce volatility by hedging sources of risk more efficiently.

2. Why would you expect securitization to take place only in highly developed capital
markets?
Securitization requires access to a large number of potential investors. To attract these
investors, the capital market needs:
 a safe system of business laws and low probability of confiscatory taxation/regulation.
 a well-developed investment banking industry.
 a well-developed system of brokerage and financial transactions.
 well-developed media, particularly financial reporting.
These characteristics are found in (indeed make for) a well-developed financial market.

3. What is the relationship between securitization and the role of financial intermediaries in
the economy? What happens to financial intermediaries as securitization progresses?
Securitization leads to disintermediation; that is, securitization provides a means for
market participants to bypass intermediaries. For example, mortgage-backed securities channel
funds to the housing market without requiring that banks or thrift institutions make loans from
their own portfolios. As securitization progresses, financial intermediaries must increase other
activities such as providing short-term liquidity to consumers and small business, and financial
services.

4. Although we stated that real assets comprise the true productive capacity of an economy,
it is hard to conceive of a modern economy without well-developed financial markets and
security types. How would the productive capacity of the U.S. economy be affected if there were
no markets in which one could trade financial assets?
 The existence of efficient capital markets and the liquid trading of financial assets make it
easy for large firms to raise the capital needed to finance their investments in real assets.
 If BHP, for example, could not issue stocks or bonds to the general public, it would have
a far more difficult time raising capital.
  Contraction of the supply of financial assets would make financing more difficult,
thereby increasing the cost of capital.
 A higher cost of capital results in less investment and lower real growth.

5. Firms raise capital from investors by issuing shares in the primary markets. Does this
imply that corporate financial managers can ignore trading of previously issued shares in the
secondary market?
Even if the firm does not need to issue stock in any particular year, the stock market is
still important to the financial manager. The stock price provides important information about
how the market values the firm's investment projects. For example, if the stock price rises
considerably, managers might conclude that the market believes the firm's future prospects are
bright. This might be a useful signal to the firm to proceed with an investment such as an
expansion of the firm's business.
In addition, shares that can be traded in the secondary market are more attractive to initial
investors since they know that they will be able to sell their shares. This in turn makes investors
more willing to buy shares in a primary offering and thus improves the terms on which firms can
raise money in the equity market.
Remember that stock exchanges like those in New York, London, and Paris are the heart of
capitalism, in which firms can raise capital quickly in primary markets because investors know
there are liquid secondary markets.

6. Suppose you discover a treasure chest of $10 billion in cash.

a. is this a real or financial asset?
Yes. 10 billion cash is the financial asset. Because it is the liability of the federal
government.
b. is society any richer for the discovery?
No. The cash does not directly add to the productive capacity of the economy.
c. are you wealthier?
Yes. You would become wealthier with RM10 billion cash.
d. can you reconcile your answers to B and C? Is anyone worse off as a result of the
discovery?
Yes, Society as a whole is worse off, since taxpayers, as a group will make up for
the liability.

