Question

Old economy traders opened an account to short-sell 1,000 shares of internet dreams at $100 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of internet dreams has risen from $100 to $104.80, and the stock has paid a dividend of $16.00 per share. Required:

a. What is the remaining margin in the account?
b-1. What is the margin on the short position?

Answer 1

To calculate the remaining margin after short-selling shares, subtract the total obligation from the initial margin. In this case, the trader would find themselves with a negative margin, indicating a deficit due to a price increase and dividends. This highlights the risks associated with short-selling activities.

Step-by-step explanation:

The question regards calculating the remaining margin in a margin account for an individual engaging in short-selling and understanding the margin requirement after a stock price change and dividend payment. Let's suppose that Old economy traders short-sell 1,000 shares of internet dreams at $100 per share, with a 50% initial margin requirement. After a year, the stock price increased to $104.80, and a dividend of $16 per share was paid.

To calculate the remaining margin and the margin on the short position, we would follow these steps:

1. Initial Margin: $100 * 1,000 shares * 50% = $50,000
2. Total Obligation after price increase: ($104.80 * 1,000 shares) + (1,000 shares * $16 dividend) = $120,800
3. Remaining Margin: Initial Margin - Total Obligation = $50,000 - $120,800 = -$70,800 (negative indicating a deficit)
4. Margin on the short position = Remaining Margin / Market Value of Short Position = -$70,800 / $104,800 = -0.675

This result indicates that the trader not only has wiped out the original margin but now owes additional funds to cover the loss because the stock price increased and dividends were paid to the stockholders.