Solution Manual for Global Investments, 6/E 6th Edition Bruno Solnik, Dennis McLeavey

Solution Manual for Global Investments, 6/E 6th

Edition Bruno Solnik, Dennis McLeavey

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Chapter 5
Equity: Markets and Instruments

1. The central electronic limit order book is the hub of those automated markets that are order-driven
(not price-driven.) Statement III, therefore, is not correct.

2. a. The market order will be executed against the best matching order(s). Accordingly, Vincent
Jacquet will buy 500 shares at €146 each, 500 shares at €147 each, and the remaining 500 shares
at €149 each.
b. Again, the market order will be executed against the best matching order(s). Accordingly,
Vincent Jacquet will sell 500 shares at €145 each and 500 shares at €143 each.

3. On the Paris Bourse, the investor who placed the limit order at €24 stands to lose. Informed market
participants can sell the share to this investor at €24, although the share is truly worth only €21.
In contrast, the dealer is exposed to lose on Nasdaq. The dealer quote is $23.90 – 24.45, which is
equivalent to €24.90 – 25.47 at the prevailing exchange rate. Informed market participants can sell
the share to the Nasdaq dealer at the bid price of $23.90, although the share is truly worth only
€21 or $20.16.

4. Small orders are generally market orders (buy or sell at the best price available in the market). In an
order-driven system without developed market making, the automated limit order book generally
shows a huge spread between the lowest ask and the highest bid of the orders currently in the system.
When a new market order reaches the system, it is unlikely that a matching opposing market order
will reach the system at exactly the same time. So, the market order will be executed against the limit
order book. Given the wide spread, this will generally imply a transaction at a price that is very
different from that of the previous transaction. To avoid this problem, one could have a periodic
auction system in which all small orders are stored for a while and an auction takes place infrequently.
Another alternative is the “trading halt” used in Tokyo.
Very large orders (such as block trades—trades of 10,000 shares or more) run a serious risk of being
“picked off” on an order-driven system. A large limit order is likely to remain posted for a long time
on the computer system. The client is exposed to the risk that someone gets some news about the
company or the market before the client is able to revise the posted limit price on the order. Buyers or
sellers of large blocks of shares do not wish to be exposed to such a risk. Hence, special procedures
have been put into place. Generally, block trades take place off the automated system and are
reported only after some accepted delay.

5. Each of the three statements about ECNs is true.

6. a. There are not enough buy orders to meet the minimum fill requirement of Participant C, and his
order would not be fulfilled. Participant A would buy 50,000 shares at €37 each, and Participant B
would sell 50,000 shares at €37 each. Half of Participant A’s order would remain unfulfilled.
Because the prevailing price is €37, Participant D’s order to buy at €36 would remain unfulfilled.
All unfulfilled orders of Participants A, C, and D would be resubmitted to the next crossing
session because they are all GFD orders.
 Chapter 5 Equity: Markets and Instruments 25

b. Taking into account the trading activity in the first crossing session and the new orders submitted
to the next session, the following orders would be there for the next session:
Participant A: a market order to buy 50,000 shares
Participant C: a market order to sell 150,000 shares, with a minimum fill of 125,000 shares
Participant D: an order to buy 20,000 shares at €36
Participant E: a market order to buy 150,000 shares
Participant F: a market order to sell 50,000 shares
In this session, the orders of Participants A, C, E, and F would be completely filled. Participants A
and E would buy 50,000 and 150,000 shares, respectively. Participants C and F would sell 150,000
and 50,000 shares, respectively. All the transactions would be at €38 per share. Participant D’s order
would still not be executed and would be resubmitted to the next crossing session later that day.

7. Unlike U.S. banks, it is common for European banks to own shares of their client banks.
Accordingly, the answer is (b).

8. Because there are no cross-holdings by either Beta or Gamma in Alpha, IWF for Alpha = 100%.
For Beta, IWF = 100 − 5 − 15 = 80%. For Gamma, IWF = 100 − 5 = 95%.