7. Lanni Products is a start-up computer software development firm. It currently owns

computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni’s
owners. For each of the following transactions, identify the real and/or financial assets that trade
hands. Are any financial assets created or destroyed in the transaction?
a. Lanni takes out a bank loan. It receives $50,000 in cash and signs a note promising to
pay back the loan over 3 years.
The bank loan is a financial liability for Lanni. The cash Lanni receives is a financial
asset. The new financial asset created is Lanni's promissory note held by the bank.
 b. Lanni uses the cash from the bank plus $20,000 of its own funds to finance the
development of new financial planning software.
The cash paid by Lanni (both the loan and its own cash) is the transfer of a
financial asset to the software developer. In return, Lanni gets a real asset, the
completed software. No financial assets are created or destroyed. Cash is simply
transferred from one firm to another
The cash paid by Lanni (both the loan and its own cash) is the transfer of a
financial asset to the software developer. In return, Lanni gets a real asset, the
completed software. No financial assets are created or destroyed. Cash is simply
transferred from one firm to another
The cash paid by Lanni (both the loan and its own cash) is the transfer of a financial asset
to the software developer. In return, Lanni gets a real asset, the completed software. No financial
assets are created or destroyed. Cash is simply transferred from one firm to another.
c. Lanni sells the software product to Microsoft, which will market it to the public under
the Microsoft name. Lanni accepts payment in the form of 1,500 shares of Microsoft stock.
Lanni sells the software, which is a real asset, to Microsoft. In exchange Lanni receives a
financial asset, 1,500 shares of Microsoft stock. If Microsoft issues new shares in order to pay
Lanni, this would constitute the creation of new financial asset.
d. Lanni sells the shares of stock for $80 per share and uses part of the proceeds to pay
off thebank loan.
In selling 1,500 shares of stock for $120,000, Lanni is exchanging one financial asset for
another. In paying off the IOU with $50,000, Lanni is exchanging financial assets (+$70,000
cash). The loan is "destroyed" in the transaction, since it is retired when paid.

8. Reconsider Lanni Products from Problem 7.

a. Prepare its balance sheet just after it gets the bank loan. What is the ratio of real assets
to total assets?
Assets Liabilities & Shareholder’s Equity
Cash $70,000 Bank loan $50,000
Computers $30,000 Shareholder’s Equity $50,000
(total assets – total
debt)
Total $100,000 Total $100,000

Ratio of real to total assets = $30,000/$100,000 = 0.3

b. Prepare the balance sheet after Lanni spends the $70,000 to develop its software
product. What is the ratio of real assets to total assets?

Assets Liabilities & Shareholder’s Equity

Software product $70,000 Bank loan $50,000
Computers $30,000 Shareholder’s Equity $50,000
Total $100,000 Total $100,000
 Ratio of real to total assets = $100,000/$100,000 = 1.0

c. Prepare the balance sheet after Lanni accepts the payment of shares from Microsoft.
What is the ratio of real assets to total assets?

Assets Liabilities & Shareholder’s Equity

Microsoft shares $120,000 Bank loan $50,000
($80/share)
Computers $30,000 Shareholder’s Equity $100,000
Total $150,000 Total $150,000

Ratio of real to total assets = $30,000/$150,000 = 0.2

((Conclusion: When the firm starts up and raises working capital, it will be characterised
by a low ratio of real to total assets. When it is in full production, it will have a high ratio of real
assets. When the project "shuts down" and the firm sells it, the percentage of real assets to total
assets goes down again because the product is again exchanged into financial assets))

9. Examine the balance sheet of commercial banks in Table 1.3. What is the ratio of real
assets to total assets?

The ratio of real assets = Total real assets/ Total assets

= $107.5 billion / $10,410.9 billion = 0.0103

What is that ratio for nonfinancial firms (Table 1.4)?

The ratio of real assets = Total real assets/ Total assets
= $13,295/$25,164 = 0.5283

Why should this difference be expected?

This difference occurs because a core function of financial institutions is to loan to
borrowers as a result more loans in the forms of financial assets accumulate on the balance sheet
of financial instituions. (Most of its assets are financial assets- there is very few equiptment). The
balance sheet of non-financial institiuions real assets pile up with plant and machinery required
for operation.

10. Figure 1.5 mờ quá em không thể xem đề để làm được

11. Discuss the advantages and disadvantages of the fol- lowing forms of managerial
compensation in terms of mitigating agency problems, that is, potential conflicts of
interest between managers and shareholders.

a. A fixed salary.
  A fixed salary means that compensation is (at least in the short run) independent
of the firm's success. This salary structure does not tie the manager's immediate
compensation to the success of the firm, so a manager might not feel too
compelled to work hard to maximize firm value. However, the manager might
view this as the safest compensation structure and therefore value it more highly.

b. Stock in the firm.

