WEEK THREE
REVIEW QUESTIONS AND PROBLEMS
Securities Markets and How Securities Are Traded
Do the following textbook questions and problems to review your readings. Then check your answers below.
Chapter 4, pages 115 to 116: Questions 4, 11, 13, 19, 21 and 24.
Chapter 5, pages 147 to 148: Questions 3, 4, 8, 10, 15, and 20.
Chapter 5, page 148: Problem 1.
ANSWERS TO REVIEW QUESTIONS
CHAPTER 4
4.The Dow-Jones Industrial Average is a price-weighted average of 30 large (blue-chip) stocks trading on the NYSE. The S&P 500 Composite Index is a market value index consisting of 500 stocks, with a base period set to 10 (1941-1943).
These measures are the two most often-used indicators of what U.S. stocks in general are doing. The Dow-Jones Averages are carried by The Wall Street Journal, while the S&P 500 Index is the indicator most often used by institutional investors.
11.Bought deals are when the issuer sells the entire issue of shares to one investment dealer (or a group of investment dealers), that attempts to resell the shares. The investment dealer accepts all of the price risk.
13.Marketing securities on a “best efforts” basis usually takes place when the issuing company is small and relatively speculative.
19.The equity markets in Canada consist of the organized exchanges (Toronto, Montreal, Vancouver, Alberta and Winnipeg), and the over- the-counter market.
Auction markets, involving exchanges, include a bidding (auction)
process in a specific physical location with brokers representing
buyers and sellers.
The over-the-counter (OTC) marketis a negotiated market where dealers make the market in securities by standing ready to buy from and sell to investors based on bid-ask prices.
21.A prospectus is a legal document that contains financial statements about the proposed use of the funds raised by the stock issue, future growth plans, and other relevant information.
24.A price-weighted index totals the prices of all the individual stocks within the index to get the index value.
A market-weighted index has each individual stock in the index weighted according to its market value (market price per share multiplied by the number of shares outstanding).
CHAPTER 5
3.If the actual margin declines below the maintenance margin, a margin call results, requiring the investor to put up additional cash or securities (or be sold out by the brokerage firm).
4.If an investor sells short, he or she is usually selling a security that is not owned. The broker borrows the security from another customer who owns it and lends it to the short seller who must subsequently replace it. In effect, the investor from whom the security is borrowed never knows it since his or her monthly statement continues to reflect a long position.
8.Both of these terms apply to limit orders. An open order remains in effect for six months unless cancelled or renewed. A day order is effective for only one day.
10.Investors may choose to use a full-service broker for several reasons. First, they may have confidence in a particular broker and wish to have the personal contact implied in such a relationship. Second, they can seek and obtain advice from the broker and, by extension, the entire resources of a firm such as RBC Dominion. Third, they can obtain considerable research reports and investing information. Fourth, full-service brokers may offer a wider range of services compared with many discount and Internet brokers, and investors needing such services will want to have them available.
15.Self-Regulatory Organizations (SROs) are organizations in the Canadian securities industry that regulate their own activities.
20.A sell limit order and a buy stop order are above the current market price.
A buy limit order and a sell stop order are below the current market price.
ANSWERS TO PROBLEMS
CHAPTER 5
1.(a)A limit order to sell is placed above the current market price. If the limit order is set at $130, the investor will realize a gross profit of at least $30 (ignoring transaction costs).
(b)A sell stop order is placed below the market price. If the stop order is placed at $120, the investor should realize a profit of approximately $20 per share. Technically, to be certain of $20 per share, the stop order probably would have to be set slightly above $120 because a stop price is actually an activator that initiates a market order when the specified price is reached.
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