FIN 353 CH 5 HW IQ AND CONCEPTS

On January 4, 2019, the DJIA opened at 12,608.56. The divisor at that time was .147691431. In January 2019, Boeing was the highest-priced stock in the DJIA and Cisco was the lowest. The closing price for Boeing on January 3, 2019, was $355.90, and the closing price for Cisco was $44.67. Suppose the next day the other 29 stock prices remained unchanged and Boeing increased 4.4 percent. What would the new DJIA level be? Now assume only Cisco increased by 4.4 percent. Find the new DJIA level

1. 12,608.56 + [(355.90 * 0.044) / .147691431] = 12,714.59 2. 12,608.56 + [(44.67 * 0.044) / .147691431] = 12,621.87

On January 4, 2019, the DJIA opened at 10,318.80. The divisor at that time was .147855317. Suppose on this day the prices for 29 of the stocks remained unchanged and 1 stock increased $4. What would the DJIA level be at the end of the day?

10,318.80 + (4/.147855317) = 10,354.85

On January 4, 2019, the DJIA opened at 12,498.11. The divisor at that time was .147574369. What would the new index level be if all stocks on the DJIA increased by $1.00 per share on the next day?

12,498.11 + [(1 * 30) / .147574369] = $12,701.40

Able, Baker, and Charlie are the only three stocks in an index. The stocks sell for $48, $400, and $100, respectively. If Able undergoes a 3-for-4 reverse stock split, what is the new divisor?

(48 + 400 + 100) / 3 = 182.6666667 182.6666667 = (48/(3/4) + 400 + 100) / d d = 564 / 182.6666667 = 3.08759

Assume the value-weighted index level was 311.05 at the beginning of the year. What is the index level at the end of the year? Price per Share Shares Outs Beg of Yr End of Year Kirk, Inc. 42,000 $53 $60 Picard Co. 30,000 78 84

Beginning value = ($53 × 42,000) + ($78 × 30,000) = $4,566,000 Ending value = ($60 × 42,000) + ($84 × 30,000) = $5,040,000 Return = ($5,040,000 − 4,566,000) / $4,566,000 = .1038, or 10.38% Ending index level = 311.05(1 + .1038) = 343.34

Assume the following information concerning two stocks that make up an index. What is the value-weighted return for the index? Price per Share Shares Outs Beg of Yr End of Yr Kirk, Inc. 42,000 $54 $61 Picard Co. 29,500 79 85

Beginning value = ($54 × 42,000) + ($79 × 29,500) = $4,598,500 Ending value = ($61 × 42,000) + ($85 × 29,500) = $5,069,500 Return = ($5,069,500 − 4,598,500) / $4,598,500 = .1024, or 10.24%

Assume that you want to reindex with the index value at the beginning of the year equal to 100. What is the index level at the end of the year? Price per Share Shares Outs Beg of Yr End of Yr Kirk, Inc. 42,000 $41 $43 Picard Co. 36,000 76 73

Beginning value = [($41 × 42,000) + ($76 × 36,000)] / 2 = $2,229,000 Ending value = [($43 × 42,000) + ($73 × 36,000)] / 2 = $2,217,000 Beginning of year: $2,229,000 / $2,229,000 × 100 = 100.00 End of year: $2,217,000 / $2,229,000 × 100 = 99.46

Assume that you want to reindex with the index value at the beginning of the year equal to 100. What is the index level at the end of the year? Price per Share Shares Outs Beg of Yr End of Year Kirk, Inc. 36,000 $45 $48 Picard Co. 26,500 75 83

Beginning value = [($45 × 36,000) + ($75 × 26,500)] / 2 = $1,803,750 Ending value = [($48 × 36,000) + ($83 × 26,500)] / 2 = $1,963,750 Beginning of year: $1,803,750 / $1,803,750 × 100 = 100.00 End of year: $1,963,750 / $1,803,750 × 100 = 108.87

3. What is the difference between a market order and a limit order? What is the potential downside to each type of order?

A market order is an order to execute the trade at the current market price. A limit order specifies the highest (lowest) price at which you are willing to purchase (sell) the stock. The downside of a market order is that in a volatile market, the market price could change dramatically before your order is executed. The downside of a limit order is that the stock may never hit the limit price, meaning your trade will not be executed.

