Practice - Chapter 3 PDF

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Questions & Solutions for Chapter 3 of the main book....

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Essentials of Investments Chapter 3 Securities Markets 1) Underwriting is one of the services provided by ________. A) the SEC B) investment bankers C) publicly traded companies D) FDIC Answer: B

2) Barnegat Light sold 200,000 shares in an initial public offering. The underwriter's explicit fees were $90,000. The offering price for the shares was $35, but immediately upon issue, the share price jumped to $43. What is the best estimate of the total cost to Barnegat Light of the equity issue? A) $90,000 B) $1,290,000 C) $2,390,000 D) $1,690,000 Answer: D Explanation: Total cost = 90,000 + (43 - 35)200,000 = $1,690,000

3) When a firm decides to sell securities it must first ensure ________. A) the preliminary registration statement is approved by the SEC B) the IPO is complete C) the offering is seasoned D) the lockup period expires Answer: A 4) Rank the following types of markets from least integrated and organized to most integrated and organized: I. Brokered markets II. Continuous auction markets III. Dealer markets IV. Direct search markets A) IV, II, I, III B) I, III, IV, II C) II, III, IV, I D) IV, I, III, II Answer: D

5) As a result of flash crashes, the SEC is trying circuit breakers that will halt trading for 5 minutes if large stocks' prices change by more than ________ in a 5-minute period. A) 10% B) 20% C) 30% D) 40% Answer: A 6) Which one of the following is not an example of a brokered market? A) residential real estate market B) market for large block security transactions C) primary market for securities D) NASDAQ Answer: D 7) Purchases of new issues of stock take place ________. A) at the desk of the Fed B) in the primary market C) in the secondary market D) in the money markets Answer: B 8) Which one of the following is a false statement regarding NYSE specialists? A) On a stock exchange most buy or sell orders are executed via an electronic system rather than through specialists. B) Specialists cannot trade for their own accounts. C) Specialists maintain limit order books, which contain the outstanding unexecuted limit orders. D) Specialists stand ready to trade at narrower bid-ask spreads in cases where the spread has become too wide. Answer: B

9) The term latency refers to ________. A) the lag between when an order is placed on the NYSE and when it is executed. B) the amount of time it takes to accept, process, and deliver a trading order. C) the time it takes to implement new rules and procedures for stock exchanges and computer trading systems. D) the lag between when an order is executed and when the investor takes possession of the securities. Answer: B

10) Advantages of ECNs over traditional markets include all but which one of the following? A) lower transactions costs B) anonymity of the participants C) small amount of time needed to execute and order D) ability to handle very large orders Answer: D 11) When matching orders from the public, a specialist is required to use the ________. A) lowest outstanding bid price and highest outstanding ask price B) highest outstanding bid price and highest outstanding ask price C) lowest outstanding bid price and lowest outstanding ask price D) highest outstanding bid price and lowest outstanding ask price Answer: D 12) The bulk of most initial public offerings (IPOs) of equity securities goes to ________. A) institutional investors B) individual investors C) the firm's current shareholders D) day traders Answer: A 13) According to multiple studies by Ritter, initial public offerings tend to exhibit ________ performance initially and ________ performance over the long term. A) bad; good B) bad; bad C) good; good D) good; bad Answer: D 14) Specialists try to maintain a narrow bid-ask spread because: I. If the spread is too large, they will not participate in as many trades, losing commission income. II. The exchange requires specialists to maintain price continuity. III. Specialists are nonprofit entities designed to facilitate market transactions rather than make a profit. A) I only B) I and II only C) II and III only D) I, II, and III Answer: B

15) The ________ price is the price at which a dealer is willing to sell a security. A) bid B) ask C) clearing D) settlement Answer: B

16) The cost of buying and selling a stock includes: I. Broker's commissions II. Dealer's bid-asked spread III. Price concessions that investors may be forced to make A) I and II only B) II and III only C) I and III only D) I, II, and III Answer: D 17) Which of the following is (are) true about dark pools? I. They allow anonymity in trading. II. They often involve large blocks of stocks. III. Trades made through them might not be reported. A) I and II only B) II and III only C) I and III only D) I, II, and III Answer: D 18) Consider the following limit order book of a specialist. The last trade in the stock occurred at a price of $40. If a market buy order for 100 shares comes in, at what price will it be filled? Limit Buy Price $39.75 $39.50 A) $39.75 B) $40.25 C) $40.375 D) $40.25 or less

Orders Shares 100 100

Limit Sell Orders $40.25 $40.50

Orders Shares 100 100

Answer: D Explanation: In this case the specialist would have the option of matching the buy order with the lowest limit sell order ($40.25) or setting an ask price lower than $40.25 ($40 for example) and trading the order from her own stock.

