Question

8. You are making a short sale of a stock at 173 for 100 shares with the expectation that the stock could be $143 in a year. The initial margin is 60% and maintenance margin is 40%.

8A) Determine the collateral needed in the form of cash and loan.

8B) Show this in a balance sheet form and calculate margin.

                                                                Price=173

8C) Show the short sale in a balance sheet format if price falls to 143 and calculate margin.

price: 143

8D) Show the balance sheet and margin if price rises to 193.

Price: 193

8E) At a price of 193 as in 8D, would you get a margin call? Explain.

Answer 1

Explanation :

Initial margin is what is required to be given as collateral. If after the position is taken, the price goes adverse to our expectation, margin reduces and if it reduces below maintenance margin, margin call will be raised. If the price goes favorable to the trade, the additional margin is paid to the investor.

In the above question, 8(B), market price is equal to selling price and hence no change in margin.

In 8(C), price goes favorable and reduces down to 143, hence the profit in excess of initial margin is paid to the investor.

In 8(D), the price goes adverse and rises to 193. Hence the loss is more than the maintenance margin so margin call is made as shown in the table.