9. The apparent market capitalization of these four companies taken together is 50 million  4 =
200 million. But because of their cross-holdings, there is some double counting. The usual free-float
adjustment would be to retain only the portion that is not owned by other companies within the group.
a. The adjusted market capitalization is as follows:
Company A: 50  (1 − 0.10) = $45 million (because 10% of Company A is held by Company C).
Company B: 50  (1 − 0.20 − 0.10) = $35 million (because 20% of Company B is held by
Company A and 10% of Company B is held by Company C).
Company C: 50  (1 − 0.10 − 0.15) = $37.5 million (because 10% of Company C is held by
Company A and 15% of Company C is held by Company B).
Company D: 50  (1 − 0.05) = $47.5 million (because 5% of Company D is held by Company C).
b. From (a) above, the total adjusted market capitalization = 45 + 35 + 37.5 + 47.5 = $165 million.
Because the unadjusted market capitalization of each company is the same, the total adjusted
market cap can also be computed by subtracting the total cross-holdings from 200 million.
The total cross-holdings are 50  (0.20 + 0.10 + 0.15 + 0.10 + 0.10 + 0.05) = $35 million.
Thus, the total adjusted market cap = 200 − 35 = $165 million.

10. a. Net dividend in euros, after deducting withholding tax = €0.50 per share  1,000 shares 
(1 − 0.15) = €425. So, the net dividend in dollars = €425  $0.9810 per € = $416.93.
b. The investor bought the shares for €56.91 per share  1,000 shares = €56,910, or €56,910 
$0.9795 per € = $55,743.35.
The investor sold the shares for €61.10 per share  1,000 shares = €61,100, or €61,100 
$0.9810 per € = $59,939.1.
Thus, capital gains = 59,939.1 − 55,743.35 = $4,195.75.
26 Solnik/McLeavey • Global Investments, Sixth Edition

c. The investor would need to declare the total dividends, that is, without deducting the withholding
tax, as dividend income. So, the dividend income to be declared is €0.50 per share  1,000 shares 
$0.9810 per € = $490.50.
Note that because of the tax treaty between the U.S. and Germany, however, the investor can
deduct from income tax a tax credit for the dividends withheld in Germany; the tax credit is
490.50 − 416.93 = $73.57. (The tax credit can be computed alternatively as €0.50 per share 
1,000 shares  0.15  $0.9810 per € = $73.57.)

11. a. Initial investment = 41  100 = $4,100

Gross dividend = 2  100 = $200
Selling value = 51  100 = $5,100
Gross return in dollars = (5,100 + 200 − 4,100)/4,100 = 0.2927, or 29.27%
b. Initial investment = $4,100  Skr 9.4188 per $ = Skr 38,617.08
Gross dividend = $200  Skr 9.8710 per $ = Skr 1,974.20
Selling value = $5,100  Skr 9.8710 per $ = Skr 50,342.10
Gross return in kroners = (50,342.10 + 1,974.20 − 38,617.08)/38,617.08 = 0.3547, or 35.47%
c. Capital gains = Selling value − Initial investment = 50,342.10 − 38,617.08 = Skr 11,725.02
Capital gains tax = 0.15  11,725.02 = Skr 1,758.75
Though 15 percent of the dividend was withheld in the United States, income tax in Sweden would be
levied on the gross dividend of Skr 1,974.20. So, income tax = 0.50  1,974.20 = Skr 987.10. The
effect of the dividends withheld in the U.S. is exactly offset by the withholding tax credit. So, we
could use the gross dividend (net of Swedish income taxes) in computing the net return. Accordingly,
rate of return, in kroners, net of taxes = (Capital gains + Gross dividend − Capital gains tax − Income
tax)/Initial investment = (11,725.02 + 1,974.20 − 1,758.75 − 987.10)/38,617.08 = 0.2836, or 28.36%.

12. The correct answer is (c): Investors in nondomestic common stock normally avoid double taxation on
dividend income by receiving a tax credit for taxes paid to the country where the investment is made.

13. Cost in U.S. dollars per share = $24.37  4 = $97.48 (because one Lafarge ADR is equivalent to one-
fourth of a Lafarge share). Therefore,
Cost in U.S. dollars for 10,000 shares = $974,800
Cost of purchasing in London = £67.17  $1.4580 per £  10,000 = $979,338.60
Cost of purchasing in Paris = €100.30  $0.9695 per €  10,000 = $972,408.50
Thus, it is the cheapest to buy the shares in Paris.

