Solutions for assignment 1

 CH2
19.
a. At t = 0, the value of the index is: ($90 + $50 + $100)/3 = 80
At t = 1, the value of the index is: ($95 + $45 + $110)/3 = 83.33
V1
The rate of return is: V0
－ 1 = (83.33/80) – 1 = 0.0417 or 4.17%

b. In the absence of a split, stock C would sell for $110, and the value of the index
would be the average price of the individual stocks included in the index: ($95 + $45
+ $110)/3 = $83.33.

After the split, stock C sells at $55; however, the value of the index should not be
affected by the split. We need to set the divisor (d) such that:
83.33 = ($95 + $45 + $55)/d
d = 2.34

c. The rate of return is zero. The value of the index remains unchanged since the return
on each stock separately equals zero.
CFA 1.
Answer: c. Taxation

 CH3
12.
a. In principle, potential losses are unbounded, growing directly with increases in the
price of IBX.

b. If the price of IBX shares goes above $210, then the stop-buy order would be
executed, limiting the losses from the short sale. If the stop-buy order can be filled at $200,
the maximum possible loss per share is $10. The total loss is: $10 x 100 shares = $1000.

17.
a. The market-buy order will be filled at $50.25, the best price of limit-sell orders in the
book.
b. The next market-buy order will be filled at $51.50, the next-best limit-sell order price.
 c. As a security dealer, you would want to increase your inventory. There is considerable
buying demand at prices just below $50, indicating that downside risk is limited. In
contrast, limit-sell orders are sparse, indicating that a moderate buy order could result
in a substantial price increase.

18.
a. Your initial investment is the sum of $5,000 in equity and $5,000 from borrowing,
which enables you to buy 200 shares of Telecom stock:

Initial investment $10,000

= = 200 shares
Stock price $50
The shares increase in value by 10%: $10,000 × 0.10 = $1,000.
You pay interest of = $5,000 × 0.08 = $400.
The rate of return will be:

$1,000 － $400
= 0.12 = 12%
$5,000
b. The value of the 200 shares is 200P. Equity is (200P – $5,000), and the required
margin is 30%.

200P －$5,000
Solving = 0.30, we get P = $35.71.
200P
You will receive a margin call when the stock price falls below $35.71.