Barbara buys 100 shares of DEM at $35 a share and 200 shares of GOP at $40 a sha
ID: 2758881 • Letter: B
Question
Barbara buys 100 shares of DEM at $35 a share and 200 shares of GOP at $40 a share. She buys on margin and the broker charges interest of 10% on the loan. a. If the margin requirement i 55%, what is the maximum amount she can borrow? b. If she buys the stocks using the borrowed money and holds the securities for a year, how much interest must she pay? c. If after a year she sells DEM for $29 a share and GOP for $32 a share, how much did she lose on her investment? d. What is the percentage loss on the funds she invested if the interest payment is included in the calculation?
Explanation / Answer
Solution:
a. Value of Barbara’s total portfolio = 100 shares of DEM at $35 + 200 shares of GOP at $40
Value of Barbara’s total portfolio = $3,500 + $8,000
Value of Barbara’s total portfolio = $11,500
The margin requirement represents the equity amount that Barbara should maintain. Hence, if the margin requirement is 55%, Barbara will maintain a minimum of 55% of equity in her portfolio.
Equity = 55% x $11,500 = $6,325
She can borrow = $11,500 - $6,325 = $5,175.
b. If Barbara borrows the whole amount, she will incur an interest expense of 10% of the amount borrowed. This amount can be calculated as follows:
Interest = 10% of amount borrowed
Interest = 10% x $5,175
Interest = $517.5
c. Total price of shares sold = 100*$29 + 200*$32
Total price of shares sold = $2,900 + $6,400
Total price of shares sold = $9,300
To calculate the loss on DEM, we deduct the total selling price from the original cost
Loss on DEM = $3,500 - $2,900
Loss on DEM = $600
Loss on GOP = $8,000 - $6,400
Loss on GOP = $1,600
Total loss = $600 + $1,600
Total loss = $2,200
d. Percentage loss on margin = Total loss to the interest/Equity
Percentage loss on margin = ($517.5 + $2,200)/$6,325
Percentage loss on margin = $2,717.5/$6,325
Percentage loss on margin = 0.429 or 43%
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