Investor A makes a cash purchase of 100 shares of AB&C common stock for $55 a sh

Question

Investor A makes a cash purchase of 100 shares of AB&C common stock for $55 a share. Investor B also buys 100 shares of AB&C but uses margin. Each holds the stock for one year, during which dividends of $5 a share are distributed. Commissions are 2 percent of the value of a purchase or sale; the margin requirement is 60 percent, and the interest rate is 10 percent annually on borrowed funds.

What is the percentage earned by each investor if he or she sells the stock after one year for (a) $40, (b) $55, (c) $60, and (d) $70?

If the margin requirement had been 40%, what would have been the annual percentage returns?

What conclusion do these percentage returns imply?

**Please show calculations in excel - attach if possible**

Explanation / Answer

Answer: Commission on purchase (for each) = 2% * 5500 = 110
Commission on sale: @40 = 80
@55 = 110
@60 = 120
@ 70 = 140
Dividend (for each): 500

A: Amt invested = 5500 +110 = 5610

B: Amt invested @60% margin = 3300 + 10%*2200 + 110 = 3630
@40% margin = 2200 + 10%*3300 + 110 = 2640

General Formula: Percentage Return = (amt invested after comm + dividend - proceeds of sale after comm) / amt invested after comm

Scenarios (I'll do the first one as an example):

(a) A: (4000 - 80 + 500 - 5610) / 5610 = -21.2%
B @60% margin: (4000 - 80 +500 - 3630) / 3630 = -21.8%
B @40% margin: (4000 - 80 + 500 - 2640) / 2640 = -67.4%

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