Problem 2 You sell short 100 shares of ABC at $75 a share The initial margin is

Question

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%

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

In 2 years the stock rises to $100 a share – what is the annual percentage return on your investment?

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

Explanation / Answer

Initial margin = 50 percent of $7500 (75 x 100)

                        = $3,750         

Maintenance margin    = 20 percent of $7500

                                    = $1500

The margin will be called when the price of stock increases beyond $97.50 ($75+ 22.50)

=          $3,750 - $1,500

=          $2,250

=          2,250/100

=          $22.50

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