 A salary that is paid in the form of stock in the firm means that the manager earns
the most when the shareholders’ wealth is maximized. This structure is therefore
most likely to align the interests of managers and shareholders. If stock
compensation is overdone, however, the manager might view it as overly risky
since the manager’s career is already linked to the firm, and this undiversified
exposure would be exacerbated with a large stock position in the firm.

c. Call options on shares of the firm.

 Call options on shares of the firm create great incentives for managers to
contribute to the firm’s success. In some cases, however, stock options can lead to
other agency problems. For example, a manager with numerous call options might
be tempted to take on a very risky investment project, reasoning that if the project
succeeds the payoff will be huge, while if it fails, the losses are limited to the lost
value of the options. Shareholders, in contrast, bear the losses as well as the gains
on the project, and might be less willing to assume that risk.

12. We noted that oversight by large institutional investors or creditors is one mechanism to
reduce agency problems. Why don’t individual investors in the firm have the same incentive to
keep an eye on management?

 Even if an individual investor has the expertise and capability to monitor and
improve the managers' performance, the payoffs would not be worth the effort,
since hisownership in a large corporation is so small compared to that of
institutional investors.
 These normally take place when people or entities serve their personal interests
rather than keeping up with their professional responsibilities. Put simply, a
conflict of interest arises when someone puts their own personal gain ahead of
their own duties to the corporation.

13. Give an example of three financial intermediaries and explain how they act as a bridge
between small investors and large capital markets or corporations.

 Banks accept deposits from customers and loan those funds to businesses or use the funds
to buy securities of large corporations.
 Pension funds accept funds and then invest, on behalf of current and future retirees,
thereby channeling funds from one sector of the economy to another.
 Commercial banks mobilize capital mainly in the form of: payment deposits, savings
deposits, and time deposits. Funds raised are used for lending: commercial loans,
 consumer loans, real estate loans and to buy government securities, local government
bonds.
 Mutual funds accept funds from small investors and invest, on behalf of these investors,
in the national and international securities markets.

14. The average rate of return on investments in large stocks has outpaced that on
investments in Treasury bills by about 8% since 1926. Why, then, does anyone invest in
Treasury bills?

Although the return on stock has been higher than T-bills since 1926, some investors
choose to invest into these bills because they have a low risk (can be said to be risk-free)
tolerance and want a stable return. U.S. treasury bills are the safest investment in the world
which is attractive to some people.

15. What are some advantages and disadvantages of top- down versus bottom-up investing
styles?

Advantage:
 A “top-down” investing style focus on asset allocation of the entire portfolio.
 Top-down investing strategy pays more attention to overall economic and political
conditions of a country which can affect the performance of a particular industry.
Disadvantage:
 Top-down investing strategy may ignore undervalued securities. Undervalued securities
are a good bet for investment. Undervalued stock means that it is selling for a price below
its true intrinsic value. Undervalued stocks are estimated by analyzing company's
financial statements its fundamentals, such as price/earnings ratio, return on assets and
profit retention. But top-down investment strategy tends to overlook such securities
which can give potential returns to investors.

16. You see an advertisement for a book that claims to show how you can make $1 million
with no risk and with no money down. Will you buy the book?
This is a false advertisement. I have learned, when investing must accept risk (the greater
the risk, the higher the return). All investments involve taking on risk. Before any proceeds are
made, an entrepreneur must bear the costs associated with the business. The financial market is
very competitive, to make 1 million dollars is not easy, to earn higher returns, one has to take
more risks. Therefore, it is possible to make a lot of money without risk, unless the activities are
illegal.

17. Below is an excerpt from the investor education Web site of the SEC.
a. How does the excerpt define the difference between saving and investing?
 Saving is usually put into the safest places, or products, that allow you access to your
money at any time. Savings products include savings accounts, checking accounts, and
certificates of deposit. But there’s a tradeoff for security and ready availability. Your
money is paid a low wage as it works for you. Most smart investors put enough money in
a savings product to cover an emergency, like sudden unemployment. Some make sure
 they have up to six months of their income in savings so that they know it will absolutely
be there for them when they need it.
 When you “invest,” you have a greater chance of losing your money than when you
“save.” The money you invest in securities, mutual funds, and other similar investments
typically is not federally insured. You could lose your “principal”—the amount you’ve
invested. But you also have the opportunity to earn more money.

b. In what ways does this differ from the economist’s definition given in this chapter?

