Suppose that Facebook is selling at $75 per share. You are bullish on Facebook s
ID: 2771950 • Letter: S
Question
Suppose that Facebook is selling at $75 per share. You are bullish on Facebook stock, and want to buy 1000 shares on margin. The initial margin is 50%. You can borrow from your broker at an interest rate of 6%.
(a) How much do you invest using your own money? How much do you need to borrow from your broker? (2 points)
(b) Assume that Facebook pays a year-end dividend of $2.5 per share. What will be your holding period return if the stock ex-dividend price of Facebook (i) goes up by 10% (ii) doesn’t change (iii) goes down by 10% during the next year? (6 points)
(c) How low can stock price fall before you get a margin call, if the maintenance margin is 25%? (2 points)
You are bearish on Facebook stock, and want to sell short 1000 shares at current price. The initial margin is 50%. (a) Assume that you earn no interest on the funds in your margin account. Facebook currently does not pay dividend. What will be your holding period return if the stock price of Facebook (i) goes up by 10% (ii) doesn’t change (iii) goes down by 10% during the next year? (3 points)
(b) How high can stock price rise before you get a margin call, if the maintenance margin is 25%? (2 points)
Explanation / Answer
Price per share of Facebook - $ 75, No of shares – 1000, Total price - $75000, Initial Margin 50% - $ 37500 ($75000/2)
Initial Margin is the percentage of the purchase price of securities (that can be purchased on margin) that the investor must pay for with his or her own cash or marginable securities.
(b) When a company declares a dividend, it sets a record date when you must be on the company's books as a shareholder to receive the dividend. Once the company sets the record date, the ex-dividend date is set based on stock exchange rules. The ex-dividend date is usually set for stocks two business days before the record date. If you purchase a stock on its ex-dividend date or after, you will not receive the next dividend payment. Instead, the seller gets the dividend.
So, Dividend received= $2.5 per shares, Total dividend = 1000 shares * $ 2.5 = $ 2500
(i) Holding period return if the stock ex-dividend price of Facebook goes up by 10%
Price of Facebook initially - $75, New price of Facebook - $75 + ($75 * 10%) = 82.5
Interest payment = $37500 * 6% = $2250
Current value of investment = $82.5 * 1000 shares = $82500 (ex-dividend)
Dividend Received - $ 2500
Return = (Current value of investments + dividend received – Initial value of investment – interest payment) / (Own money invested)
Return = ($ 82500 + $ 2500 - $ 75000 - $ 2250)/ 37500 = 20.67%
(ii) doesn’t change
Return = (Current value of investments + dividend received – Initial value of investment – interest payment) / (Own money invested)
Return = ($ 75000 + $ 2500 - $ 75000 - $ 2250)/ 37500 = 0.67%
(iii) goes down by 10% during the next year
Current value of investment = $75- 10% = $67.5 * 1000 shares = $67500 (ex-dividend)
Return = (Current value of investments + dividend received – Initial value of investment – interest payment) / (Own money invested)
Return = ($ 67500 + $ 2500 - $ 75000 - $ 2250)/ 37500 = -19.33%
(c) How low can stock price fall before you get a margin call, if the maintenance margin is 25%? (2 points)
The account equity (the market value of the securities minus the amount owed) must equal at least one-quarter the value of the securities in the account.
Stockprice (1- initital margin) / (1-maintainance margin)
$75 (1-0.5) / (1-0.25) = $50
You are bearish on Facebook stock, and want to sell short 1000 shares at current price. The initial margin is 50%. (a) Assume that you earn no interest on the funds in your margin account. Facebook currently does not pay dividend. What will be your holding period return if the stock price of Facebook (i) goes up by 10% (ii) doesn’t change (iii) goes down by 10% during the next year? (3 points)
(b) How high can stock price rise before you get a margin call, if the maintenance margin is 25%? (2 points)
(i) Holding period return if the stock price of Facebook goes up by 10%
Price of Facebook initially - $75, New price of Facebook - $75 + ($75 * 10%) = 82.5
Current value of investment = $82.5 * 1000 shares = $82500
Return = (Initial value of investment - Current value of investments) / (Own money invested)
Return = ( $75000 - $ 82500)/ 37500 = - 20.00%
(ii) doesn’t change
Return = (Initial value of investment - Current value of investments) / (Own money invested)
Return = ($ 75000 - $ 75000)/ 37500 = 0%
(iii) goes down by 10% during the next year
Current value of investment = $75- 10% = $67.5 * 1000 shares = $67500 (ex-dividend)
Return = (Initial value of investment - Current value of investments) / (Own money invested)
Return = ($ 75000 - $ 67500)/ 37500 = 20%
The account equity (the market value of the securities + money owed) must equal at least one-quarter the value of the securities in the account.
Stockprice (1+ initital margin) / (1 + maintainance margin)
$75 (1+ 0.5) / (1 + 0.25) = $90
Related Questions
drjack9650@gmail.com
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.