Problem 3-07 Old Economy Traders opened an account to short sell 2,200 shares of

Question

Problem 3-07

Old Economy Traders opened an account to short sell 2,200 shares of Internet Dreams at $64 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $64 to $70, and the stock has paid a dividend of $2.00 per share.

a. What is the remaining margin in the account? (Omit the "$" sign in your response.)

Remaining margin $

b. If the maintenance margin requirement is 30%, will Old Economy receive a margin call?

No
Yes

c.

What is the rate of return on the investment? (Round your answer to 2 decimal places. Negative answer should be indicated by a minus sign. Omit the "%" sign in your response.)

Rate of return %

Explanation / Answer

a. 2200 shares at $64 per share = 140,800 in proceeds from the short sale. If the margin requirement is 50%, (.5)(140,800)=70,400 will be required in additional equity in the account to cover this requirement. When the price rises from $64 to $70, and there is a dividend of $2 per share paid, the total required to repurchase the shares is (70)(2200) (2)(2200)= 158,400 Now [(70,400 140,800)-158,400]/158,400=33.3% b. 33.3% is greater than 30%, there will be no margin call c. The investors profit is 140,800-158,400=-17,600 The rate of return is therefore -17,600/140,800= -12.5%

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