Problem 3: Short Selling [12 points] A hedge fund manager has a negative view of

Question

Problem 3: Short Selling [12 points] A hedge fund manager has a negative view of retail stocks right now based on the belief that Amazon will drive many retailers into bankruptcy. To act on his view, the manager sells short 20,000 shares of Macy's (M). The manager finds a broker willing to lend the shares. The current market price is 36.00 and M pays quarterly dividends of S0.22 per share. Assume the next dividend takes place 3 months from today, and subsequent dividends follow the same pattern. a. 3] Assume the manager maintains the short sale for 6 months. List all transactions b. [3] What is the profit (loss) on the short sale if the market price of M is $46.00 when the c. [3] What is the profit (loss) on the short sale if the market price of M is $26.00 when the d. 3] Now assume the investor pays approximately $1.00 per share over the 6 months to involved in the short-sale, holding the position, and closing it out after 6 months. manager closes the position after 6 months? Assume there is no fee to borrow the stock. manager closes the position after 6 months? Assume there is no fee to borrow the stock. borrow the stock. Re-compute your answers to b. and c. incorporating that fee

Explanation / Answer

a)

Short Sale, at time t=0

Step 1: Manager borrows 20,000 shares of M.

Step 2: Manager sells 20,000 shares of M in market @ $36.

Total proceeds from Sale =20,000 x 36 = $720,000

During Holding period , at t=3 months

Step 3: The manager shall pay for dividend recieved as lender would have recieved it if he had not lended the shares

Dividend per Share = $0.22

Total dividend after 3 months = 0.22 *20,000 =$4,400

So Total money with manager now will be 720,000 -4,400 = $715,600

Closing out stage, t=6 months

Step 4: Again dividends are to be paid to lender

Dividend = 0.22*20,000 = $4,400

Amount remaining after dividends = 715,600 - 4,400 = $711,200

Step 5 : The Manager shall buy shares from market (at market rate) and give them back to lender

b) As seen from above, the amount remianing with manager will be $711,200. Now Manager shall buy 20,000 shares from market and return them back to lender. So amount spent on buying 20,000 shares at $46 per share will be = 20,000 * 46 = 920,000

Loss of Manager = 920,000 - 711,200 = 208,800

c)  

As seen from (a), the amount remianing with manager will be $711,200. Now Manager shall buy 20,000 shares from market and return them back to lender. So amount spent on buying 20,000 shares at $26 per share will be = 20,000 * 26 = 520,000

Profit of Manager = 711,200 - 520,00 = $191,200

d) If manager has to pay $1 per share for borrowing, the total rent paid = 20,000*1 =$20,000

So in (b), Loss will be 208,800 + 20,000 = $ 228,800

In (c) Profit will be 191,200 - 20,000 = $171,200

  

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