Any type always comes with risks. The best way to limit risk is always to diversify tools
and portfolios and at the same time take a long-term view when planning investment
strategies.
“Don’t put all your eggs in one basket.” It is often said that the greater the risk, the
greater the potential reward of an investment, but taking unnecessary risks can often be
avoided. Investors are best protected against risk by spreading their money between different
investments, in the hope that if one investment loses, the other investments will more than
make up. cover those losses.
Once you've saved money to invest, carefully weigh all your options and think about which
diversification strategy is right for you (stocks and mutual funds, public bonds, etc.).
companies and municipalities, bond mutual funds, certificates of deposit, money market
funds, and USTreasury securities).
Diversification cannot guarantee that your investments will not be affected if the market
drops. But it can improve your chances of not losing money, or if you do, it won't be as much
as if you weren't diversifying.

Chapter III. How Securities Are Traded

1. 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 6 months from now.
b. Investing an equivalent amount in 6-month at-the-money call options on IBM stock
now and selling them 6 months from now.
Full-service broker: broker that provides a large variety of financial services to the client
including advise, research, and planning which usually costs service fees to the client instead of
brokerage fees
One discount broker: carrying out the buying and selling of the orders at a discounted rate (which
is less than the full service brokers because it doesn't include commission and other fees); they
are in service of the trading not the planning, etc

2. What purpose does the SuperDot system serve on the New York Stock Exchange?
The SuperDot system expedites the flow of orders from exchange members to the specialists. It
allows members to send computerized orders directly to the floor of the exchange, which allows
the nearly simultaneous sale of each stock in a large portfolio. This capability is necessary for
program trading.
 3. 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?
The dealer sets the bid and asked price. Spreads should be higher on inactively traded stocks and
lower on actively traded stocks.

4. Suppose you short sell 100 shares of IBM, now selling at $120 per share.
a. What is your maximum possible loss?
b. What happens to the maximum loss if you simultaneously place a stop-buy order at
$128?
a. In principle, potential losses are unbounded, growing directly with increases in the price of
IBM.
b. If the stop-buy order can be filled at $128, the maximum possible loss = (120-
128)*100=$800=$8 per share. If the price of IBM shares goes above $128, then the stop-buy
order would be executed, limiting the losses from the short sale.

5. 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?
b. If the share price falls to $30 per share by the end of the year, what is the
remaining margin in her account? If the maintenance margin requirement is 30%,
will she receive a margin call?
c. What is the rate of return on her investment?

a. The stock is purchased for $40 x 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 x (1 + Interest rate) = $4,000 x (1 + 0.08) = $4,320.
The value of the stock falls to: $30 x 300 shares = $9,000.

The remaining margin in the investor's account is:

Margin on long position = Equity in account / Value of stock
= $9,000 － $4,320 / $9,000 = 0.52 = 52%
Therefore, the investor will not receive a margin call.

c. Rate of return = Ending equity in account － Initial equity in account / Initial equity in account
= $4,680 － $8,000 / $8,000 = - 0.4150 = - 41.50%

6. 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?
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?
a. The initial margin was: $40 x 1,000 x 0.50 = $20,000.
As a result of the $10 increase in the stock price, Old Economy Traders loses: $10 x 1,000 shares
= $10,000. Moreover, Old Economy Traders must pay the dividend of $2 per share to the lender
of the shares: $2 x 1,000 shares = $2,000.
The remaining margin in the investor's account therefore decreases to: $20,000 - $10,000 -
$2,000 = $8,000.
b. Margin on short position = Equity Value of shares owed
$8,000 / $50 x 1,000 shares = 0.16 = 16%
Because the percentage margin falls below the maintenance level of 30%, there will be a margin
call.
c. The rate of return = Ending equity － Initial equity / Initial equity
= $8,000－ $20,000 / $20,000
= - 0.60 = - 60%
7. Do you think it is possible to replace market-making specialists with a fully automated,
computerized trade-matching system?
Much of what the specialist does (e.g., crossing orders and maintaining the limit order book) can
be accomplished by a computerized system. In fact, some exchanges use an automated system
for night trading. A more difficult issue to resolve is whether the more discretionary activities of
specialists involving trading for their own accounts (e.g., maintaining an orderly market) can be
replicated by a computer system.

