please explain how you got all calculated numbers Suppose that the current price
ID: 2774627 • Letter: P
Question
please explain how you got all calculated numbers
Suppose that the current price of eBay is $40 per share. Suppose further that the share price of eBay one month from now depends 011 the state of the economy as follows: Also note that eBay will not pay any dividends over the next month. 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? What is the probability that you will receive a margin call from your broker one month from now? Explain with quantitative justification. 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).Explanation / Answer
Part 1.1
The present price of eBay shares = $ 40.
The value of eBay Shares one month from now as per the given table is 0.2 * 52 + 0.5*44 + 0.3*30 = $41.4
Purchase of 500 shares @ $40 = $20,000
Total Amount On purchase of shares =$20,000
Total Amount on sales of shares @ $41.4 = $20,700
Pay back the margin Money = -$10,000
Pay back interest on margin money @ 2% per month = -$200
Therefore Total amount got back after a month is20700-10000-200 =$10,500
Therefore expected Return on investment is = 10,500-10,000 =$500 . In percentage terms 5%
Part 1.2
You will not receive a margin under all three scanrios. The possible of getting margin call is in the recession case.
Stock has been purchased at at $20,000.
Now if the price falls to $30, the investment value will be 15,000. Brokers money is 10,000 and your money is 5,000. Since your money 5,000 is 33 % of 15,000 which still above the maintenance margin of 30%, you will never get a call.Hence the probability of getting a margin call is zero.
Part 1.3
Because you short sold the stock, the loss will be 52-40 = $12/share and total of $6,000
So Money got back after a month will be 20000-6000 =14,000
Pay back the broker 10,000 + 200 for the margin money principal + Interest
Total avaivalbe balance = 14000-1000-200 = 3,800
Therefore Loss is 10,000 -3,800 =6,200
Return is -6,200 (loss)
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