You’ve just opened a margin account with $25,200 at your local brokerage firm. Y

Question

You’ve just opened a margin account with $25,200 at your local brokerage firm. You instruct your broker to purchase 500 shares of Landon Golf stock, which currently sells for $84 per share. Suppose the call money rate is 7 percent and your broker charges you a spread of 1.25 percent over this rate. You hold the stock for six months and sell at a price of $91 per share. The company paid a dividend of $0.46 per share the day before you sold your stock.

a. What is your total dollar return from this investment?

What is your effective annual rate of return?

Explanation / Answer

Initial purchase = 500 × $84 = $42,000

Amount borrowed = $42,000 – 25,200 = $16,800

Interest on loan = $16,800*(1 + 8.25%) ^1/2 – $16,800 = $679.27

Dividends received = 500($.46) = $230.00

Proceeds from stock sale = 500($91) = $45,500

Dollar return = $45,500 + 230 – 16,800 – 25,200 – 679.27 = $3050.73

Rate of return = $3,050.73 / $25,200 = 12.11% per six months

Effective annual return = (1 + .1211) ^12/6 – 1 = 25.68%

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