Question

Suppose that ZX Inc. is currently selling at $50 per share. You buy 200 shares, using $5,000 of your own money and borrowing the remainder of the purchase price from your broker. The rate on the margin loan is 5%.

Suppose that you sell short 400 shares of ZX Inc., currently selling for $50 per share, what will your rate of return be after one year if ZX Inc. stock is selling at (i) $54, (ii) $50, (iii) $46? Assume that ZX Inc. pays no dividends.

Answer 1

While buying 200 shares, totalamount needed is $200*50= $10000

own money =$5000

so, borrowed money = $(10000-5000) = $5000

interest paid on loan = $5000*5%=$250

i)sale proceeds =400 shares *$50 = $20000

owed money = 400shares*$54=$21600

interest on loan=$250

rate of return=[(owed money+interest-sale proceed)/sale proceeds]*100

=[($21600+250-20000)/20000]*100

=9.25%

ii)sale proceeds =400 shares *$50 = $20000

owed money = 400shares*$50=$20000

interest on loan=$250

rate of return=[(owed money+interest-sale proceed)/sale proceeds]*100

=[($20000+250-20000)/20000]*100

=1.25%

iii)sale proceeds =400 shares *$50 = $20000

owed money = 400shares*$46=$18400

interest on loan=$250

rate of return=[(owed money+interest-sale proceed)/sale proceeds]*100

=[($18400+250-20000)/20000]*100

=-6.75%