1. How are the SIPC and FDIC similar? Why are securities laws frequently referred to as full disclosure laws, and what is the role of the SEC?
2. In an underwriting, what role does each of the following play?
- the investment banker
- the syndicate
- the preliminary and final prospectus
- the SEC
3. What is the difference between an underwriting and a best- efforts sale of securities? Who bears the risk associated with each sale? If the investment banker overprices a new issue of securities, who sustains the losses?
4. A stock sells for $ 10 per share. You purchase 100 shares for $ 10 a share ( i. e., for $ 1,000), and after a year the price rises to $ 17.50. What will be the percentage return on your investment if you bought the stock on margin and the margin requirement was
- 25 percent,
- 50 percent, and
- 75 percent? ( Ignore commissions, dividends, and interest expense.)
5. Repeat Problem 1 to determine the percentage return on your investment but in this case suppose the price of the stock falls to $ 7.50 per share. What generalization can be inferred from your answers to Problems 1 and 2?
6. Ms. Tejal Gandhi has decided that the stock of SmallCap Inc is overvalued at $ 4 a share and wants to sell it short. Since the price is relatively low, short sales cannot be executed on margin, so Ms. Gandhi must put up the entire value of the stock when it is sold short.
- What is the percentage loss if the price of the stock rises to $ 8?
- What is the percentage loss if the price of the stock rises to $ 10?
- What is the percentage gain if the company goes bankrupt and is dissolved?
- What are the maximum percentage gain the short seller can earn and the largest percentage loss the short seller can sustain?
- From the short sellers perspective, what are the best and worst case scenarios?