Question

You believe the price of Freeze Frame Co. stock is going to fall, so you short 650 shares at a price of $63. The initial margin is 55 percent. Ignore dividends. a. Construct the equity balance sheet for the original trade. (Input all amounts as positive values.) b-1. Construct an equity balance sheet for a stock price of $59 per share. (Input all amounts as positive values.) b-2. What is your margin? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) b-3. What is your effective annual return if you cover your short position at this price in four months? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) c-1. Construct an equity balance sheet for a stock price of $68 per share. (Input all amounts as positive values.) c-2. What is your margin? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.) c-3. What is your effective annual return if you cover your short position at this price in four months? (A negative value should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

Solution:-

a. Construct the equity balance sheet for the original trade:-

Assets		Liabilities and account equity
Proceeds from sale	40,950	Short position	40,950
Initial margin deposit	22,522.50	Account equity	22,522.50
Total	63,472.50	Total	63,472.50

b-1. Construct an equity balance sheet for a stock price of $59 per share:-

Assets		Liabilities and account equity
Proceeds from sale	40,950	Short position	38,350
Initial margin deposit	22,522.50	Account equity	25,122.50
Total	63,472.50	Total	63,472.50

b-2. What is your margin:-

Margin

65.51 %

Explanation:-

25,122.50 / 38,350 = 65.51%

b-3. What is your effective annual return if you cover your short position at this price in four months:-

Effective annual return

-30.79 %

Explanation:-

Four month return = (25,122.50 - 22,522.50) / 22,522.50 = 11.54%

Effective annual return = (1 - 0.1154) ^12/4  -1

= - 30.79%

c-1. Construct an equity balance sheet for a stock price of $68 per share:-

Assets		Liabilities and account equity
Proceeds from sale	40,950	Short position	44,200
Initial margin deposit	22,522.50	Account equity	19,272.50
Total	63,472.50	Total	63,472.50

c-2. What is your margin:-

Margin

43.60 %

Explanation:-

19,272.50 / 44,200 = 43.60%

c-3. What is your effective annual return if you cover your short position at this price in four months:-

Effective annual return

49.84 %

Explanation:-

Four month return = (19,272.50 - 22,522.50) / 22,522.50 = -14.43%

Effective annual return = [1 - (-0.1443) ^12/4]  -1

= - 49.84%