Question

2. (i) Your stockbroker told you about buying stocks on margin last year. You were NOT sure if it is a good investment decision to buy stocks on borrowed funds at the time. You decided to give using margin a try anyway. Your stockbroker bought 100 shares of ABC Corp. on margin for $65 a share. The margin requirement was 60 percent with an interest rate of 6.5 percent on borrowed funds, and commissions on the purchase and sale were 2%. One year after you invested in the stock ABC corp. paid annual dividend of $2 a share and the price of the stock rose to $110 in one year. (12 points)

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a. What is the percentage earned on the investment if the stock is bought for cash (i.e., the investor did not use margin)?

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b. What is the percentage earned on the investment if the stock is bought on margin?

2 (ii). An investor sells 100 shares short at $22. The sale requires a margin deposit equal to 60 percent of the proceeds of the sale. (8 points)

1. If the investor closes the position at $30, what was the percentage earned or lost on the investment?

2. If the position had been closed when the price of the stock was $17, what would have been the percent earned or lost on the position?

Answer 1

2(i)]
a]	Total cost of purchase = 100*65+100*65*2% =	$ 6,630
	Diviends received = 100*2 =	$               200
	Proceeds on sale = 100*110-100*110*2% =	$ 10,780
	% earned if, the stock is bought for cash = (200+10780)/6630-1 =	65.61%
b]	Margin deposited = 100*65*60% =	$ 3,900
	Borrowing from the broker = 100*65*40% = $2,600
	-Interest on borrowings = 2600*6.5% =	$               169
	-Commission on purchase = 100*65*2% =	$               130
	-Commission on sale = 100*110*2% =	$               220
	+Dividends received = 100*2 =	$               200
	+Difference in share price = 100*(110-65) =	$ 4,500
	Balance in margin account at the end of the year =	$ 8,081
	% earned if, the stock is bought on margin = 8081/3900-1 =	107.21%
2(ii)]
a]	Margin deposited = 100*22*60% =	$ 1,320
	Debit for difference in price = 100*(30-22) =	$               800
	Ending balance in margin account = 1320-800 =	$               520
	% loss on investment = 520/1320-1 =	-60.61%
b]	Margin deposited = 100*22*60% =	$ 1,320
	Credit for difference in price = 100*(22-17) =	$               500
	Ending balance in margin account = 1320+500 =	$ 1,820
	% loss on investment = 1820/1320-1 =	37.88%