19) You sold short 300 shares of common stock at $30 per share. The initial margin is 50%. You must put up ________. A) $4,500 B) $6,000 C) $9,000 D) $10,000 Answer: A Explanation: Investment = 300(30)(.50) = 4,500

20) You purchased 250 shares of common stock on margin for $25 per share. The initial margin is 65%, and the stock pays no dividend. Your rate of return would be ________ if you sell the stock at $32 per share. Ignore interest on margin. A) 35% B) 39% C) 43% D) 28% Answer: C Explanation:

= 0.43

21) You sell short 200 shares of Doggie Treats Inc. that are currently selling at $25 per share. You post the 50% margin required on the short sale. If your broker requires a 30% maintenance margin, at what stock price will you get a margin call? (You earn no interest on the funds in your margin account, and the firm does not pay any dividends.) A) $28.85 B) $35.71 C) $31.50 D) $32.25 Answer: A Explanation: Account at the time of the short sale: Cash from SS $5,000.00 Liability Cash For Equity $2,500.00 Equity TA $7,500.00 TL+E

$5,000.00 $2,500.00 $7,500.00

Account as prices change: Cash from SS $ 5,000.00 Cash For Equity $ 2,500.00 TA $ 7,500.00

Liability Equity TL+E

$ 200P $ 7,500−200P $ 7,500.00

Margin call if Equity/Market Value = 3 0.3 = ($7,500 − 200P)/200P 60P = $7,500 − 200P 260P = $7,500 P = $28.84615

22) All major stock markets today are effectively ________. A) specialist trading systems B) electronic trading systems C) continuous auction markets D) direct search markets Answer: B

23) If an investor uses the full amount of margin available, the equity in a margin account used for a stock purchase can be found as ________. A) market value of the stock - amount owed on the margin loan B) market value of the stock + amount owed on the margin loan C) market value of the stock ÷ margin loan D) margin loan × market value of the stock Answer: A 24) Maintenance requirements for margin accounts are set by ________. A) brokerage firms B) the SEC C) the Federal Reserve System's Board of Governors D) the Supreme Court Answer: A

25) Which of the following are true concerning short sales of exchange-listed stocks? I. Proceeds from the short sale must be kept on deposit with the broker. II. Short-sellers must post margin with their broker to cover potential losses on the position. III. The short-seller earns interest on any cash deposited with the broker that is used to meet the margin requirement. A) I only B) I and III only C) I and II only D) I, II, and III Answer: C 26) In ________ markets, participants post bid and ask prices at which they are willing to trade, but orders are not automatically executed by computer. ________ execute trades for people other than themselves, and in ________ markets a computer matches orders with an existing limit order book and executes the trades automatically. A) electronic; Dealers; brokers B) dealer; Brokers; electronic C) direct search; Brokers; electronic D) brokered; Dealers; direct search Answer: B

27) The primary market where new security issues are offered to the public is a good example of ________. A) an auction market B) a brokered market C) a dealer market D) a direct search market Answer: B

28) An investor buys $16,000 worth of a stock priced at $20 per share using 60% initial margin. The broker charges 8% on the margin loan and requires a 35% maintenance margin. The stock pays a $.50-per-share dividend in 1 year, and then the stock is sold at $23 per share. What was the investor's rate of return? A) 17.5% B) 19.67% C) 23.83% D) 25.75% Answer: C

Explanation: Value of stock in 1 yr Dividends received Interest due Loan payoff Ending account balance

$18,400 400 (512) (6,400) 11,888

Return = $11,888/$9,600 - 1 = 23.83% 29) Privately held firms may have only ________ shareholders. A) 10 B) 99 C) 250 D) 2,000 Answer: D...