Question

Paul has a margin account with a balance of ¢150,000. The initial margin deposit is 60 percent and Choco Industries is currently selling at ¢50 per share. a. How many shares of Choco can Paul purchase? b. What is Paul's profit/loss if Choco's price after one year is ¢40? c. If the maintenance margin is 25 percent, to what price can Choco Industries fall before Paul receives a margin call?

Answer 1

a.

Let w be the number of shares.

So, the maximum shares he can afford should be valued at ¢150,000.

150000 = 50 × w × 60/100 {since 60% is the marginal deposit, that's the percentage Paul needs to make initially}

Solving for w, we get w = 5000

So, Paul can buy 5000 shares.

b.

As Paul has bought 5000 shares, the net loss in this case = 5000 × (50 - 40) = ¢ 50,000

Since, Paul has deposited 60% initially, his loss will be 60% of the nett loss = ¢ 30,000

c

Maintenance margin is 25% which implies Paul's margin account must have at least ¢150,000 × .25 = ¢37,500 in his margin account. So, the amount which Paul can pay for the losses is 150,000 - 37,500 = ¢112,500

Let the Choco prices fall to y. Then the total loss for 5000 shares is,

5000 × (50 - y)

And this should equal to ¢112,500

112,500 = 5000(50 - y)

=> y= 27.5

So, the share prices can fall till ¢27.5 until Paul receives a margin call.

Hope this helps. Do hit the thumbs up. Cheers!