Investment Analysis (FIN 670) Fall Homework 2

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1 Investment Analysis (FIN 670) Fall 2009 Homework 2 Instructions: please read carefully You should show your work how to get the answer for each calculation question to get full credit The due date is Tue, Sep 29, Late homework will not be graded. Name(s): Student ID

2 Chapter 3 1. Market orders are buy or sell order that will be executed immediately at prices 1. b a. the best b. current market c. the highest d. the lowest 2. Trading of exiting stock take place in the. 2. a a. secondary market b. third market c. forth market d. All of the above. 3. You purchased 100 shares of AAA common stock on margin for $40 per share. The initial margin is 60% and the stock pays no dividend. Your rate of return would be if you sell the stock at $43 per share a % b. -7.5% c. 7.5% d. 12.5% 3.d Intial position Stock 4000 Borrowed 1600 Equity 2400 When stock price is 43, the position is Stock 4300 Borrowed 1600 Equity 2700 Return = ( )/ 2400 = 12.5% 4. The price is the price a dealer is willing to purchase a security. a. Bid b. Ask c. Limit d. Offering 4. a 5. You purchased ABC stock at $50 per share. The stock is currently selling at $49. Your potential loss could be reduced by placing a. a. limit-buy order b. limit-sell order c. market order d. stop-loss order

3 5. d 6. The Nasdaq Stock Market is a. a. primary market b. secondary market c. dealer market d. Both B and C above. 6. d 7. You purchased 400 shares of XYZ common stock on margin at $20 per share. Assume the initial margin is 60% and the maintenance margin is 30%. You would get a margin call if the stock price is below. Assume the stock pays no dividend and ignore interest on margin. a. $15.71 b. $11.43 c. $13.57 d. $ b Initial position: Stock 400*2 = 800 borrowed 3200 Equity 4800 Let P be the price you would get a call Position Stock 400P borrowed 3200 Equity 400P-3200 To get a margin cal (400P 3200)/400P = 0.3 P = So when P is below 11.43, you will get a margin call 8. You sold short 200 shares of XYZ common stock at $40 per share with an initial margin of 60%. Your initial investment was. a. $3,200 b. $4,800 c. $6,000 d. $8, b Cash (Sale) 8000 borrowed 8000 Cash (deposit) 4800 Equity In buying on margin, the margin is the of the investor's account a. loan amount b. equity value c. total value d. none of the above

4 9. b 10. In a, the investment bankers purchase securities from the issuing company and then resell to the public. a. best-efforts agreement b. total package agreement c. firm commitment d. private placement 10. c 11. Electronic Communication Networks are private computer networks that link. a. buyers and sellers b. different stock exchanges c. different stock brokers d. global stock exchanges 11. a 12. You wish to sell short 100 shares of XYZ corporation stock. If the last two transactions were at $34.12 followed by $34.25, you can sell short on the next transaction only at a price of a or higher b or higher c or lower d or lower 12. b As a regulation, you can only short sell if the price goes up compared with the last transaction. In this case, the current price is 34.25, the next price has to be higher than in order for you to be able to short sell. 13. 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 day order expires at the close of the trading day. e. None of the above. 13. e All of the order descriptions above are correct.

5 14. Assume you sold short 200 shares of common stock at $60 per share. The initial margin is 50%. What would be the maintenance margin if a margin call was made at a stock price of $70? a. 29% b. 40% c. 25% d. 33% e. none of the above 14. a $200 x $60 x 1.5 = $18,000; [$18, ($70)]/200($70) = 28.6%. 15. Assume you sell short 100 shares of Citibank 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 per 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. 25% b. 22% c. 20% d. 77% e. none of the above 15. b Profit on stock = ($45 - $40) * 100 = $500, $500/$2,250 (initial investment) = 22.22%. 16. Shelf registration a. increases transaction costs to the issuing firm b. allows firms to register securities for sale for a two-year period. c. is a way of placing issues in the primary market. d. A and C e. B and C 16. e Shelf registration allows firms to register securities for sale for a two-year period and is a way of placing issues in the primary market. 17. A sale by Wal-Mart of new stock to the public would be a(n) a. short sale b. initial public offering. c. secondary market transaction d. seasoned equity offering. e. none of the above. 17. A sale by Wal-Mart of new stock to the public would be a seasoned new issue offering.

