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Assume you want to purchase 100 shares at $40 per share at a time when the initi

ID: 2739301 • Letter: A

Question

Assume you want to purchase 100 shares at $40 per share at a time when the initial margin requirement is 70%. Because 70% of the transaction must be finance with equity, the 30% balance can be financed with a margin loan. So, how much will you borrow? What happens to the margin as the value of the security changes to $65/share? What happens if the price of the stock drops to $30/share? Finally, by how much would the price of the stock have to decrease for the investor to receive a margin call (note that the maintenance margin on equity securities is 25%)? Assume you want to purchase 100 shares at $40 per share at a time when the initial margin requirement is 70%. Because 70% of the transaction must be finance with equity, the 30% balance can be financed with a margin loan. So, how much will you borrow? What happens to the margin as the value of the security changes to $65/share? What happens if the price of the stock drops to $30/share? Finally, by how much would the price of the stock have to decrease for the investor to receive a margin call (note that the maintenance margin on equity securities is 25%)? Assume you want to purchase 100 shares at $40 per share at a time when the initial margin requirement is 70%. Because 70% of the transaction must be finance with equity, the 30% balance can be financed with a margin loan. So, how much will you borrow? What happens to the margin as the value of the security changes to $65/share? What happens if the price of the stock drops to $30/share? Finally, by how much would the price of the stock have to decrease for the investor to receive a margin call (note that the maintenance margin on equity securities is 25%)?

Explanation / Answer

Determine the amount that should be borrowed:

In the total requirement, 70% are own funds and rest would be financed. Let us calculate the margin loan amount as follows.

Margin loan = (Number of shares * Price per share) * % of margin loan

= (100*$40) * 30%

= $1,200

If value of security changes to $65:

Margin loan = (Number of shares * Price per share) * % of margin loan

= (100*$65) * 30%

= $1,950

If value of security drops to $30:

Margin loan = (Number of shares * Price per share) * % of margin loan

= (100*$30) * 30%

= $900

How much would the price of the stock have to decrease:

Let us understand that, the 75% of the debt would be equal to $1,200 the price of the share should be computed as follows:

(100 shares * ‘X’ * 0.25) * 3 = $1,200

75X = $1,200

X = $1,200 / 75

= $16.

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