You received a cash bonus of $20,000 from your company so you decided to invest

Question

You received a cash bonus of $20,000 from your company so you decided to invest that
money in MMM Stocks. The current stock price of MMM is $100. Assume that the
initial margin is 50%.
a) If you buy MMM on margin then what is the maximum number of shares you can
buy?
b) If the price of MMM goes down then you may receive a margin call. At what
price will you receive a margin call from your broker? (Assume that the
maintenance margin is 30% and you can ignore the interest payments on the loan)
c) If the price fell to this level and you don

Explanation / Answer

a. On margin I can buy MMM shares at 50% of price and the rest 50% is financed. So I can buy MMM shares at 50 only.

So Maximum number of shares I can buy = 20000/50 =400

b. Since the maintenance margin is 30%, we will get the call when the share price depreciates by 20%. As we have initially put 50% as initial margin

Or, I can get a margin call if the share price falls to 100*(1-0.2) =80

c. Since shares has fallen by 20% which is equal to $20.

Total loss =400*20=8000

Since the share price =80 now, the number of share need to be sold =8000/80 =100

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