8. Consider the following limit-order book of a specialist. The last trade in the stock
occurred at a price of $50.
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?
a. The market-buy order will be filled at $50.25, the best price of limit-sell orders in the book.
b. The next market-buy order will be filled at $51.50, the next-best limit-sell order price.
c. As a security dealer, you would want to increase your inventory. There is considerable buying
demand at prices just below $50, indicating that downside risk is limited. In contrast, limit-sell
orders are sparse, indicating that a moderate buy order could result in a substantial price increase.
 9. 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
Price per share $50
Equity invested $5,000
Borrowed funds $5,000
Interest rate 8.00%
Total investment $10,000
Price change 10.00%
Margin required 30.00%

Your initial investment is the sum of $5,000 in equity and $5,000 from borrowing, which enables
you to buy 200 shares of Telecom stock:
Initial investment / Stock price = $10,000 / $50 = 200 shares
The shares increase in value by 10%: $10,000 * 0.10 = $1,000.
You pay interest of = $5,000 * 0.08 = $400.
The rate of return will be:
$1,000 － $400 / $5,000 = 0.12 = 12%
The value of the 200 shares is 200P. Equity is (200P - $5,000), and the required margin is 30%.
Solving 200P －$5,000 / 200P = 0.30, we get P = $35.71.
You will receive a margin call when the stock price falls below $35.71.

10. 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?
Initial margin is 50% of $5,000, which is $2,500.
Total assets are $7,500 ($5,000 from the sale of the stock and $2,500 put up for margin).
Liabilities are 100P. Therefore, net worth is ($7,500 - 100P).
Solving $7,500－100P / 100P = 0.30, we get P = $57.69.
A margin call will be issued when the stock price reaches $57.69 or higher.

11. Suppose that Intel currently is selling at $40 per share. You buy 500 shares using
$15,000 of your own money, 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 1 year at: (i) $44; (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?
a. Equity increases to: ($44 * 500) - $5,000 = $17,000
Percentage gain = $2,000/$15,000 = 0.1333 = 13.33%
(ii) With price unchanged, equity is unchanged.
Percentage gain = 0
(iii) Equity falls to ($36 * 500) - $5,000 = $13,000
Percentage gain = (-$2,000/$15,000) = -0.1333 = -13.33%
b. The value of the 500 shares is 500P. Equity is (500P - $5,000). You will receive a margin call
when:

(500P-$5000)/500P
= 0.25 --> when P = $13.33 or lower
c. The value of the 500 shares is 500P. But now you have borrowed $10,000 instead of $5,000.
Therefore, equity is (500P - $10,000). You will receive a margin call when:

(500P-$10,000)/500P
= 0.25 --> when P = $26.67 or lower

With less equity in the account, you are far more vulnerable to a margin call
d. By the end of the year, the amount of the loan owed to the broker grows to:
$5,000 * 1.06 = $5,300
The equity in your account is (500P - $5,400). Initial equity was $15,000. Therefore, your rate of
return after one year is as follows:

i. [(500*$44) - $5300-$15000]/$15000 = 0.1133 = 11.33%

ii. [(500*$40)-$5300-$15000]/$15000 = (0.0200) = -2%

iii. [(500*$36)-$5300-$15000]/$15,000 = (0.1533 = -15.33%

e. The value of the 500 shares is 500P. Equity is (500P - $5,300). You will receive a margin call
when:

