Problem 2 Margin (34 Points) 2.A. The current market price for XYZ is $48 per sh
ID: 2813899 • Letter: P
Question
Problem 2 Margin (34 Points)
2.A. The current market price for XYZ is $48 per share. Initial margin is 50%, maintenance margin is 35% and margin interest is 1.50% per year. XYZ pays annual cash dividends of $2.25 per share.
2.A.1) You believe the stock price will increase over the next year and wish to trade exactly one round lot. What trade should you make (2 points)? How much margin would you have to post to your account (4 points)? At what price would you receive a margin call (7 points)?
2.A.2) Suppose you are correct and the stock rises to $55 per share at the end of the year. What is your percentage return on equity for this trade (4 points)?
2.B. The current market price for ABC is $75 per share. Initial margin is 50%, maintenance margin is 35% and there is no margin interest. ABC pays annual cash dividends of $3.50 per share.
2.B.1) You believe the stock price will decrease over the next year and wish to trade exactly one round lot. What trade should you make (2 points)? How much margin would you have to post to your account (4 points)? At what price would you receive a margin call (7 points)?
2.B.2) Suppose you are correct and the stock falls to $68 per share at the end of the year. What is your percentage return on equity for this trade (4 points)?
Please provide steps to reach answer.
Explanation / Answer
Suppose 1 round lot = 100 shares
2A1) Buy 100 shares of stock with 50% margin
Total price = 100* 48 = 4800
Intial Margin = 0.5* 4800 = 2400
Amount Borrowed = 4800 - 2400 = 2400
Maintenance Margin = 35%
Margin = ( value of the investment - Amount borrowed) / Value of the investment
= 1- (amount borrowed / Value of investment)
Amount borrowed = 2400
Value of Investment for margin call = Amount borrowed / ( 1- Maintenance margin )
= 2400 / (1-.35)
= 3692.31
Price of stock for margin call = 3692.31 / 100 = 36.92
2A2)
Cash flow from selling shares @55 = 5500
Cash flow from dividend = 225
Loan amount paid back = 2400 * 1.015 = 2436
Initial Investment by investor = 2400
Return on equity = [ (5500 + 225) - 2436 -2400 ] / 2400
= 0.3704
= 37.04%
2B1)
Short sell 100 shares
Total proceeds from short sell = 7500
Deposit in margin account = 0.5 * 7500 = 3750
For short sell,
Margin = (proceeds from short sell + margin deposit - Value of shares) / Value of shares
Maintenance Margin = 35%
Value of shares for margin call =(Proceeds from short sell + margin deposit) / (1+ maintenance margin)
= (7500+3750) / 1.35
= 8333.33
Price for margin call = 8333.33 / 100 = 83.33
2B2)
new stock price = 68
Investor closes her position. She gets back her margin money and the gain
Gain from the sale = 7500-6800 = 700
Margin deposit = 3750
Return on equity = 700/ 3750 = 18.67%
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