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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