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Chapter 3 How securities are traded
1. What is the difference between an IPO (initial public offering) and an SEO (seasoned equity offering)?  (LO 3-1)
2. What are some different components of the effective costs of buying or selling shares of stock?  (LO 3-3)
3. What is the difference between a primary and secondary market?  (LO 3-3)
4. How do security dealers earn their profits?  (LO 3-3)
5. In what circumstances are private placements more likely to be used than public offerings?  (LO 3-1)
6. What are the differences between a stop-loss order, a limit sell order, and a market order?  (LO 3-3)
7. Why have average trade sizes declined in recent years?  (LO 3-3)
8. What is the role of an underwriter? A prospectus?  (LO 3-1)
9. How do margin trades magnify both the upside potential and downside risk of an invest- ment portfolio?  (LO 3-4)
10. A market order has:  (LO 3-2)
a. Price uncertainty but not execution uncertainty.
b. Both price uncertainty and execution uncertainty.
c. Execution uncertainty but not price uncertainty.
11. Where would an illiquid security in a developing country most likely trade?  (LO 3-3)
a. Broker markets.
b. Electronic crossing networks.
c. Electronic limit-order markets.
12. Suppose you short-sell 100 shares of IBX, now selling at $200 per share.  (LO 3-4)
a. What is your maximum possible loss?
b. What happens to the maximum loss if you simultaneously place a stop-buy order at $210?
13. Call one full-service broker and one discount broker and find out the transaction costs of implementing the following strategies:  (LO 3-3)
a. Buying 100 shares of IBM now and selling them six months from now.
b. Investing an equivalent amount in six-month at-the-money call options on IBM stock now and selling them six months from now.
14. DRK, Inc., has just sold 100,000 shares in an initial public offering. The underwriter’s explicit fees were $60,000. The offmargin rateering price for the shares was $40, but immediately up
on issue, the share price jumped to $44.  (LO 3-1)
a. What is your best guess as to the total cost to DRK of the equity issue?
b. Is the entire cost of the underwriting a source of profit to the underwriters?
15. 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%.  (LO 3-4)
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?
16. Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dream
s from the previous question. 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.  (LO 3-4)
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?
17. Consider the following limit order book for a share of stock. The last trade in the stock occurred at a price of $50.  (LO 3-3)
Limit Buy Orders
Limit Sell Orders
Price
Shares
Price
Shares
$49.75
500
$50.25
100
49.5
800
51.5
100
49.25
500
54.75
300
49
200
58.25
100
48.5
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 a security dealer, would you want to increase or decrease our inventory of this stock?
18. 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.  (LO 3-4)
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.
19. You are bearish on Telecom and decide to sell short 100 shares at the current market price of $50 per share.  (LO 3-4)

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