1. Suppose that the current price of eBay is $40 per share. Suppose further that
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Question
1. Suppose that the current price of eBay is $40 per share. Suppose further that the share price of eBay one month from now depends on the state of the economy as follows:
Also note that eBay will not pay any dividends over the next month.
1.1 You buy 500 shares, using $10,000 of your own money and borrowing the remainder of the purchase price from your broker. The interest rate on the margin loan is 2% per month, and the maintenance margin is 30%. What is the expected return of your investment?
1.2 What is the probability that you will receive a margin call from your broker one month from now? Explain with quantitative justification.
1.3 Suppose you sold short 500 shares of eBay at $40, using the maximum leverage allowed, and the price went up to $52 after one month. If you close out your short position, what would be the rate of return on your investment? (ignoring transaction costs).
**Please explain how you got calculated numbers
State of Economy Probability Price Boom .2 $52 Normal .5 $44 Recession .3 $30Explanation / Answer
Purchase amount = 500*40 =20,000.
After one month , the profit will be 41.4*500 -20000 = $700.
Loan of 10,000 @ 2% interest per month = $200
Therefore the profits now will be $500 ignoring maintenance margin.
With maintenance margin of 30%, the investor can withdraw only $14,490 -14,000 = $490
Therefore, profit is $490 - $200 (interest) = $290 with margin included
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