Problem 3-09 You are bullish on Telecom stock. The current market price is $80 p

Question

Problem 3-09

You are bullish on Telecom stock. The current market price is $80 per share, and you have $9,000 of your own to invest. You borrow an additional $9,000 from your broker at an interest rate of 9% per year and invest $18,000 in the stock.

a.

What will be your rate of return if the price of Telecom stock goes up by 8% during the next year? (Negative answer should be indicated by a minus sign. Omit the "%" sign in your response.)

Rate of return %

b.

How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30%? Assume the price fall happens immediately. (Round your answer to 2 decimal places. Omit the "$" sign in your response.)

Margin call will be made at price $ or lower

Explanation / Answer

a. You buy 200 shares of Telecom ($10,000/$50 per share). These shares increase in
value by 10%, or $1,000. You pay interest of: 0.08 x 5,000 = $400

The rate of return will be:
($1,000 $400)/5000 = 0.12 = 12%

b. The value of the 200 shares is 200P. The equity in the account is (200P – $5,000).
You will receive a margin call when:

(200P $5,000)/200P
= 0.30 when P = $35.71 or lower

c. The value of the 200 shares is 200P. After one year, the equity in the account is
(200P – $5,000(1.08)). You will receive a margin call when:

200P $5,000(1.08)/200P
= 0.30 when P = $38.57 or lower

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