You are bullish on Telecom stock. The current market price is $80 per share, and
ID: 2722695 • Letter: Y
Question
You are bullish on Telecom stock. The current market price is $80 per share, and you have $12,000 of your own to invest. You borrow an additional $12,000 from your broker at an interest rate of 5.0% per year and invest $24,000 in the stock.
a. What will be your rate of return if the price of Telecom stock goes up by 7% during the next year? (Ignore the expected dividend.) (Round your answer to 2 decimal places.)
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.)
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.)
Explanation / Answer
Total value for investment = $24,000
Value of own fund invested = $12,000
Current stock price = $80
Number of stock purchased = 300
Value of loan is $12,000 and interest rate is 5%
So value of loan after one year = $12,000 × (1 +5%)
= $12,600
Value of loan after one year is $12,600.
Stock price goes up by 7%. So next year stock price = $80 × (1 + 7%)
= $85.60
So total dollar value of return after one year
= (300 × $85.6) – 12,600 - $12,000
= $25,680 - $24,600
= $1,080
So total return on investment = $1,080 / 12,000
= 9%
Hence, total return on investment is 9%.
b.
Margin call
Total value of own fund invested = $12,000
Loan = $12,000
Number of stock Purchase = 300
Current stock price = $80
Maintenance margin = 30%
Maximum fall per stock until call is not required = $12,000 × (1 – 30%) / 300
= $28
Stock price after fall of $40 = $80 - $28
= $52
Hence, price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30% is up to $52 per stock.
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