4. What is a stop-loss order? Why might it be used? Is it sure to stop a loss?

A stop-loss order is an order to sell at market price if the price declines to the stop price. As the name suggests, it is a tool to limit losses. As with any stop order, however, the price received may be worse than the stop price, so it may not work as well as the investor hopes. For example, suppose a stock is selling for $50. An investor has a stop loss on at $45, thereby limiting the potential loss to $5, or so the naive investor thinks. However, after the market closes, the company announces a disaster. The next morning, the stock opens at $30. The investor's sell order will be executed, but the loss suffered will far exceed $5 per share.

Concept Quiz #4 Which one of the following statements regarding the Dow Jones Industrial Average is false? A.The DJIA contains 30 well-known large-company stocks. B.The DJIA is affected equally by dollar changes in low- and high-priced stocks. C. The DJIA is affected equally by percentage changes in low- and high-priced stocks. D. The DJIA divisor must be adjusted for stock splits

C. The DJIA is affected equally by percentage changes in low- and high-priced stocks. In DJIA a $1 change in a high priced stock has the same impact as a $1 change in a low priced stock. Since the % change of $1 increase or decrease is different for a high priced or a low priced stock, the option C is incorrect

The following three defense stocks are to be combined into a stock index in January 2019 (perhaps a portfolio manager believes these stocks are an appropriate benchmark for his or her performance). Suppose that Douglas McDonnell shareholders approve a 2-for-1 stock split on January 1, 2020. Price Shares(millions) 19 20 21 Douglas McDon 360 $65 $69 $83 Dynamics General 450 52 46 60 International Rockwell170 81 70 86 a. What is the new divisor for the index? b. Calculate the rate of return on the index for the year ending December 31, 2020, if Douglas McDonnell's share price on January 1, 2021, is $25.10 per share.

a. Share price after the stock split = $69 × 1/2 = $34.50 1/1/20: Index value = ($69 + 46 + 70) / 3 = 61.67 Index value on 1/1/20 without the split is 61.67 ($34.50 + 46 + 70) / d = 61.67; d = $150.50 / 61.67 = 2.441 b. 1/1/21: Index value = ($25.10 + 60 + 86) / 2.441 = 70.107 From this, the 2020 return = (70.107 − 61.67) / 61.67 = .1369, or 13.69%

An analyst gathered the following data about Stocks J, K, and L, which together form a value-weighted index: year 1 year 2 Stock Price Shares Outs Price Shares Outs J $40 10,000 $50 10,000 K 30 6,000 20 12,000* L 50 9,000 40 9,000 * 2-for-1 stock split The ending value-weighted index (base index = 100) is closest to: a. 93.64 b. 106.80 c. 92.31 d. 108.33

b. 106.80

What is the over-the-counter market for exchange-listed securities called? a. After-market b. Third market c. Fourth market d. Block market

b. Third market

You find the following order book on a particular stock. The last trade on the stock was at $32.09.

buy at selling price sell at buying price

Able, Baker, and Charlie are the only three stocks in an index. The stocks sell for $94, $312, and $90, respectively. If Baker undergoes a 2-for-1 stock split, what is the new divisor for the price-weighted index?

d = ($94 + 312 / 2.0 + 90) / [($94 + 312 + 90) / 3] = 2.05645

Private equity funds will often use convertible preferred stock or bonds with attached call options. These types of securities are used because they: a. Increase the risk of the transaction. b. Shorten the life of the investment. c. Meet SEC regulations for such investments. d. Allow upside potential associated with a successful venture.

d. Allow upside potential associated with a successful venture

What is a securities market characterized by dealers who buy and sell securities for their own inventories called? . a. A reordered market b. An institutional market c. A primary market d. An over-the-counter market

d. An over-the-counter market

Which of the following is false? a. DMMs stand ready to trade at quoted bid and ask prices. b. On the NYSE, all buy and sell orders are negotiated through a floor broker. c. DMMs can trade for their own accounts. d. DMMs earn income from providing liquidity.

d. DMMs earn income from providing liquidity.

9. Is it necessarily true that, all else the same, an index with more stocks is better? What is the issue here?

The issue is index staleness. As more stocks are added, we generally start moving into less frequently traded issues; thus, the tradeoff is between comprehensiveness and recency.

concept questions EOC: 1. At your local Chevrolet retailer, both a primary and a secondary market are in action. Explain. Is the Chevy retailer a dealer or a broker?

