Suppose that Xtel currently is selling at $74 per share. You buy 300 shares usin

Question

Suppose that Xtel currently is selling at $74 per share. You buy 300 shares using $15,000 of your own money, borrowing the remainder of the purchase price from your broker. The rate on the margin loan is 796. a. What is the percentage increase in the net worth of your brokerage account if the price of Xtel immediately changes to: (0 $83 62 (i) S74: (i)$64.38? What is the relationship between your percentage return and the percentage change in the price of Xtel? (Leave no cells blank - be certain to enter "o" wherever required. Negative volues should be indicated by a minus sign. Round your answers to 2 decimal places.) i. Per ii. Per ili. Percentage gain gain b. If the maintenance rmargin is 25%, how low can Xtel's price fall before you get a margin call? (Round your answer to 2 decimal places.) Margin call will be made at price

Explanation / Answer

a. Purchase price = $74 and purchase consideration = 74*300 = 22200 however equity (own contribution) is only 15000. The change in networth will be as below:

(i) price at 83.62 : gain = (83.62-74) * 300 = 2886 which is as % = (2886/15000) = 19.24%

(ii) price at 74 : gain = (74-74) * 300 = 0

(iii) price at 64.38 : loss = (64.38-74) * 300 = -2886 which is as % = (-2886/15000) = -19.24%

b. Maintenance margin = 25% * 22200 = 5550

The current margin is 15000. Hence the margin needs to erode by (15000-5550) = 9450 for the position or per share level = 9450/300 = 31.5. Hence the price has to fall below (74-31.5) = 42.5 for the margin call to come.

c. If the margin at the begining was only 11100, then the margin needs to erode only by (11100 - 5550) = 5550 for the margin call. This translates into price fall of 18.5 per share.

d. Return after 1 year . First we calculate the interest cost (22200 - 15000) * 7% = 504. Now we can calculate the return after 1 year:

(i) price at 83.62 : gain = (83.62-74) * 300 - 504 = 2382 which is as % = (2382/15000) = 15.88%

(ii) price at 74 : loss = (74-74) * 300 - 504 = -504 which is as % = (-504/15000) = -3.36%

(iii) price at 64.38 : loss = (64.38-74) * 300 - 504 = -3390 which is as % = (-3390/15000) = -22.60%

e. Now for the margin call we have to adjust the interest cost also ; hence margin can erode upto (9450-504) = 8946 or per share basis = 8946/300 = 29.82. Hence the price can fall upto 44.18 before the margin call will be initiated.

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