You’ve just opened a margin account with $18,000 at your local brokerage firm. Y

Question

You’ve just opened a margin account with $18,000 at your local brokerage firm. You instruct your broker to purchase 750 shares of Landon Golf stock, which currently sells for $78 per share. Suppose the call money rate is 6.5 percent and your broker charges you a spread of 1 percent over this rate. You hold the stock for 3 months and sell at a price of $85 per share. The company paid a dividend of $.33 per share the day before you sold your stock.
A. What is your total dollar return from this investment?
B. What is your effective annual rate of return? You’ve just opened a margin account with $18,000 at your local brokerage firm. You instruct your broker to purchase 750 shares of Landon Golf stock, which currently sells for $78 per share. Suppose the call money rate is 6.5 percent and your broker charges you a spread of 1 percent over this rate. You hold the stock for 3 months and sell at a price of $85 per share. The company paid a dividend of $.33 per share the day before you sold your stock.
A. What is your total dollar return from this investment?
B. What is your effective annual rate of return? You’ve just opened a margin account with $18,000 at your local brokerage firm. You instruct your broker to purchase 750 shares of Landon Golf stock, which currently sells for $78 per share. Suppose the call money rate is 6.5 percent and your broker charges you a spread of 1 percent over this rate. You hold the stock for 3 months and sell at a price of $85 per share. The company paid a dividend of $.33 per share the day before you sold your stock.
A. What is your total dollar return from this investment?
B. What is your effective annual rate of return?

Explanation / Answer

In the given question, the cash flows involved are as follows:

1. Margin amount by the investor = $ 18,000

2. Purchase of 750 shares at $ 78/share. Thus, the total amount invested = 750 * $ 78/share = $ 58,500

3. Amount is required to be borrowed from the brokerage firm because investment in shares of $ 58,500 is greater than margin amount of $ 18,000. Amount borrowed = $ 58,500 - $ 18,000 = $ 40,500

4. Rate of borrowing of amount = call money rate + spread = 6.5% + 1% = 7.5%

5. Interest charged on borrowed amount for 3 months = $ 40,500 * 7.5% * 3/12 = $ 759.38

[ Borrowed amount = $ 40,500 (Refer point 3)

Rate of interest = 7.5% (Refer point 4)

Time = 3 months ]

6. Dividend received after 3 months = $ 0.33/share * 750 shares = $ 247.50

7. Sale proceeds = $ 85/share * 750 shares = $ 63,750

To answer the question:

A. Total dollar return

i) The investor started with margin money of $ 18,000

ii) Amount remaining with him at the end of 3 months = Sale proceeds + Dividend - Principal repayment of loan borrowed - Interest

= $ 63,750 + $247.50 - $40,500 - $ 759.38 = $ 22,738. 12

Thus, total dollar return from the investment = (ii) -(i)

= $ 22,738.12 - $ 18,000

= $ 4,738.12

B) Effective annual rate of return

The investor earned a return of $ 4,738.12 on $ 18,000 invested by him over a period of 3 months

Thus, effective annual rate of return = $ 4,738.12 / $ 18,000 * 12/3

= 105.29%

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