CHAPTER 3

TRADING ON SECURITIES MARKETS

PROBLEMS:
1. Individual solution—answers to this problem will vary. In general, full-service
brokers charge more fees/commission on trading than the discount brokers
because full-service entails cost for the resources such as personnel (financial
advisors), facilities and technologies.

2. a. In principle, potential losses are unbounded, growing directly with increases in

the share price of Restaurant Brands.

b. If the stop-buy order can be filled at $78, the maximum possible loss per share is
$8. If Restaurant Brand’s shares go above $78, the stop-buy order is executed,
limiting the losses from the short sale.

3. a. The stock is purchased for 300  $40 = $12,000. Borrowed funds are $4,000.
Therefore, the investor put up equity or margin of $8,000.

b. If the share price falls to $30, the total value of the stocks falls to $9,000. The
amount of the loan owed to the broker grows to $4,000  1.08 = $4,320.
Therefore, remaining margin is $9,000  $4,320 = $4,680.

The percentage margin is now $4,680/$9,000 = 0.52 = 52%, so there will not be
a margin call.

c. The rate of return on investment over the years is (Ending value of account 
Initial equity)/Initial equity = ($4,680  $8,000)/$8,000 = 0.415 = 41.5%.

4. a. The initial margin was 0.50  1,000  $40 = $20,000. Old Economy Traders loses $10
 1,000 = $10,000 due to the increase in the stock price so margin falls by $10,000.
Moreover, the firm must pay the dividend of $2 per share, which means the margin
account falls by an additional $2,000. So, the remaining margin is $8,000.

b. The percentage margin is $8,000/$50,000 = 0.16 = 16%, so there will be a margin

call.

c. The margin in the account fell from $20,000 to $8,000 in one year, for a rate of
return of $12,000/$20,000 = 0.60 = 60%.

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5. The stop-loss order will be executed as soon as the stock price hits the limit
price. If the stock price later rebounds, the investor does not participate in the
gains because the stock has been sold. In contrast, the put option need not be
exercised when the stock price falls below the exercise price. An investor who
owns a share of stock and a put option can hold on to both securities. If the stock
price never rebounds, the put can be exercised eventually, and the stock sold for
the exercise price. This provides the same downside protection as the stop-loss
order. If the price does rebound, however, the investor benefits because the stock
is still held. This advantage of the put over the stop-loss order justifies the cost
of the put.

6. Calls are options to purchase a stock at any time prior to expiration. Stop-buys
require purchase as soon as the stock price hits the limit. The advantage of the call
over the stop-buy is that the investor need not commit to buying until expiration.
If the stock price later falls, the holder of the call can choose not to purchase.

7. Placing a stop-loss order to sell at $38, you are telling your broker to sell Barrick
stock as soon as a sale takes place at a price of $38 or less. Here, the broker will
attempt to execute your order considering the bid price. Since the bid price now
is $37.80 which is below $38, the broker executes your order (at current market
price) and sell the stock at $37.80.

8. The broker is instructed to attempt to sell your Kinross stock as soon as the Kinross
stock trades at a bid price of $11.50 or less. Here, the broker will attempt to execute,
but may not be able to sell at $11.50, since the bid price is now $11.47. The price at
which you sell may be more or less than $11.50 because the stop-loss becomes a
market order to sell at current market prices. If the bid has sufficient quantity you are
likely to get $11.47, however.

9. a. The buy order will be filled at the best limit-sell order, $50.25.

b. At the next-best price, $51.50.

c. You should increase your position. There is considerable buy pressure at prices just
below $50, meaning that downside risk is limited. In contrast, sell pressure is
sparse, meaning that a moderate buy order could result in a substantial price
increase.

10. The system expedites the flow of market orders or limit 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.

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11. The dealer (or market maker). Spreads should be higher on inactive stocks and lower on
active stocks.

12. Cost of purchase is $80 × 250 = $20,000. You borrow $5,000 from your broker,
and invest $15,000 of your own funds. Your margin account starts out with a net
worth of $15,000.

a. (i) Net worth rises by $2,000 from $15,000 to $88 × 250 – $5,000 = $17,000.

Percentage gain = $2,000/$15,000 = 0.1333 = 13.33%

(ii) With unchanged price, net worth remains unchanged.

Percentage gain = zero

(iii) Net worth falls to $72 × 250 – $5,000 = $13,000.

Percentage gain = = –0.1333 = –13.33%

The relationship between the percentage change in the price of the stock and the
investor’s percentage gain is given by:

% gain = % change in price × = % change in price × 1.333

For example, when the stock price rises from $80 to $88, the percentage change in
price is 10%, while the percentage gain for the investor is 1.333 times as large,
13.33%:

% gain = 10% × = 13.33%

b. The value of the 250 shares is 250P. Equity is 250P – $5,000. You will receive
a margin call when

250 P−5 , 000

250 P = 0.3 or when P = $28.57

c. The value of the 250 shares is 250P. But now you have borrowed $10,000 instead of
$5,000. Therefore, equity is only $250P – $10,000. You will receive a margin call
when

250 P−10 , 000

=. 3
250 P or when P = $57.14

Bodie et al. Investments 10th Canadian Edition Solutions Manual

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 With less equity in the account, you are far more vulnerable to a margin call.

d. The margin loan with accumulated interest after one year is $5,000 × 1.08 = $5,400.
Therefore, equity in your account is $250P – $5,400. Initial equity was $15,000.
Therefore, your rate of return after one year is as follows:

(250×$ 88−$ 5 , 400 )−$ 15 , 000

(i) $ 15 , 000 = 0.1067, or 10.67%.

