Question

Suppose that Weston (WN) currently is selling at $80 per share. You buy 250 shares, using $15,000 of your own money and borrowing the remainder of the pur- chase price from your broker. The rate on the margin loan is 8%.

a. What is the percentage increase in the net worth of your brokerage account if the price of WN immedi- ately changes to (i) $88; (ii) $80; (iii) $72? What is the relationship between your percentage return and the percentage change in the price of WN?

b. If the minimum margin is 30%, how low can WN's price fall before you get a margin call?

c. How would your answer to (b) change if you had fi- nanced the initial purchase with only $10,000 of your own money?

d. What is the rate of return on your margined position (assuming again that you invest $15,000 of your own money) if WN is selling after one year at (i) $88; (ii) $80; (iii) $72? What is the relationship be- tween your percentage return and the percentage change in the price of WN? Assume that WN pays no dividends.

e. Continue to assume that a year has passed. How low can WN price fall before you get a margin call?

Answer 1

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