Ms. Tejal Gandhi has decided that the stock of SmallCap Inc is overvalued at $4

Question

Ms. Tejal Gandhi has decided that the stock of SmallCap Inc is overvalued at $4 a share and wants to sell it short. Since the price is relatively low, short sales cannot be executed on margin, so Ms. Gandhi must put up the entire value of the stock when it is sold short. a) What is the percentage loss if the price of the stock rises to $8? b) What is the percentage loss if the price of the stock rises to $10? c) What is the percentage gain if the company goes bankrupt and is dissolved? d)What are the maximum percentage gain the short seller can earn and the largest percentage loss the short seller can sustain? e) From the short seller's perspactive, what are the best and worst case scenarios? Thank you for your help.

Explanation / Answer

a) Percentage loss is 100% she put $4 and lost 8 - 4 = 4.

b) percentage loss is 150%

c) percentage gain is 100%

d) maximum gain is 100% as stock cant fall below 0 and the maximum loss has no bounds as the stock can go as high as it wants.

e) best is that the company bankrupts and the worst is the company price skyrockets to infinity.

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