Question

Suppose you open a brokerage account and purchases 300 shares of XYZ at $40 per share. You borrow $4,000 from your broker to help pay for the purchase. The interest rate on the loan is 8%. a. What is the margin in your account when you first purchase the stock? b. If the share price falls to $30 per share by the end of the year, what is the remaining margin in your account? If the maintenance margin requirement is 30%, will you receive a margin call? c. What is the rate of return on your investment?

Answer 1

Ans.

a) the margin in your account when you first purchase the stock is 66.67%

b) If the share price falls to $30 per share by the end of the year, the remaining margin would be 39%

c) If the share dorps to $30, the rate of return of this invesment would be -41.50%

Step-by-step explanation:

Hi, your margin is the total cost of the shares minus the money you borrowed, in terms of percentage this is:

`Margin=(12,000-4,000)/(12,000) =0.6667`

Or 66.67%

If the price goes down to $30 by the end of the year, we are going to have to take into account the interest amount, therefore this is is going to be the new margin:

`Margin=(30*300-4,000*1.08)/(12,000) =(9,000-4320)/(12,000) =0.39`

The new margin is 39%

Ok, now if all this happened, this means that after 1 year, you will have to pay the loan plus its interests, that is 4,000(1+0.08)=4,320. and you sell the shares and receive 300 shares x $30 = $9,000, therefore your rate of return is:

`R=((9,000-4,320))/(8,000) -1=-0.415`

8,000 is because that was the money you invested (your own) and 4,680 (9000-4320) is the money that you finally got from all this adventure. This means that your rate of return will be -41.5%

Best of luck.