In: Finance
Suppose the Xenon (XO) currently is selling at $90 per share. You buy 300 shares, using $20,000 of your own money, and borrow the remainder of the purchase price from your
broker. The rate on the margin loan is 6 percent.
a. If the minimum margin is 30 percent, how low can XO’s price fall before you get a margin call?
b. How would your answer to (a) change if you had financed the initial purchase with only $15,000 of your own money?
a). Loan Amount = Value of Investment - Initial Margin
= ($90*300) - $20,000 = $27,000 - $20,000 = $7,000
Assume price be P
Value of 300 shares is 300P
Equity = Value of Shares - Borrowed Amount = 300P - $7,000
Required margin = Equity / The value of the shares
0.30 = [300P - $7,000] / 300P
0.30 * 300P = 300P - $7,000
90P = 300P - $7,000
300P - 90P = $7,000
210P = $7,000
P = $7,000 / 210 = $33.33
You will receive a margin call when the stock price falls below $33.33
b). Loan Amount = Value of Investment - Initial Margin
= ($90*300) - $15,000 = $27,000 - $15,000 = $12,000
Assume price be P
Value of 300 shares is 300P
Equity = Value of Shares - Borrowed Amount = 300P - $12,000
Required margin = Equity / The value of the shares
0.30 = [300P - $12,000] / 300P
0.30 * 300P = 300P - $12,000
90P = 300P - $12,000
300P - 90P = $12,000
210P = $12,000
P = $12,000 / 210 = $57.14
You will receive a margin call when the stock price falls below $57.14