Question & Answer

Describe inside information as applied to the trading of stocks. Why is it illegal to trade based on inside information? Describe the evidence that suggests some investors use inside information. (LO4)

What are dark pools? How can they help investors accumulate shares without other investors knowing about the trades? Why are dark pools criticized by public stock exchanges? Explain the strategy used by public stock exchanges to compete with dark pools. (LO2)

Why did the SEC impose a temporary ban on short sales of specific stocks in 2008? Do you think a ban on short selling is effective? (LO1)

Your friend just told you about a penny stock that they purchased, which increased in price from $0.10 to $0.50 per share. You start investigating penny stocks, and after conducting a large amount of research, you find a stock with a quoted price of $0.05. Upon further investigation, you notice that the ask price for the stock is $0.08 and that the bid price is $0.01. Discuss the possible reasons for this wide bid–ask spread. (LO2) 

Explain how foreign stock exchanges have reduced transactions costs. (LO2, LO5)

 What are the implications of Regulation FD? (LO4)

Why are trading halts sometimes imposed on particular stocks? (LO4)

Explain how circuit breakers are used to reduce the likelihood of a large stock market crash. (LO4)

Explain how the Securities and Exchange Commission attempts to prevent violations of SEC regulations. (LO4)

Briefly describe the structure and role of the Securities and Exchange Commission. (LO4)

What are electronic communication networks? (LO2)

Describe the roles of market makers. (LO2)

Describe the short selling process. Explain the short interest ratio. (LO1)

Under what conditions might investors consider short selling a specific stock? (LO1)

Explain how margin requirements can affect the potential return and risk from investing in a stock. What is the maintenance margin? (LO1)

Explain the difference between a market order and a limit order. (LO1)

The credit crisis that occurred in 2008–2009 could also be called an equity crisis due to systemic risk. Write a short essay to explain the impact of the credit markets on the equity markets during the crisis.  

Explain why participants in the stock market monitor the VIX. What does a decline in VIX imply about a change in expected volatility by market participants? (LO4)

Use a stock valuation framework to explain why the Sarbanes-Oxley Act (SOX) could improve the valuation of a stock. Why might SOX cause a reduction in the valuation of a stock? (See the chapter appendix). (LO1)

Explain (using intuition instead of math) why stock prices may decrease in response to a higher risk-free rate according to the CAPM. In some periods, the risk-free rate rises in response to higher economic growth. Explain (using intuition instead of math) why stock prices may increase in this situation even though the risk-free rate increases. (LO2)

Consider the prevailing conditions that could affect the demand for stocks, including inflation, the economy, the budget deficit, and the Fed’s monetary policy, political conditions, and the general mood of investors. Based on these conditions, do you think stock prices will increase or decrease during this semester? Offer some logic to support your answer. Which factor do you think will have the biggest impact on stock prices? (LO3)

At the time that a management group of RJR Nabisco initially considered engaging in a leveraged buyout, RJR’s stock price was less than $70 per share. Ultimately, RJR was acquired by the firm Kohlberg, Kravis Roberts (KKR) for about $108 per share. Does the large discrepancy between the stock price before an acquisition was considered and after the acquisition mean that RJR’s price was initially undervalued? If so, does this imply that the market was inefficient? (LO3, LO6)

Explain the meaning and use of implied volatility. (LO4) 

Describe the value-at-risk method for measuring risk. (LO4)

A consulting firm was hired to determine whether a particular trading strategy could generate abnormal returns. The strategy involved taking positions based on recent historical movements in stock prices. The strategy did not achieve abnormal returns. Consequently, the consulting firm concluded that the stock market is weak-form efficient. Do you agree? Explain. (LO6)