Question

Old Economy Traders opened an account to short sell 1,600 shares of Internet Dreams at $52 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $52 to $60, and the stock has paid a dividend of $2.00 per share.

a.	What is the remaining margin in the account? (Omit the "$" sign in your response.)

Remaining margin

$

b.	If the maintenance margin requirement is 30%, will Old Economy receive a margin call?
	Yes No

c.	What is the rate of return on the investment? (Round your answer to 2 decimal places. Negative value should be indicated by a minus sign. Omit the "%" sign in your response.)

Rate of return

%

Answer 1

Number of shares = 1600

Initial price per share = $52

Initial margin requirement = 50%

Price after 1 year = $60

Dividend paid per share = $2

a) Initial margin in account = Initial margin requirement * Total Value of shares = 0.5 * 1600 * 52 = $41,600

Price of share increased by: $60 - $52 = $8

Because of this price increase, Old Economy traders will lose amount equal to Number of shares * Price increase

= 8 *1600 = $12,800

Total dividend paid by Old Economy traders = Dividend per share * Number of shares = $2 * 1600 = $3,200

Therefore, remaining margin = $41,600 - $12,800 - $3,200 = $25,600

b) Current percentage margin on short position is given by current margin divided by the value of shares owed

therefore, Margin = $25,600/(60*1600) = 26.67%

Because the maintenance margin reuirement of 30% is greater than the percentage margin, Old Economy will receive a margin call

c) Rate of return = (Ending margin - Initial Margin)/Initial Margin = (25600 - 41600)/41600 = -38.46%