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Problem 2 Margin (34 Points) 2.A. The current market price for XYZ is $48 per sh

ID: 2813899 • Letter: P

Question

Problem 2 Margin (34 Points)

2.A. The current market price for XYZ is $48 per share. Initial margin is 50%, maintenance margin is 35% and margin interest is 1.50% per year. XYZ pays annual cash dividends of $2.25 per share.

2.A.1) You believe the stock price will increase over the next year and wish to trade exactly one round lot. What trade should you make (2 points)? How much margin would you have to post to your account (4 points)? At what price would you receive a margin call (7 points)?

2.A.2) Suppose you are correct and the stock rises to $55 per share at the end of the year. What is your percentage return on equity for this trade (4 points)?

2.B. The current market price for ABC is $75 per share. Initial margin is 50%, maintenance margin is 35% and there is no margin interest. ABC pays annual cash dividends of $3.50 per share.

2.B.1) You believe the stock price will decrease over the next year and wish to trade exactly one round lot. What trade should you make (2 points)? How much margin would you have to post to your account (4 points)? At what price would you receive a margin call (7 points)?

2.B.2) Suppose you are correct and the stock falls to $68 per share at the end of the year. What is your percentage return on equity for this trade (4 points)?

Please provide steps to reach answer.

Explanation / Answer

Suppose 1 round lot = 100 shares

2A1)    Buy 100 shares of stock with 50% margin

   Total price = 100* 48 = 4800

   Intial Margin = 0.5* 4800 = 2400

   Amount Borrowed = 4800 - 2400 = 2400

  

   Maintenance Margin = 35%

   Margin = ( value of the investment - Amount borrowed) / Value of the investment

   = 1- (amount borrowed / Value of investment)

   Amount borrowed = 2400   

   Value of Investment for margin call = Amount borrowed / ( 1- Maintenance margin )

   = 2400 / (1-.35)

   = 3692.31

   Price of stock for margin call = 3692.31 / 100 = 36.92

2A2)

Cash flow from selling shares @55 = 5500

Cash flow from dividend = 225

Loan amount paid back = 2400 * 1.015 = 2436

Initial Investment by investor = 2400

Return on equity = [ (5500 + 225) - 2436 -2400 ] / 2400

= 0.3704

= 37.04%

2B1)

Short sell 100 shares

Total proceeds from short sell = 7500

Deposit in margin account = 0.5 * 7500 = 3750

For short sell,

Margin = (proceeds from short sell + margin deposit - Value of shares) / Value of shares

Maintenance Margin = 35%

Value of shares for margin call =(Proceeds from short sell + margin deposit) / (1+ maintenance margin)

= (7500+3750) / 1.35

= 8333.33

Price for margin call    = 8333.33 / 100    = 83.33

2B2)

new stock price = 68

Investor closes her position. She gets back her margin money and the gain

Gain from the sale = 7500-6800 = 700

Margin deposit    = 3750

Return on equity = 700/ 3750 = 18.67%

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