Suppose that Xtel currently is selling at $70 per share. You buy 250 shares usin

Question

Suppose that Xtel currently is selling at $70 per share. You buy 250 shares using $10,000 of your own money, borrowing the remainder of the purchase price from your broker. The rate on the margin loan is 8%

b. If the maintenance margin is 25%, how low can Xtel’s price fall before you get a margin call? (Round your answer to 2 decimal places.)

c. How would your answer to (b) change if you had financed the initial purchase with only $8,750 of your own money? (Round your answer to 2 decimal places.)

e. Continue to assume that a year has passed. How low can Xtel’s price fall before you get a margin call? (Round your answer to 2 decimal places.)

Explanation / Answer

b. Computation of Xtel's Price before margin call

Margin call will happen if the value of Equity fall below 25%

Thus Margin Rate = Equity / Assets <0.25

(Assets - Liabilities) / Assets <0.25

(250X - 7500) / 250X <0.25

(250X - 7500) / 250X <0.25

250 X - 7500 < 62.5 X

250 X - 62.5 X <7 500

X < $40

Margin Call will happen if price is less than $40

c. If finance amount if $8750

Margin call will happen if the value of Equity fall below 25%

Thus Margin Rate = Equity / Assets <0.25

(Assets - Liabilities) / Assets <0.25

(250X - 8750) / 250X <0.25

(250X - 8750) / 250X <0.25

250 X - 8750 < 62.5 X

250 X - 62.5 X < 8750 => 187.5X < $8750

X < $46.67

Margin Call will happen if price is less than $46.67

e. Margin call after one year

Liability after one year = Liability at Year 0 * (1+r)

Liability after one year = 7500 * (1+0.08) = $8100

Margin call will happen if the value of Equity fall below 25%

Thus Margin Rate = Equity / Assets < 0.25

(Assets - Liabilities) / Assets < 0.25

(250X - 8100) / 250X <0.25

(250X - 8100) / 250X <0.25

250 X - 8100 < 62.5 X

250 X - 62.5 X < 8100 => 187.5X < $8100

X < $43.20

Margin Call will happen if price is less than $43.20

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