The new car lot is a primary market; every new car sold is an IPO. The used car lot is a secondary market. The Chevy retailer is a dealer, buying and selling out of inventory.

2. Why would floor brokers be willing to pay $40,000 per year just for the right to trade on the NYSE?

The right to trade on the NYSE is a valuable asset. For floor brokers, they are able to trade on the behalf of investors and, in return, receive a commission for their services. If trading volume is large enough, these commissions more than offset the cost of the license.

8. There are basically four factors that differentiate stock market indexes. What are they? Comment on each.

What market is covered; what types of stocks are included; how many stocks are included; and how the index is calculated.

7. With regard to the NASDAQ, what are inside quotes?

With a multiple market maker system, there are, in general, multiple bid and ask prices. The inside quotes are the best ones, the highest bid and the lowest ask.

5. Suppose Intel is currently trading at $50. You want to sell it if it reached $55. What type of order should submit?

You could submit either a limit order to sell or a stop order to sell. In this case, both order types would sell when the price increased to $32. The difference would be the stop order would convert to a market order and the price you receive could actually be below $32 if that is where the next trade settled.

The following three defense stocks are to be combined into a stock index in January 2019 (perhaps a portfolio manager believes these stocks are an appropriate benchmark for his or her performance): Price Shares(millions) 19 20 21 Douglas McDonnell 420 $63 $67 $84 Dynamics General 450 53 47 61 International Rockwell 250 82 71 87 a. Calculate the initial value of the index if a price-weighting scheme is used. b. What is the rate of return on this index for the year ending December 31, 2019? For the year ending December 31, 2020?

a. 1/1/19: Index value = ($63 + 53 + 82) / 3 = 66 b. 1/1/20: Index value = ($67 + 47 + 71) / 3 = 61.67 2019 return = (61.67 − 66) / 66 = -.0657, or -6.57% 1/1/21: Index value = ($84 + 61 + 87) / 3 = 77.33 2020 return = (77.33 − 61.67) / 61.67 = .2541, or 25.41%

The following three defense stocks are to be combined into a stock index in January 2019 (perhaps a portfolio manager believes these stocks are an appropriate benchmark for his or her performance). Assume the index is scaled by a factor of 10 million; that is, if the total value of all firms in the market is $5 billion, the index would be quoted as 500. Price Shares(millions) 19 20 21 Douglas McD 205 $103 $109 $123 Dynamics General 450 48 44 58 International Rockwell 290 77 66 80 a. Calculate the initial value of the index if a value-weighting scheme is used. b. What is the rate of return on this index for the year ending December 31, 2019? For the year ending December 31, 2020?

a. 1/1/19: Index value = [$103(205) + $48(450) + $77(290)] / 10 = 6,504.50 b. 1/1/20: Index value = [$109(205) + $44(450) + $66(290)] / 10 = 6,128.50 2019 return = (6,128.50 − 6,504.50) / 6,504.50 = −.0578, or −5.78% 1/1/21: Index value = [$123(205) + $58(450) + $80(290)] / 10 = 7,451.50 2020 return = (7,451.50 − 6,128.50) / 6,128.50 = .2159, or 21.59%

In addition to price-weighted and value-weighted indexes, an equally weighted index is one in which the index value is computed from the average rate of return of the stocks comprising the index. Equally weighted indexes are frequently used by financial researchers to measure portfolio performance. The following three defense stocks are to be combined into a stock index in January 2019 (perhaps a portfolio manager believes these stocks are an appropriate benchmark for his or her performance): Price Shares(millions) 19 20 21 Douglas McD 95 $97 $100 $113 Dynamics General 455 27 22 36 International Rockwell 230 56 45 62 a. Compute the rate of return on an equally weighted index of the three defense stocks for the year ending December 31, 2019. b. If the index value is set to 100 on January 1, 2019, what will the index value be on January 1, 2020? c. What is the rate of return on the index for 2020?