6 18. You sell short 200 shares of Bad Co. at a market price of $55 per share. Your maximum possible loss is a. $11,000. b. zero. c. unlimited. d. $22,000. e. cannot tell from the given information 18. c The potential loss on a short sale is theoretically unlimited. You are required to replace the stock and theoretically, the stocks price could go to infinity. 19. Assume you purchased 100 shares of common stock at $50 per share using 2,500 of your own money. The initial margin requirement is 50%. If the maintenance margin is 30%, at what prince would you get a margin call? a. $26.14 b. $50.00 c. $35.71 d. $77.12 e. $ shares * $50 *.5 = $5,000 * 0.5 = $2,500 (loan amount); 0.30 = (100P - $2,500)/100P; 30P = 100P - $2,500; -70P = -$2,500; P = $ Consider the following limit order book of a specialist. The last trade occurred at a price of $50. Limit buy orders Limit sell orders Price Shares Price Shares 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? 51.50

7 c. If you were the specialists, would you want to increase or decrease your inventory of this stock The responsibilities of the specialists are (1) match buyers and seller (i.e., find the best seller for the buyer and best buyer for the seller), (2) maintain the liquidity for the market (i.e., if there is no buyer for the seller, or no seller for the buyer, the specialists will come in and buy from the seller or sell to the buyer). In this case, the buy side has more order than the sell side, therefore, the specialists have to be ready to sell to the buyer, so they should increase their inventory 21. Here is some information on XYZ stock. Suppose first that XYZ trades in a dealer market such as Nasdaq Bid Ask 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 your broker to sell at market. At what price will your trade be executed c. Suppose you have submitted a limit order to sell at What will happen As soon as the price rises above 55.62, you sell the stock. In this case, the order will not be executed immediately. Since the price the dealer is willing to buy is which is below the limit price you set. d. Suppose you have submitted a limit order to buy at What will happen As soon as the price fall below 55.37, you buy the stock. In this case, the order will not be executed immediately. Since the price the dealer is willing to sell is which is above the limit price you set.

8 22. Now reconsider question 14, assume that XYZ trades in an exchange market like NYSE (specialist system). Is there any chance of an immediate trade at for the limit buy order in part d. Explain Whereas the limit order to buy at $55.37 would not be executed in a dealer market (since the asked price is $55.50), it could be executed in an exchange market. A broker for another customer with an order to sell at market would view the limit buy order as the best bid price; the two brokers could agree to the trade and bring it to the specialist, who would then execute the trade. 23. 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 requirements is 50% Asset Liabilities + Equity Cash (sale): 100*50 = 5000 Borrow: 100*50 = 5000 Cash (deposit): 50%*5000 = 2500 Equity: 2500 Answer: cash deposit is 2500 b. How high can the price of the stock go before you get a margin call if the maintenance margin is 30% Position Asset Liabilities + Equity Cash (sale): 100*50 = 5000 Borrow: 100*P = 100P Cash (deposit): 50%*5000 = 2500 Equity: P To get a margin call ( P)/100P = 0.3 P = $57.69 So when P = $57.69 or higher, you will get a margin call

9 24. You are bullish on Telecom stock. The current market price is $50 per share, and you have $5000 of your own to invest. You borrow an additional $5000 from your broker at an interest rate 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 dividend) a. You buy 200 shares of Telecom for $10,000. These shares increase in value by 10%, or $1,000. You pay interest of: 0.08 x 5,000 = $400 The rate of return will be: $ 1,000 $400 = 0.12 = 12% $5,000 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. b. The value of the 200 shares is 200P. Equity is (200P $5,000). You will receive a margin call when: Initial position: Stock 50*200 = borrowed 5000 Equity 5000 Let P be the price you would get a call Position Stock 200P borrowed 5000 Equity 200P-5000 You will receive a margin call when: 200P $5,000 = 0.30 when P = $35.71 or lower 200P Chapter Which one of the following statements regarding open-end mutual funds is false? a. The funds redeem shares at net asset value. b. The funds offer investors professional management. c. The funds offer investors a guaranteed rate of return. d. B and C. e. A and B. 25. c

