Problem 1

 

You buy 100 shares of GE in a margin account at $60 a share

The initial margin is 40%

The cost of borrowing is 5% (from your broker)

The stock pays a dividend of $1 a share

The minimum maintenance requirement is 20%

1) In 1 year the stock rises to $80 – what is the percentage return on your investment?

2) Calculate the % return if you had not used margin (cash account)- why are they different?

Given that net worth = Assets (items of value) – Liabilities (things you owe)

3) What would your net worth be if the stock dropped to $35 in 1 year? Explain what would most likely happen in this scenario.

4) Calculate the price at which you will receive a margin call – base your calculation on the information that is present when you make the purchase – hence at time t=0

Problem 2

You sell short 100 shares of ABC at $75 a share

The initial margin is 50%

The cost of borrowing money in the margin account in 5%

Ignore cost of borrowing shares

The stock pays a dividend of $2 a share

The minimum maintenance requirement is 20%

5) Calculate the price at which you will receive a margin call – base your calculation on the information that is present when you initiate the short sale – hence at time t=0

6) In 2 years the stock rises to $100 a share – what is the annual percentage return on your investment?

7) What is the equity in your account after 2 years and would you have received a margin call before the 2-year time period elapsed? Explain

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