Assume you want to purchase 100 shares at $40 per share at a time when the initi
ID: 2739301 • Letter: A
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%)? 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%)? 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%)?Explanation / Answer
Determine the amount that should be borrowed:
In the total requirement, 70% are own funds and rest would be financed. Let us calculate the margin loan amount as follows.
Margin loan = (Number of shares * Price per share) * % of margin loan
= (100*$40) * 30%
= $1,200
If value of security changes to $65:
Margin loan = (Number of shares * Price per share) * % of margin loan
= (100*$65) * 30%
= $1,950
If value of security drops to $30:
Margin loan = (Number of shares * Price per share) * % of margin loan
= (100*$30) * 30%
= $900
How much would the price of the stock have to decrease:
Let us understand that, the 75% of the debt would be equal to $1,200 the price of the share should be computed as follows:
(100 shares * ‘X’ * 0.25) * 3 = $1,200
75X = $1,200
X = $1,200 / 75
= $16.
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