10 Open-end mutual funds redeem shares at net asset value and offer investors professional management. However, they do not offer investors a guaranteed rate of return. 26. Which one of the following statements regarding closed-end mutual funds is false? a. The funds always trade at a discount from NAV. b. The funds redeem shares at their net asset value. c. The funds offer investors diversification. d. A and B. e. None of the above 26. d Closed-end mutual funds trade at premiums and discounts from NAV 27. Which of the following functions do mutual fund companies perform for their investors? a. Record keeping and administration b. Professional management c. Diversification and divisibility d. Lower transaction costs e. All of the above 27. e Mutual fund companies provide record keeping and administration, professional management, diversification and divisibility, and lower transaction costs. 28. Large amounts of money invested in a portfolio that is fixed for the life of the fund are called a. closed-end funds. b. unit investment trusts. c. REITS. d. open-end funds. e. redeemable trust certificates. 28. b Large amounts of money invested in a portfolio that is fixed for the life of the fund are called unit investment trusts. 29. At issue, offering prices of open-end funds will typically be a. less than NAV due to limited demand. b. greater than NAV due to greater demand. c. less than NAV due to loads and commissions. d. NAV or greater due to loads and commissions. e. less than or greater than NAV with no apparent pattern. 29. d At issue, offering prices of open-end funds will typically be NAV or greater due to loads and commissions.

11 30. Ultra Fund had year-end assets of $862,000,000 and liabilities of $12,000,000. There were 32,675,254 shares in the fund at year-end. What was Ultra Fund's Net Asset Value? a. $28.17 b. $25.24 c. $19.62 d. $26.01 e. $ d NAV = (862,000,000-12,000,000)/ 32,675,254 = Premier Fund had year-end assets of $825,000,000 and liabilities of $25,000,000. If Premier's NAV was $32.18, how many shares must have been held in the fund? a. 21,619,346,92 b. 22,930, c. 24,860, d. 25,693, e. None of the above. 31. c (Assets liabilities) / shares = NAV; 800M / S = 32.18; S = 24,860, Most actively managed mutual funds, when compared to a market index such as the Wilshire 5000, 32. d a. beat the market return in all years. b. beat the market return in most years. c. exceed the return on index funds. d. do not outperform the market. e. None of the above is a correct statement. 33. You purchased shares of a mutual fund at a price of $17 per share at the beginning of the year and paid a front-end load of 5.0%. If the securities in which the find invested increased in value by 12% during the year, and the funds expense ratio was 1.0%, your return if you sold the fund at the end of the year would be. a b c d e. None of the above 33. b {[$17 *.95*( )]-$17} / $17 = 5.45%.

12 34. Which of the following statements is true about hedge funds? a. Hedge funds are mutual funds that specialize in derivative investments designed primarily for hedging purposes. b. Because of their large size and varied investments, hedge funds are closely regulated by both the SEC and the CFTC. c. The term hedge fund derives from a common hedge fund strategy based on anticipated changes in relative valuations in two market sectors. d. Investments in hedge funds are very liquid, which means that investors in a hedge fund can withdraw their investments at any time without risk of loss in market value. 34. a 35. Open-end equity mutual funds find it necessary to keep a significant percentage of total investments, typically around 5% of the portfolio, in very liquid money market assets. Closed-end funds do not have to maintain such a position in cash-equivalent securities. What difference between open-end and closed-end funds might account for their differing policies? Open-end funds are obligated to redeem investor's shares at net asset value, and thus must keep cash or cash-equivalent securities on hand in order to meet potential redemptions. Closed-end funds do not need the cash reserves because there are no redemptions for closed-end funds. Investors in closed-end funds sell their shares when they wish to cash out.

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