4. Suppose you sold short 20 shares of XYZ stock at $40 per share. A year later,
ID: 2815771 • Letter: 4
Question
4. Suppose you sold short 20 shares of XYZ stock at $40 per share. A year later, the price of the stock has fallen from $40 to $34. What is the profit on this investment? a. A year later, the price of the stock has risen from $40 to $44. What is the loss on this investment? b. Shorting a stock requires posting collateral to the broker (since you are borrowing shares and selling them). If the broker requires you to post half of the purchase price for collateral, what is the return on capital invested in case a? c. d. (just to think about) What is the maximum you can lose in a short position?Explanation / Answer
a) in the first case
Profit = (40-34)*20
= 6*20
=$120 ( $800 from the sale of the stock- $680 paid to repurchase the stock)
b) Loss = (44-40)*20
4*20
= $80 ($800 from the sale of the stock- $880 paid to repurchase the stock)
c) Collateral for shorting = $400 ( 40*20/2)
Profit = $120
Return on Capital invested = 120/400
= 30%
d) The loss in short selling is infinite because the price of the stock can rise to any high. For example in this case if it rises to $80 from $40, the loss would be $800 and can be more if there is any further rise. Because there is no upper limit to the rise, in contrary the profit is maximum when the stock price is 0, because the price cannot go further. So theoretically, there is ing=finite loss in short selling.
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.