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The first public sale of a company’s stock

1. Jeff’s Poker Supplies Inc. (JFPS) would like to offer shares to the public for the first time. According to the approved and final prospectus, 1 million shares are being offered for $10 per share after the underwriting discount, for a total of $10 million.

a. What do we call the first public sale of a company’s stock, and in which type of market (primary or secondary) does it occur?

The 1st public sale of a company’s stock is referred to as the initial public offering (IPO). This type sale is offered in the primary market.

b. Who initially purchases all 1 million shares, and what is that process called?

c. Suppose that JFPS opens at $19 per share on its first day. Does Jeff’s Poker Supplies earn $19 million, or just the original $10 million? Explain.

2. Today, Mike buys 100 shares of Kraft Foods (KRFT) on the Nasdaq exchange for $55.22, resulting in a purchase price of $5,522. Assume that this is *not* the first time these shares have been offered to the public. Does Kraft end up with this money? If not, who does?

3. Greg, a U.S. citizen, purchased 100 shares of Bayer on the Frankfurt stock exchange. Bayer was trading for €55, and the exchange rate was €1 = $1.5778.

a. How much (in dollars) did Greg need to purchase the 100 shares?

b. Suppose that Greg now wants to sell his shares, which have increased in price to €58, and the exchange rate is now €1 = $1.3036. How much will Greg receive from the sale (in dollars)?

c. In addition to the exchange rate risk shown in this example, what other added risks are there in purchasing a stock directly from a foreign market? Give at least two and explain.

d. If you want to reduce these added risks, what are some ways to invest indirectly in foreign companies? Give at least two ways and explain.

4. Marie wants to use a margin account to buy 400 shares of AT&T (ATT). The stock is trading at $30, making an investment cost of $12,000.

a. If Marie wants to open the position with a 60% margin, then how much of the $12,000 will be borrowed?

b. Suppose the share price drops to $14. What is the total value of her shares? What is her margin in this position now? Show work. (Hint: Use the Basic Margin Formula)

c. What must Marie do if her margin drops below 25%?

5. Ned purchased stock with a value of $30,000 using 50% margin. He later sold the stock when it had a value of $40,000. The stock paid $600 in dividends while he was holding it. Ned paid $1,500 in interest on the margin loan.

a. Find the return on invested capital.

b. Suppose instead that Ned had not used margin, therefore paying the full $30,000 to buy the stock with his own money. The dividend and selling price remain the same. Find the return on invested capital, and explain why it is lower.

6. Sam wants to short sell 300 shares of Wal-Mart (WMT), trading for $77 a share. There is a 50% initial margin requirement on short sales.

a. How can Sam sell shares he doesn’t own? In other words, where do the shares come from?

b. What is Sam’s initial margin deposit and total deposit with the broker? Show work or explain.

c. What is Sam’s profit if the price of Wal-Mart falls to $68? Show work or explain.


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