(500P-$5,300)/500P = 0.25 --> when P = 14.13 or lower

 12. 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 1 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? 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.

a. general --
share value (cash in) = 20,000
margin account (another asset/insurance) = 15,000
current debt = 20,000
current equity = 15,000

a) rate of return = (new equity - initial equity)/initial equity

(i) new equity = 35,000 - (44*500) = 13,000
(13,000 - 15,000)/15,000 = -13.33%

(ii) new equity = 35,000 - (40*500) = 15,000

0%

(iii) new equity = 35,000 - (36*500) = 17,000

(17,000 - 15,000)/15,000 = 13.33%
b. .25 = (35,000 - 500P)/500P
P = $56
c) rate of return = (new equity - initial equity)/initial equity
(i) new equity = 35,000 - (44*500) - 500 = 12500
(12500 - 15,000)/15000 = -16.67%

(ii) new equity = 35000 - (40*500) - 500 = 14,500

(14500 - 15000)/15000 = -3.33%

(iii) new equity = 35000 - (36*500) - 500 = 16,500

(16500 - 15000)/15000 = 10%

Price at which you get margin call --

(35000 - 500P - 500)/500P = $55.20

13. Here is some price information on Marriott:

Bid Asked
Marriott 37.95 38.05
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?
The broker is instructed to attempt to sell your Marriott stock as soon as the Marriott stock trades
at a bid price of $38 or less. Here, the broker will attempt to execute but may not be able to sell
at $38, since the bid price is now $37.95. The price at which you sell may be more or less than
$38 because the stop-loss becomes a market order to sell at current market prices

14. Here is some price information on Fincorp stock. Suppose first that Fincorp trades in
a dealert market.
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?
a. The trade will be executed at $55.50.
b. The trade will be executed at $55.25.
c. The trade will not be executed because the bid price is lower than the price specified in the
limit-sell order.
d. The trade will not be executed because the asked price is higher than the price specified in the
limit-buy order.
15. Now reconsider Problem 14 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)?
a) Price improvement:
The Asked Price is $55.50
The Limit order to sell is $55.50
The Limit order to buy is $55.37
Yes, there are chances of price improvement, which can be beneficial for both the buyer and the
seller.
As asked price is $55.50, it means that the price of Fincorp cannot go above $55.50. If trade is
executed at $55.37, then the customer will benefit by$0.13, as the limit order to sell is $55.62.
This means that prices may go up to $55.62 if the asked price is not an option.
In this way, customer benefits by:
Benefit = $55.37 - $55.50
= $0.13
The benefit is because customer needs to pay $0.13 less.
The seller will benefit by:
Benefit = $55.62 -$55.50
= $0.12
The seller will benefit by $0.12.
b. No, there is no immediate trade opportunity at $55.37 for a limit buy order in part (d) because
the price offered is higher than the price specified in the buy limit order
 16. You’ve borrowed $20,000 on margin to buy shares in Disney, 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?
b. How low can the price of Disney shares fall before you receive a margin call?
a. You will not receive a margin call. You borrowed $20,000 and with another $20,000 of your
own equity you bought 1,000 shares of Disney at $40 per share. At $35 per share, the market
value of the stock is $35,000, your equity is $15,000, and the percentage margin is:
$15,000/$35,000 = 42.9%
Your percentage margin exceeds the required maintenance margin.

b. You will receive a margin call when:

(1000P - $20,000)/1000P = 0.35 --> when P = $30.77 or lower

17. 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 proceeds from the short sale (net of commission) were: ($14 x 100) - $50 = $1,350
A dividend payment of $200 was withdrawn from the account. Covering the short sale at $9 per
share cost you (including commission): $900 + $50 = $950
Therefore, the value of your account is equal to the net profit on the transaction:
$1350 - $200 - $950 = $200
Note that your profit ($200) equals (100 shares x profit per share of $2). Your net proceeds per
share was:
$14 selling price of stock
-$9 repurchase price of stock
-$2 dividend per share
-$1 2 trades x $0.50 commission ea.
$2