Assume you want to purchase 100 shares at $40 per share at a time when the initi

Question

Assume you want to purchase 100 shares at $40 per share at a time when the initial margin requirement is 70%. Because 70% of the transaction must be finance with equity, the 30% balance can be financed with a margin loan. So, how much will you borrow? What happens to the margin as the value of the security changes to $65/share? What happens if the price of the stock drops to $30/share? Finally, by how much would the price of the stock have to decrease for the investor to receive a margin call (note that the maintenance margin on equity securities is 25%)? Show all work.

Explanation / Answer

Margin loan:

= 100×$40×30%

= $1,200

Stock price dropped to $30:

New required margin = $30×100×70% = $2,100

Excess margin account balance = 100×$40×70%-$2,100 = $700

New margin loan = $1,200-$700 = $500

Margin call will be made only when stock price is increased. When stock prices are increased, required initial margin will increase. It leads to margin call. No margin call will be made when stock price is decreased.

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