Professional Documents
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1. You put up $10,000 to take a long position in a stock with a price of $20.
(a) If the initial margin rate on the position is 80%, how many shares can you purchase? What
dollar amount are you borrowing from the brokerage firm?
(b) You will receive a margin call if the margin rate drops below 30%. Below what price will you
receive a margin call?
(Assume immediate price change, so you can ignore the dividend yield and interest on the loan)
(c) Calculate the return on the stock at the margin call price. Calculate the return on your equity
at the margin call price. Calculate the ratio of the return on the stock to the return on your
equity. How does this ratio compare to the initial margin rate?
(d) Assume the stock pays a single annual dividend of $1.00 one year from today. If, at the end of
the year, the stock’s price is $15, calculate the total return on the stock over the year.
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(e) If your broker charges 8% on margin loans, calculate your return on equity (ROE) over the
year.
2. You invest $25,000 and take a SHORT position in a stock with a price of $100.
(a) If the initial margin rate is 50%, how many shares did you short?
Sanity check:
Margin Rate = Equity/Value of Stocks Owed = Equity/(Shares x P) = $25,000/(500 x $100) = 0.50
(b) Assume you will receive a margin call if the margin rate drops below 30%. ABOVE what price
will you receive a margin call?
(Assume immediate price changes, so you can ignore dividend yield and interest expense)
(c) Calculate the return on the stock at the margin call price. Calculate you return on equity
(ROE) at the margin call price. Calculate the ratio on the return on the stock to the return on
your equity. How does this ratio compare to the margin rate?
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Stock Return/Equity Return = 15.38%/-30.76% = -50%
Note: the ratio equals the margin rate, with the opposite sign.
(d) Assume the stock pays a single annual dividend of $2.50 one year from today. If, at the end of
the year, the stock’s price is $90, calculate the total return on the stock over the year.
(e) The broker charges 8% on borrowed shares (calculated on the initial value of the position) and
you earn 2% on the cash in the account. Calculate the return on your equity over the year.
(Note: interest and dividends are listed as “payable” liabilities. Once those are paid, the amount of cash
decreases so the equity does not change.)