Question

Old Economy Traders opened an account to buy 1,000 shares of Internet Dreams at $40 per share. The initial margin requirement was 50%, and interest on margin loan is 8%. A year later, the price of Internet Dreams has risen from $40 to $50, what is Old Economy Traders' return on equity?

Answer 1

6000 (representing a decrease in the OET account)

Step-by-step explanation:

The initial margin was $40 x 1000 x 0.50 = $20,000

As a result of the $10 increase in the stock price, the Old Economy Trader loses $10 x 1000 shares = $10,000

Now, considering the fact that an interest margin of %8 was paid on the load, we therefore arrive at:

$4 (representing %8 of $50) x 1000 = $4000

Old Economy Trader return on equity will now therefore be:

20000 - 10000 - 4000

= 6000 (representing a decrease in the OET account.)

For further clarity, we try break it down further

To sell the shares, the OET had to pay 50% of their market value and

thus the value of total assets in OET’s account is initially $40, 000 + $20, 000 = $60, 000. At the time of the sale, total liabilities are $40,000 and thus OET’s margin is initially $60, 000 − $40, 000 = $20, 000.