a. 2019: Douglas McDonnell return = ($100 − 97) / $97 = .0309, or 3.09% Dynamics General return = ($22 − 27) / $27 = −.1852, or −18.52% International Rockwell return = ($45 − 56) / $56 = −.1964, or −19.64% 2019: Index return = (.0309 − .1852 − .1964) / 3 = −.1169, or −11.69% b. 1/1/20: Index value = 100(1 − .1169) = 88.31 c. 2020: Douglas McDonnell return = ($113 − 100) / $100 = .1300, or 13.00% Dynamics General return = ($36 − 22) / $22 = .6364, or 63.64% International Rockwell return = ($62 − 45) / $45 = .3778, or 37.78% 2020: Index return = (.1300 + .6364 + .3778) / 3 = .3814, or 38.14% 1/1/21: Index value = 88.31(1.3814) = 121.99

Assume the following information concerning two stocks that make up an index. What is the price-weighted return for the index? Price per Share Shares Outs Beg of Yr End of Yr Kirk, Inc. 38,000 $46 $51 Picard Co. 34,000 76 82

Beginning index value = ($46 + 76) / 2 = 61.00 Ending index value = ($51 + 82) / 2 = 66.50 Return = (66.50 − 61.00) / 61.00 = .0902, or 9.02%

Concept Quiz #3 In calculating the Standard & Poor's stock price indexes, how are adjustments for stock splits made? A.By adjusting the divisor. B. Automatically, due to the manner in which the index is calculated. C.By adjusting the numerator. D.Quarterly, on the last trading day of each quarter.

B. Automatically, due to the manner in which the index is calculated. There is an automatic adjustment for stock splits because the decrease in the stock price is offset by an increase in the number of shares outstanding.

concept from slides: Concept Quiz #1 Private equity funds that concentrate in smaller, family-owned companies with established cash flows are typically referred to as A.Venture capital B. Middle market C.Leveraged buyouts D.Distressed assets

B. Middle market

Concept Quiz #2 Which of the following activities is not conducted by DMMs on the NYSE? A.Acting as dealers for their own accounts. B. Monitoring compliance with margin requirements. C.Providing liquidity to the market. D.Posting bid and ask prices.

B. Monitoring compliance with margin requirements.

You construct a price-weighted index of 25 stocks. At the beginning of the day, the index is 8,526.75. During the day, 24 stock prices remain the same, and 1 stock price increases $5.10. At the end of the day, your index value is 8,543.08. What is the divisor on your index?

Change in index = 8,543.08 − 8,526.75 = 16.33 5.10 / d = 16.33 d = .31230863

10. Why would venture capitalists provide financing in stages?

Funding in stages reduces the risk faced by the venture capitalist. For example, if the VC invests in the first round and the company is unsuccessful, the VC has limited its loss. This structure actually provides the venture capitalist with an implicit call option on future financing rounds.

6. Suppose Tesla is currently trading at $300. You think that if it reaches $210, it will continue to climb, so you want to buy if it and when it gets there. Should you submit a limit order to buy at $310?

No, you should submit a stop order to buy at $17, also called a stop buy. A limit buy would be executed immediately at the current price.

The compensation constraint that requires private equity fund managers to "give back" performance fees when subsequent losses occur is a(n) _____ provision. a. High-water mark b. Index c. Clawback d. Zen

c. Clawback

The compensation constraint that requires private equity fund managers to meet a particular return target before performance fees can be taken is a(n) _____ provision. a. Index b. Zenith c. High-water mark d. Cl

c. High-water mark

IQ questions: Which of the following indexes includes the largest number of actively traded stocks? a. The NASDAQ Composite Index b. The Value Line Composite Index c. The Wilshire 5000 Index d. The NYSE Composite Index

c. The Wilshire 5000 Index The Wilshire 5000 Index is characterized by the large number of companies the index tracks. As a result, it is considered the definitive benchmark of market indices.

If the market price of each of the 30 stocks in the Dow Jones Industrial Average changes by the same percentage amount during a given day, which stock will have the greatest impact on the DJIA? a. The one having the lowest volatility b. The one having the greatest amount of equity in its capital structure c. The one whose stock trades at the highest dollar price per share d. The one whose total equity has the highest market value

c. The one whose stock trades at the highest dollar price per share

You are given the following total market values for an index over a five-year period. Assuming the index starts at 1,000, calculate the index value each year.

year 1: year 1 / year 1 * 1000 year 2: year 2 / year 1 * 1000 year 3: year 3 / year 1 * 1000