You have decided to invest $7,021,360,27 in the common stock of Kano Industries,

Question

You have decided to invest $7,021,360,27 in the common stock of Kano Industries, which is currently trading at $5.50 per share

a) i) compute the number of shares you can buy with your investment, ii) suppose the price of Kano stock rises to $6.00 three months later, what is your total profit and rate of return?

b) Your brokage firm has a policy of using 60% margin(i.e. your personal funds have to account for a minimum of 605 of the total funds and you can borrow the remaining 40% of the funds).

i) Assuming you use the maximum amount of margin loan, how many shares can you buy from your total investment?

ii)Suppose the price of Kanon stock rises to $6.00 three months later, what is your total profit and rate of return? Assume that the broker charges a margin loan interest rate of 8% per year or 2% for three months.

c) using the infromation from a) and i), what would your total profit and rate of return be if Kano Industries stock declines to $4.50 in three months?

Explanation / Answer

a)

i)

No. of shares that can be bought = Amount to be invested/Market price per share = $7,021,360,270/$5.50 = 1,276,610,958 shares

ii)

Profit per share = Current price – Purchase price = $6 - $5.50 = $0.50 per share

Total profit = No. of shares bought * Profit per share = $0.50 * 1,276,610,958 shares = $638,305,479

Rate of return = Profit per share / Purchase price per share = $0.5/$5.50 = 0.0909 = 9.09%

b)

i)

Personal funds = $7,021,360,270

Margin = 60%

Total investments = $7,021,360,270/0.60 = $11,702,267,117

No. of shares that can be bought = Amount to be invested/Market price per share = $11,702,267,117/$5.50 = 2,127,684,930 shares

ii)

Borrowed funds = Total investment * 40% = $11,702,267,117*40% = $4,680,906,847

Interest for 3 months period = $4,680,906,847 * 0.02 = $93,618,137

Total profit = ($6 - $5.50)*2,127,684,930 shares = $1,063,842,465

Net profit = $1,063,842,465 - $93,618,137 = $970,224,328

Rate of return = $970,224,328/$11,702,267,117 = 0.0829 = 8.29%

c)

Profit per share = $4.50 - $5.50 = -$1.00 = $1 per share loss

Total loss = $1 * 1,276,610,958 = $1,276,610,958

Rate of return = -$1/$5.50 = -0.1818 = -18.18%

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