You are buying 100 shares of Netflix at the market price of $500 per share. You

Question

You are buying 100 shares of Netflix at the market price of $500 per share. You have $30,000 of your own money and borrows the rest of money for the purchase of the stock. The interest rate on the loan is 10%. Suppose your broker’s initial margin requirement is 60% of the value of the position and maintenance margin is 30% of the value of the position.
(Keep your answer to only two decimals)

a.      If the share price falls to $400 (20% drop) per share by the end of the year, what is the remaining margin in your account?  (example of answer format: xx.xx%, such as 12.34%)
b.       What is the rate of return on your investment if the share price falls to $400 per share by the end of the year?  (example of answer format: xx.xx%, such as 12.34%)
c.      Assume that a year has passed. How low can Netflix’s price fall before you get a margin call?  (example of answer format: $xxx.xx, such as $123.45)
d.     Assume that you shorted 100 shares at the market price of $500 per share and a year has passed. How high can Netflix’s price go before you get a margin call?   (example of answer format: $xxx.xx, such as $123.45)

Explanation / Answer

Answer:

Cost of shares = 100* $500 = $50,000

Initial margin requirement = 60% * $50,000 = $30,000

Equity = $30,000

Loan amount = $50,000 - $30,000 = $20,000

Interest rate = 10%

By end of the year:

If share prIce falls to =$400, value of shares = $400 * 100 = $40,000

Amount of loan with interest = $20,000 + 10% * $20,000 = $22,000

The remaining margin = Equity in account / Value of stock = ($40,000 - $22,000)/$40,000 = 45%

Answer b:

ROI = (Share value at year end - Purchase cost + Interest) / Equity value = ($40,000 - $50,000 - $2000) / $30,000 = - 40% or (40%)

Answer c:

Let us assume price upto which share price can fall before you get a margin = X

Value of shares at this price = 100X

Maintenance margin =30%

Hence,

Maintenance margin = [Value of shares - Debit balance(loan amount with interest)] / Value of shares  

30% = (100X - 22,000) / 100X

=> 30 X = 100X - 22,000

=> X =22,000 / 70 = $314.29

The Price can fall upto $314.29 before you get a margin call

Answer d:

Let us assume the price be = X

Share value = 100X

Hence,

30% = ($50,000 -$2,000 - 100 X) / 100X

30 X = $48,000 - 100X

X = $48,000 / 70 = $685.71

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