Assignment (2):

Chapter 3: Financial Markets

---------------------Problem 1
Suppose that Intel currently is at $40 per share. You buy 500 shares by
using $15000 0f your own money and borrowing the reminder of the
purchase price from your broker. The rate on the margin loan %8.
A- What is the percentage increase in the net worth of your
brokerage account if the price of Intel immediately change to ($44);
($40); ($36).
The total cost of the purchase is
($40 500) = $20,000.
You borrow $5,000 from your broker, and invest $15,000 of your own funds.
Your margin account starts out with net worth of $15,000.
Percentage increase in the net worth:
(i) Net worth increases to: ($44 500) $5,000 = $17,000
Percentage gain = $17000 $15000 /$15,000 = 13.33%
(ii) With price unchanged, net worth is unchanged.
Percentage gain = zero
(iii) Net worth falls to ($36 500) $5,000 = $13,000
Percentage gain = $13,000 $15,000 /$15,000 = 13.33%
B- If the maintenance margin is 25%, how low can Intel price fall
before you get a margin call?
The value of the 500 shares is 500P. Equity is (500P $5,000).
(500P $5,000) / 500P = 0.25
You will receive a margin call when:
P = $13.33 or lower
C- How would your answer to (b) change if you had financed the
initial purchase with only $10000 of your own money?
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The value of the 500 shares is 500P.

Therefore, equity is (500P $10,000).
You will receive a margin call when:
(500P $10,000) / 500P = 0.25
When P = $26.67
D- What is the rate of return on your margin position (assuming
again that you invest $15000 of your own money) if Intel is selling
after one year at: $44; $40; $36.( assume that Intel pays no
dividends)
By the end of the year, the amount of the loan owed to the broker grows to:
($5,000 1.08) = $5,400.
The new equity in your account is (500P $5,400).
Initial equity was $15,000.

[(500 $44) $5,400] $15,000

Therefore,
your rate of return after one year is as follows:
$15,000

= 10.67%
[(500 $40) $5,400] $15,000
$15,000

= 2.67%
[(500 $36) $5,400] $15,000
$15,000
=

16.00%
E- Continue to assume that a year has passed. How low can Intels
price fall before you get a margin call?
The value of the 500 shares is 500P.
Equity is (500P $5,400).
You will receive a margin call when:
500 P $5,400
500 P

= 0.25
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When P = $14.4 or lower

Problem 2
A. If you earn no interest on the fund in your margin account, what will be your rate
of return after one year if Intel stock is selling at: (i) $44; (ii) $40; (iii) $36?
Initial equity or initial margin = 15,000
New equity = total Assets stock owed
= (proceeds + initial margin) - stock owed
= (20,000 + 15,000) (500 * 44)
35,000 22,000 = 13,000
The rate of return is: 13,000 15000/15,000 = -13.3%
(ii) New equity = (20,000 + 15,000) (500 * 40) = 15,000
The rate of return is: 15,000 15000/15,000 = 0
(iii) New equity = (20,000 + 15,000) (500 * 36) = 17,000
The rate of return is: 17,000 15000/15,000 = +13.3%
B. If the maintenance margin is 25%, how high can Intels price rise before you get a
margin call?
Total assets in the margin account are: $35,000
Liabilities are 500P.
A margin call will be issued when: 35,000 500 p / 500 p = 25%
$56.

P=

C. Redo parts (a) and (b), assuming that Intels dividend (paid at year-end) is $1 per
share.
(a) The rate of return:
Initial equity or initial margin = 15,000
New equity = total Assets stock owed - dividends
= (20,000 + 15,000) (500 * 44) -500 = 12,500
The rate of return is: 12,500 15000/15,000 = -16.7%
(b) Total assets are $35,000, and liabilities are (500P + 500)
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A margin call will be issued when:

35,000 (500P + 500) / 500 P = 25%
When P = $55.20.