At the T. Rowe Price Trading Desk (A) Tuesday, August 21, 1984 It was 9:58 a.m. and the markets were about to open. Greg Donovan, one of two traders for the T. Rowe Price New Horizons Fund (and accounts holding similar securities) was going over the list of buys and sells that he was hoping to execute during the day. Greg saw his most difficult task being the sale of a large block of Avantek shares. Avantek traded in the Over The Counter Market (OTC) and had been around $25/share during the previous few weeks, after being as low as $18 in May. (Exhibit lA). The T. Rowe Price analyst covering the company thought that an earnings disappointment was imminent, and that news to that effect would cause the stocks price to plummet back into the teens. The analyst liked the stock on a long-term basis, however, and only wanted to trim down T. Rowe Prices current position of around 600,000 shares. Gregs instructions were to sell 183,000 shares at a price no lower than $23. At 10:30 the Dow was up $7.50. Greg looked at the screen of his NASDAQ machine and saw that Kidder Peabody was the highest bidder for Avantek at $24 5/8. Several brokers were at $24 bid, with yet several others, including Goldman Sachs, at $24 3/8. (These bids were all for only 100 shares.) Goldman, knowing that T. Rowe Price had a large position in Avantek, had called earlier that morning to say that it was a buyer of the stock in sizeable quantities. Goldman was the largest and most preeminent OTC dealer, and would regularly offer to deal in large positions (50,000 shares or more) for its own account. Greg decided to try Kidder first. Kidder historically had not committed much of its capital to the OTC market, but recently had decided to try to become a more prominent player. It seemed to Greg that he might get a better execution from Kidder since they would gain visibility on a trade of this magnitude and they might even be willing to lose a little money on the trade. In addition, T. Rowe Price liked Kidders research, and here was an opportunity to compensate them, in part, for that service.1 Greg in any event often looked for opportunities to trade with brokers other than Goldman Sachs since T. Rowe Price tended to get the best execution from Goldman, and typically did a disproportionately large share of its trading through that firm. At 10:40 Greg somewhat nervously picked up the phone. Greg (talking to Steve, a Kidder trader): Hi Steve, I see youre interested in some Avantek. How much do you want to buy? Steve: Let me see. Ill call you right back. Two minutes later: Steve: I can do 12,000 shares at [24] 5/8. Greg: I am interested in a more medium sized quantity. Can you do better? Steve: I dont really think so. But, let me look again. Dont do anything until I get back to you. Ten minutes later: Steve: Look, the best I can do is 20,000 shares. Greg: Thats not enough. It seems as if I am going to have to go elsewhere. Is that OK? Steve: (After a pause) If I do more, say up to 35,000 shares, will you then deal? Greg: No, thats still not enough. Im just going to have to go elsewhere. OK? Steve: I suppose youll have to. Greg was upset with himself. He had hoped to be able to do a large trade with Kidder. However, all Steve had done was to try to get him on the hook, and he was not going to bite. The hook referred to a situation where if you did one trade with a dealer and had more of the same stock to trade, then by the implicit rules of the game you would have to give that dealer a right of first refusal on what remained. The dealer typically would have taken part of the other side of the trade on his or her own account, a position that would be endangered if you then went and offloaded the rest of your position elsewhere. Greg was afraid that, if he did do an initial trade with Steve, the price of this lightly traded stock might fall by as much as one or even several dollars as Steve scurried around looking for more buyers knowing that he most likely had Greg on the hook for a lot more. Not all was lost at this point, however. By getting Steve to answer affirmatively when he had asked if he could go elsewhere, Greg had at least obtained an implicit commitment from Steve not to tell other traders of T. Rowe Prices intention to sell a large quantity of Avantek. At least, not immediately. At this point Greg felt that his only option was to call Michael, a trader at Goldman Sachs. He wanted to move quickly and knew that Goldman would be willing to do the whole deal for its own account if necessary, as evidenced in particular by the early morning phone call. The problem was that Greg now had to tell Michael that Steve already knew about the deal. Thus, since Goldmans position would now be riskier, Michael was unlikely to give him as good a price as he might have had Greg gone to him first. Greg decided that perhaps the best way to approach Michael was to offer him a swap. For several weeks New Horizons had been adding to an already substantial long-term position in Tandem (also traded OTC) and Greg had done several of these trades through Michael. In fact, Goldman had mentioned that morning that they knew of a seller of Tandem. New Horizons and related accounts were interested in acquiring up to another 320,000 shares of this stock in the near term. It was up to Greg to choose how and when to acquire it. Gregs decision was to offer Michael both the Tandem purchase and the Avantek sale as a package deal. At 11:25 he placed the call. At this point Kidder still showed up on the screen at $24 5/8 bid on Avantek, with Goldman at $24 3/8. During the course of the morning, small lots of Avantek stock had traded at levels as high as $24 7/8. (Exhibit 1C). Tandem, being much more active, had traded in small lots in the range $15 1/4$14 7/8, with a 10,000 share block having just traded at $14 7/8. (Exhibit 2C). Currently, the lowest asking price for Tandem was $15 1/8 (Kidder, Salomon, Merrill), with Goldman asking $15 3/8. The Dow was up $11.81 for the day so far on moderate volume. Greg: Id like to do a swap of 183,000 Avantek for 320,000 Tandem. Michael: Now those are the kinds of deals I just love! Is it a package deal? A one shot deal? What? I like one shot deals. Greg: One shot. Then, apologetically: Listen, Ive already talked to Kidder but didnt give him any numbers. I did it because theyre good on research. But, he only wanted to bid for medium size. Michael: Ill get back to you. 15 minutes later, Michael called back to say that the Tandem side of the deal was easy to do, but that the Avantek part was harder; no prices as yet. He called back once again at 12:22. Michael: I can do Avantek at $23 and Tandem at $15 1/4. Background T. Rowe Price Associates, Inc. was an independent investment counseling firm, founded in 1937 and located in Baltimore, Maryland. In 1984, the firm had $15.5 billion under management. This was divided about equally between fixed income and equities, and also about equally among 12 mutual funds on one hand and separately managed accounts on the other, the latter consisting mostly of large corporate pension plan accounts. The New Horizons Fund was founded in 1960 and, in 1984, was the largest and oldest emerging growth mutual fund in the United States. The Funds objectives were to invest in companies in the early stages of their corporate life cycle, before they became widely recognized. On June 30, 1984, the Fund had $1.2 billion in assets, of which 88% was invested in the common shares of 161 companies with five year EPS growth rates estimated to be at least 25% per year. The remaining 12% was in short-term fixed income securities. Investment decisions for the New Horizons Fund were made by an investment advisory committee consisting of the president of the Fund, a trader (Greg), and five analysts who spent most of their time researching emerging growth companies. The analysts each managed a portion of the Fund corresponding to their areas of expertise, and could make individual stock selection decisions without prior committee approval. They were also responsible for coordinating and overseeing the trading in their stocks.

1

What would be the most likely fair value during that period for Tandem that would make sense to Goldman?

A

15

B

15 1/4

C

15 1/2

D

14 7/8