Market Organization and Structure: Chapter Test

Market Organization and Structure: Chapter Test (10 questions, 15 minutes)

(1) John places a day order to buy 500 shares of a stock at a limit price of $12.35. Assuming that no more orders are submitted on that day after his order, what would be his average trade price? The limit orders standing before his order on the stock is given below:

(a) $12.31
(b) $12.33
(c) $12.35

(2) Based on the commonly used order precedence hierarchy, which of these sell orders will have precedence over others in an order-driven market?

(a) Display order at a limit price of $25.40 at an arrival time of 10:05:35
(b) Display order at a limit price of $25.42 at an arrival time of 10:01:28
(c) Hidden order at a limit price of $25.38 at an arrival time of 10:08:12

(3) Kamal bought 100 shares of a stock trading at $110 on margin. The initial margin and the maintenance margin for the stock are 25 percent and 15 percent respectively. Below what price will a margin call occur?

(a) $93.50
(b) $97.05
(c) $99.00

(4) A US businessman is going to receive EUR 3 million after 3 months. He is concerned about the exchange rate movement between the USD and EUR. So, he shorts 3 months futures contract for the exchange rate. The businessman is most likely to be classified as:

(a) Investor
(b) Information-motivated trader
(c) Hedger

(5) A company offers 5 new shares for every 100 shares to the existing shareholders at 20 percent discount. This type of offering is called as:

(a) Dividend reinvestment plan
(b) Private placement
(c) Rights offering

(6) Akram purchases a put option on a stock and writes a call option on the same stock. The exercise prices, the settlement date of both the call and put options are the same. How can Akram hedge his exposure in the stock?

(a) The positions are already hedged
(b) Taking long position in the futures contract of the stock
(c) Taking short position in the futures contract of the stock

(7) The interest rate charged by the brokerage company on the margin loans provided to the traders is best described as:

(a) Initial margin
(b) Short rebate rate
(c) Call money rate

(8) Which of the following is the most aggressive position taken by a trader?

(a) Making a market
(b) Making a new market
(c) Taking the market

(9) The risk that the entire issue may not be sold to the public at the stipulated offering price is borne by which party in the best effort offering?

(a) Investment bank
(b) Issuer
(c) Investors

(10) Which of the following feature primarily distinguishes between a forward contract and a futures contract?

(a) Obligation of the parties
(b) Homogeneous and non-homogeneous payoff
(c) Margin requirement






Solutions to the Chapter Test

(1) Correct Answer is A: Only 400 shares of John will get executed. 100 shares at $12.27, 100 shares at $12.31 and 200 shares at $12.33. The average price = (100*12.27 + 100*12.31 + 200*12.33)/400 = $12.31.

(2) Correct Answer is C: The price is paid the first preference followed by the visibility of the order followed by the arrival time of the order. For a short order, the lowest price will have the first preference. So, the hidden order at a price of $25.38 will have the first preference over the other orders.

(3) Correct Answer is B: Margin call price for a long order = Initial price*(1 - Initial Margin)/(1 - Maintenance Margin) = 110*(1-0.25)/(1-0.15) = 110*0.75/0.85 = $97.058.

(4) Correct Answer is C: The US businessman is trying to hedge his currency exposure by taking a short position in the currency contract. He will be best classified as a hedger.

(5) Correct Answer is C: In the rights offering, the company gives its existing shareholders a right to purchase the new securities at a discount.

(6) Correct Answer is B: Purchasing a put option is equivalent to a short exposure in the stock. Selling a call option is also equivalent to a short exposure in the stock. So, he has an overall short exposure in the stock and he needs to take a long position in the futures contract of the stock to hedge the short exposure.

(7) Correct Answer is C: The interest rate charged on the margin loans is called as call money rate.

(8) Correct Answer is C: Making a new market is a more aggressive position that making a market. But taking the market is the most aggressive position as taken by the market orders.

(9) Correct Answer is B: In the best effort offering, the risk that the issue might not be sold completely is borne by the issuer.

(10) Correct Answer is C: Both forward and futures positions have homogeneous payoffs. The obligations of the parties are also the same in both the contracts. Futures require margin money whereas forward contracts do not require any margin money.