(250×$ 80−$ 5 , 400 )−$ 15 , 000

(ii) $ 15 , 000 = –0.0267, or –2.67%.

(250×$ 72−$ 5 , 400)−$ 15 , 000

(iii) 15 , 000 = –0.160, or –16.0%.

The relationship between the percentage change in the price of WN and

investor’s percentage return is given by

% gain = × – 8% ×

For example, when the stock price rises from $80 to $88, the percentage change
in price is 10%, while the percentage gain for the investor is

% gain = 10% × – 8% × = 10.67%

e. The value of the 250 shares is $250P. Equity is $250P – $5,400. You will
receive a margin call when

250 P−5 , 400

250 P = 0.3 or when P = $30.86

13. a. The gain or loss on the short position is (–250 × ΔP). Invested funds are
$15,000. Therefore, rate of return = (–250 × ΔP)/$15,000. The returns in each
of the three scenarios are

(i) Rate of return = (–250 × $8)/$15,000 = –0.1333 = –13.33%

(ii) Rate of return = (–250 × $0)/$15,000 = 0

(iii) Rate of return = [–250 × (–$8)]/$15,000 = +0.1333 = +13.33%

Bodie et al. Investments 10th Canadian Edition Solutions Manual

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 b. Total assets in the margin account are $20,000 (from the sale of the stock) +
$15,000 (the initial margin) = $35,000; liabilities are $250P. A margin call will be
issued when

35 , 000−250 P
250 P = .30, or when P = $107.69.

c. (a.) With a $2 dividend, the short position must also pay $2/share × 250 shares
= $500 on the borrowed shares. Rate of return will be (–250 × ΔP –
$500)/$15,000.

(i) Rate of return = (–250 × $8 – $500)/$15,000 = –0.167 = –16.7%

(ii) Rate of return = (–250 × $0 – $500)/$15,000 = –0.033 = –3.33%

(iii) Rate of return = [–250 × (–$8) – 500]/$15,000 = +0.100 = +10.0%

(b.) Total assets (net of the dividend repayment) are $35,000 – $500, and
liabilities are $250P. A margin call will be issued when

= 0.30, or when P = $106.15

14. a. The trade will be executed at the price of $55.50.

b. The trade will be executed at the price of $55.25.

c. The trade will not be executed since the bid price is less than the price on the
limit sell order.

d. The trade will not be executed since the asked price is greater than the price on
the limit buy order.

15. The proceeds from the short sale (net of commission) were $14 × 100 – $50 =
$1,350. A dividend payment of $200 was withdrawn from the account.
Coverage at $9 cost you (including commission) $900 + $50 = $950, leaving you
with a profit of $1350 – $200 – $950 = $200.

Note that your profit, $200, equals 100 shares × profit per share of $2. Your net
proceeds per share were:
$14 sales price of stock
– $ 9 repurchase price of stock
– $ 2 dividend per share
– $ 1 2 trades × $.50 commission per share on each trade.
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 –––––––
$ 2

16. a. You buy 200 shares of Dollarama. These shares increase in value by 10%, or
$1000. You pay interest of .08 × $5,000 = $400. The rate of return will be

= 0.12, or 12%.

b. The value of the 200 shares is 200P. Equity is 200P – $5,000. You will receive
a margin call when

200 P−5000
200 P = 0.30 or when P = $35.71.

17. a. You will not receive a margin call. You borrowed $20,000 and with another
$20,000 of your own equity you bought 500 shares of Bombardier at $80 a share.
At $75 a share the market value of the stock is $37,500, your equity is $17,500,
and the percentage margin is $17,500/$37,500 = 46.7%, which is above the
required maintenance margin.

b. A margin call will be issued when

500 P−20 , 000

500 P = 0.35, or when P = $61.54.

18. a. Initial margin is 50% of $2,500 or $1,250.

b. Total assets are $3,750 and liabilities are 100P. A margin call will be issued
when

3750−100 P
=¿ 0 .30, or when P = $28.85.
100 P

19. a. The proceeds from the short sale were $45 × 100 = $4,500. Your funds will be
$4,500 × .6 = $2,700. If the stock price goes up to $50 you owe $50 × 100 =
$5,000 and your position will be

Assets Liabilities
Cash $4,500 Short position $5,000
Funds $2,700 Equity $2,200

Your rate of return will be –18.5% (= $2,200/$2,700 – 1)

Bodie et al. Investments 10th Canadian Edition Solutions Manual

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 b. Total assets are $7,200 and liabilities are 100P. A margin call will be issued
when

7200−100 P
100 P = 0.30, or when P = $55.38.

20. The NYSE, which is owned by the Intercontinental Exchange (ICE) is the
leading exchange in terms of value of stocks listed (market capitalization), as
well as trading activity (value of trading). The Nasdaq is in second place for both
value of listed stocks and value of trading.
CFA Problems
1. d; the broker will attempt to sell after the first transaction at $55 or less.

2. a. In addition to the explicit fees of $70,000, FBN appears to have paid an implicit
price in underpricing of the IPO. The underpricing is $3/share or $300,000 total,
implying total costs of $370,000.
b. No. The underwriters do not capture the part of the costs corresponding to the
underpricing. The underpricing may be a rational marketing strategy. Without it,
the underwriters would need to spend more resources to place the issue with the
public. They would then need to charge higher explicit fees to the issuing firm.
The issuing firm may be just as well off paying the implicit issuance cost
represented by the underpricing.

3. d

4. b; there are regulations in place governing short selling activities.

Bodie et al. Investments 10th Canadian Edition Solutions Manual

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