14. The German firm is considering a Level III ADR program. Accordingly, it must satisfy the requirements
of both the NYSE and the U.S. Securities and Exchange Commission (SEC). This could impose
substantial dual-listing costs on the German firm. The SEC will require the German firm to file a
Form 20-F annually. On this form, the firm will have to provide a reconciliation of earnings and
shareholder equity under German and U.S. GAAP. This implies that the company will have to supply
all information necessary to comply with U.S. GAAP. Furthermore, the NYSE will require timely
disclosure of various information, including quarterly accounting statements.
Solution Manual for Global Investments, 6/E 6th Edition Bruno Solnik, Dennis McLeavey

Chapter 5 Equity: Markets and Instruments 27

Overall, the disclosure requirements may cause considerable concern, as German and U.S. accounting
practices differ substantially. Also, German firms are not accustomed to disclosing as much information
in Germany as is required in the United States. They are also not used to producing frequent reports
in English. The firm may face another hurdle if it is accustomed to smoothening reported earnings by
using various hidden reserves. Another concern that the German firm may have is that cross-listing
may increase the volatility of its share prices. It may feel that the U.S. investors may be quicker in
selling their shares of the German firm in response to bad news than would the German investors.

15. The cost in British pounds, including commission and transaction tax, would be £3.60/share 
10,000 shares  (1 + 0.0010 + 0.0050) = £36,216. So, the cost in dollars would be £36,216  $1.5010
per £ = $54,360.22.

16. The receipt in TW$, after excluding commission and transaction tax, would be TW$150.35/share 
20,000 shares  (1 − 0.0010 − 0.0030) = TW$2,994,972. So, the receipt in euros would be
TW$2,994,972 /( TW$ 32.88 per €) = €91,087.96.

17. Each of the three statements is true.

18. The creation of WEBS for a country creates an additional option for an investor seeking to invest in
equities in that country. Having an additional method by which to participate in a foreign market is
likely to cause the premium on an existing closed-end country fund to narrow if the fund is trading at
a premium. Or, if the existing closed-end country fund is trading at a discount, the launching of
WEBS for that country is likely to make it even less attractive, leading to a widening of the discount.

19. The announcement of foreign investment restrictions increases the importance of closed-end country
funds for U.S. investors who want exposure to that country in their investment portfolios. Therefore,
all other things constant, these restrictions are likely to increase the premium or decrease the discount
on the country fund’s shares. That is, the price-net asset value ratio is likely to increase.

20. The cost of 20,000 shares in the United States is $43.65 per share  20,000 shares = $873,000.
The cost in Germany in euros, including a 0.10% commission, would be €44.95  20,000 shares 
1.0010 = €899,899. So, the cost in dollars is €899,899  $ 0.9710 per € = $873,801.93. Thus, it is
better to buy the shares traded on the NYSE, saving 873,801.93 − 873,000.00 = $801.93.

21. During the six-hour time period when London is trading but the United States is not, the NAV of
the fund in British pounds would be fluctuating in accordance with how the prices of the stocks in the
index are changing. Because the U.S. market is closed, the most recent reported dollar price of the
fund in the United States would not have changed. Then the U.S. market opens, and the fund’s shares
in the United States would open at a price based on the NAV in the United Kingdom at that time and
the prevailing dollar-to-pound exchange rate. During the two-hour overlapping time period when
both markets are open, the NAV in pounds would continue to change. The price of the fund in dollars
would also be changing consistent with the changes in NAV and exchange rate. During the
subsequent 4.5-hour time period when the New York market is open but the London market is not,
the most recent reported NAV in pounds would remain the same. However, the price of the fund in
the United States could change as the exchange rate changes and as new information comes in that
affects investors’ expectations about future stock prices in the United Kingdom. Then, the U.S.
market closes, and during the time period when both markets are closed, the most recent reported
U.S. prices and NAV in pounds also stay the same.

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