Question

You are bullish on Telecom stock. The current market price is $30 per share, and you have $3,000 of your own to invest. You borrow an additional $3,000 from your broker at an interest rate of 6.5% per year and invest $6,000 in the stock.a. What will be your rate of return if the price of Telecom stock goes up by 8% during the next year? (Ignore the expected dividend.) (Round your answer to 2 decimal places.)Rate of return %b. How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30%? Assume the price fall happens immediately. (Round your answer to 2 decimal places.)Stock price falls below

Answer 1

(a) 9.5%

(b) $21.43%

Step-by-step explanation:

Given that,

Current market price = $30 per share

Money own to invest = $3,000

Amount of money borrowed = $3,000

Interest rate = 6.5% per year

Investment in stock = $6,000

(a) No. of shares = Investment in stock ÷ Current market price

= $6,000 ÷ $30 per share

= 200 shares

If the price of Telecom stock goes up by 8% during the next year,

Increase in investment:

= [Investment in stock × (1 + 8%)] - Initial investment

= ($6,000 × 1.08) - $6,000

= $6,480 - $6,000

= $480

Interest paid:

= Amount of money borrowed × Interest rate

= $3,000 × 6.5%

= $195

Therefore, the rate of return is as follows:

= (Increase in investment - Interest paid) ÷ Borrowed amount

= ($480 - $195) ÷ $3,000

= $285 ÷ $3,000

= 0.095 or 9.5%

(b) Maintenance margin = 30%

Let the value of each share be y,

Total value of 200 shares = 200y

Equity = Total value of 200 shares - Borrowed amount

= 200y - $3,000

Margin = Equity ÷ Value of shares

0.3 = (200y - $3,000) ÷ 200y

60y = 200y - $3,000

140y = $3,000

y = $21.43

Therefore, the price of Telecom stock falls below $21.43.