You have just opened a margin account with $10,000 at your local brokerage firm.

Question

You have just opened a margin account with $10,000 at your local brokerage firm. You instruct your broker to purchase 500 shares of Wet scope, Inc. stock, which currently sells for $45 per share. Suppose the call money rate is 6 percent and your broker charges you a spread of 1.25 percent over this rate. You hold the stock for 6 months and sell at a price of $50 per share. The company paid a dividend of $.25 per share the day before you sold your stock. What is your total dollar return from this investment? What is your effective annual rate of return? If your wanted to purchase the right to sell 2,000 shares of J.C. Penny stock in August 2008 at a strike price of $45 per share. Suppose J.C. Penny stock sells for $36.50 per share immediately before your options' expiration. What is the rate of return on your investment? What is your rate of return if the stock sells for $52.50 per share? Assume your holding period for this investment is exactly four months.

Explanation / Answer

Total money required to buy shares of Wetscope = 500*45=22500

Margin account has $10000 so remaining $12500 needs to funded by call money.

Now total interest charged on this amount will be @7.25%(6%+1.25%)

Interest amount for 6 months would be 12500*7.25%/2=$453.12

So total cost= purchase amount+interest amount= 22500+453.12=22953.12

Dividend earned =0.25*500=$125

After 6 months stock will be sold @50 per share

total sale price= 500*50=25000

Profit=Sale price+ dividend- purchase price

=25000+125-22953.12

Profit=$2171.87

Holding period returns=profit/purchase price*100

2171.87/22953.12*100

Holding period returns=9.46%

Now we will Calculate EAR as per the given formula

EAR=(1+9.46%)^12/6-1

EAR=19.82%

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