Question

1. The current market for Papi's Electronics equity shares is below. It displays bid, ask prices and quote depth (shares).

Given this information, what would happen if you placed a market sell order for 400 shares ?

BID   (SHARES) |    ASK (SHARES)

$48    (300)     |    $48.50 (2,000)

$47.5    (250) |    $49.00   (300)

1. Your trade would not be executed and your order becomes the new best Ask price at $48 for 400 shares.
2. You would sell 300 shares at $48; and then sell 100 shares at $47.50
3. You would sell 400 shares at $48
4. You would sell 400 shares at $48.50

2. Firm A has a debt/equity ratio of 3.2x and their income statement shows that 80% of their costs are fixed costs.

Firm B has a debt/equity ratio of 1.1x and their income statement shows that 14% of their costs are fixed costs.

Given this information and your newly found knowledge of investments, please state which firm's stock should perform BETTER on a relative basis in a DECLINING economic environment.    Assume all else is equal between the two firms (industry, valuation metrics, etc...)

A. Firm A should outperform Firm B

B. Firm B should outperform Firm A

C. Firm A and Firm B should not have a material difference in returns since they are in the same industry and have similar valuation metrics.

Answer 1

A market order is executed immediately at the best possible market rates .So, a market sell order for 400 shares

will be matched with the bid quotes of 300 at $48 and remaining 100 shares will be sold at $47.5 which are the best available prices (option B is correct)

Firm A has high fixed costs i.e. high operating leverage as well as high Debt (3.2 times Equity) i.e high financial leverage as compared to Firm B. Thus, its cashflows will show more variability as compared to that of Firm B

Thus, in a DECLINING economic environment, when revenues decline, the operating income of Firm B will decrease more than that of Firm A because of high operating leverage

The firm B will also experience comparatively more erosion of earnings due to high financial leverage as compared to Firm A.

These two factors will make firm B outperform firm A (option B)