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17-1ANSWERSTOQUESTIONSFORCHAPTER17(Questionsareinboldprintfollowedbyanswers.)1.Whatarethethreefactorscontributingtothesignificantchangesinthecommonmarketoverthepast50years?Thestockmarketshavealsochangedsincetheearly1960s,dueto(1)institutionalization(smallinvestorsnowplayonlyaminorrole);(2)changesingovernmentregulations,e.g.disclosure,typesoftrades,marginrequirements;(3)innovations,e.g.computertechnologypermitsprogramtrading.2.a.Howdoescommonstockdifferfrompreferredstock?b.Whyispreferredstockviewedasaseniorcorporatesecurity?a.Preferredstockisentitledtoafixedparticipationintheformofdividendsoftheearningsofthecompany.Dividendsmustbedeclaredandordinarilytheyareatthediscretionoftheboard.Commonstockisentitledtotheresidualcashflow,andisjuniortothepreferredstockbothintermsofdistributionandliquidationpreference.b.Preferredstockisconsideredaseniorinstrumentbecausedividendsmustbepaidbeforeanydistributionofdividendscanbemadetothecommonstockholders.Also,inaliquidation,thepreferredstockholdersarepaidbeforethecommonstockholders,whoareconsideredresidualclaimants.3.Whatisthedifferencebetweenordinarydividendsandqualifieddividendsandhowiseachtreatedfortaxpurposes?Ordinarydividendsaretaxedattheincometaxbracket.Qualifieddividendsreceivepreferentialtaxrate,either5%or15%,dependingontheindividual’sregularincometaxrate.4.Whatismeantbyalong-termcapitalgainandhowisittreatedfortaxpurposes?Long-termcapitalgainsareappreciationsinvalueofthestockthathasbeenheldformorethanoneyear.Itisentitledtopreferentialtaxrate,either5%or15%dependingontheindividual’sregularincometaxrate.17-25.ThefollowingquoteistakenfromWayneH.Wagner,“TheTaxonomyofTradingStrategies,”inKatrinaF.Sherrerd(ed.),TradingStrategiesandExecutionCosts(Charlottesville,VA:TheInstituteofCharteredFinancialAnalysts,1988).Whenatraderdecideshowtobringanordertothemarket,heorshemustdealwithsomeveryimportantissues;tome,themostimportantis:Whatkindoftradeisthis?Itcouldbeeitheranactiveorapassivetrade.Thetypeoftradewilldictatewhetherspeedofexecutionismoreorlessimportantthancostofexecution.Inotherwords,doIwantimmediatetrading(amarketorder);oramIwillingtoforgotheimmediatetradeforthepossibilityoftradinglessexpensivelyifIamwillingto“give”onthetimingofthetrade(alimitorder)?a.Whatismeantbyamarketorder?b.Whywouldamarketorderbeplacedwhenaninvestorwantsimmediatetrading?c.Whatismeantbyalimitorder?d.Whataretherisksassociatedwithalimitorder?a.Amarketorderisonewhichissenttothefloorforimmediateexecutionassoonasitisreceived.Thebuyerorsellerreceivesthemarketpriceatthetimethetradeisexecuted.b.Amarketorderisexecutedassoonaspossible.c.Alimitorderisexecutedwhenthepricereachesapredeterminedlevel.d.Thelimitmaynotbereached.Theinvestorcannotpredictthetimingoftheexecution.6.SupposethatMr.Mancusohaspurchasedastockfor$45andthathesetsamaximumlossthathewillacceptonthisstockof$6.WhattypeofordercanMr.Mancusoplace?Hewillputasellstopordersettingthestoppriceat$45.7.a.Whatisaprogramtrade?b.Whatarethevarioustypesofcommissionarrangementsforexecutingaprogramtradeandtheadvantagesanddisadvantagesofeach?a.Aprogramtradeisaninstitutionalbuyorsellofalargebasketofstocks.b.Ifaprogramtradeisexecutedonanagencybasis,commissionsarebidforbyagroupofbrokeragefirms.Theadvantageisthatthecommissionstendtobelower,butthedisadvantageisthattheexecutionpricemaynotbethebestbecausetheimpactcostsandthepotentialforfront-running.Dealerscanalsoexecuteaprogramtradeonaprincipalbasis,whichmeansthattheybuyorselltheamountsfrominventoryandbeartheriskofdistribution.Theadvantageisthattheinvestorknowsthetradingpriceinadvance,butpaysahighercommission.17-38.a.Explainthemechanicsandsomekeyrulesofashortsale.b.Whatrestrictionsareimposedonshortsellingactivities?a.Ashortsellerborrowsthestockstosellonthemarket,givingtheproceedsofthesaletohisbrokerascollateral.Shouldpricesdeclinehewillbuythestocks,returnthemtothebrokerandobtainthesalesproceeds.b.Ashortsalemustbeannouncedatthetimetheorderisgiven,anditcanoccuronlyafteranuptickinthemarketpriceofthestock.Theshortsellerisalsoresponsibleforpayinganydividendsdueonthestocksbeforehecoversthemwithapurchase.9.Whatroledoesthebrokercallrateplayinamarginpurchase?Thebrokercallrateistheratepaidonabankloanbyabroker,whoislendingthecashtoacustomerbuyingstocksonmargin.Thebrokerwillnormallyaddaslightservicechargetothisfee.Thisratewillaffectthemargintransaction’sprofitability.10.a.Whatismeantbymaintenancemarginwhenstocksarepurchasedonmargin?b.Whatismeantbydebitbalance?c.Whatismeantbycreditbalance?a.Themaintenancemarginistheminimumamountofequityintheinvestor'smarginaccount.Ifthevalueofthesecuritieschangesenoughtoerodethevalueofequity,theinvestormustprovideadditionalcashtosupplementtheamountposted.b.Adebitbalanceisthevalueoftheequitylesstheborrowedamountinamarginpurchase.c.Acreditbalanceisthevalueoftheequityplustheborrowedamountinashortsale.11.ThefollowingstatementsaretakenfromGretaE.Marshall’sarticle“ExecutionCosts:ThePlanSponsor’sView,”whichappearsinTradingStrategiesandExecutionCosts,publishedbyTheInstituteofCharteredFinancialAnalystsin1988.(Thepubl