At the beginning of 2005, Steve purchased ACME stock on margin. The initial marg

Question

At the beginning of 2005, Steve purchased ACME stock on margin. The initial margin requirement is 50 percent and the broker loan rate is 8 percent. Steve invested $15,000 of his own funds and margined the maximum amount allowed by the broker to purchase ACME stock. At the time, the purchase price of the stock was $25 a share. No dividends were paid during the year, and the stock was sold for $32 a share at the end of the 2005. What is the one-year holding period return for this investment?



a. 40.0%

b. 24.0%

c. 48.0%

d. 28.0%

e. 56.0%

Explanation / Answer

To find the answer we'd first start by calculating the values or the stock at purchase and at sale. With a 50% margin, the broker will be loaning $15,000 to Steve making the initial stock purchased worth $30,000 purchasing 1200 shares. Once the stock goes to $32 its now worth $38,400. This is a $8,400 gain. However there is interest to be paid to the broker of $1,200 ($15,000 * 8%). This leaves a gain of $7,400. To calculate the return we take $7,400/$15,000 and find it to be 48%, or answer C.

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