Question

Suppose that you sell short 300 shares of CYSCO (CY), currently selling for $90 per share, and give your broker $20,000 to establish your margin account.

a. If you earn no interest on the funds in your margin account, what will be your rate of return after one year if CY stock is selling at $98? Assume that CY pays no dividends.

b. If the minimum margin is 30 percent, how high can CY’s price rise before you get a margin call?

c. Redo part (a) and (b), now assuming that CY’s dividend (paid at year-end) is $3 per share.

Answer 1

1. The short sell description are as follows

Volume sold = 300

Sold price = 90

Total position Value = 90*300 = 27,000

Initial deposited = 20,000

So we calcite the IMR or the Initial margin requirement as

IMR % = Deposit / Position value *100

=20,000/27000*100 =74.07%

A No interst was earned on the funds

The last selling price the stocks is 98

So this is a LOSS position as we SHORT sold the shares

Total Loss = (98-90) *300 = - 2400 Loss

Rate of return % = Profit or loss / Amount deposited * 100

=2400/20,000 * 100 = -12% loss

B The MMR or the maintenance margin requirement is now 30%

So

MMR = 30%

We have previously calculated IMR = 74.07%

So the change in price = (1+IMR%) /(1+MMR%) * Sold price

= (1+0.7407)/(1+0.30) * 90 = $120.51

So margin call will be placed on price at 120.51 .

C Now dividends are paid at $3 per share

So the short seller must make good the dividend loss also

Initial loss = (98-90) *300 = -2400 loss

Dividend loss = 3*300 = -900 loss

Total loss = -3300 loss

Return % = -3300 / 20,000 * 100 = -16.50% loss