Question

Harmony Shadwell wants to buy 100 shares of Google, which is currently selling in the market for $56 a share. Rather than liquidate all her savings, she decides to borrow through her broker. Assume that the margin requirement on common stock is 50%. If the stock rises to $66 a share by the end of the year, show the dollar profit and percentage return that Harmony would earn if she makes the investment with 50% margin. Contrast this to what she'd make if she uses no margin. Assume 9% interest on the borrowed money.

Answer 1

100 Shares of Google
Current Price Per Share = $56

Total Amount Required = 100 * 56 = $5600

Margin provided by Broker (50%) = $2800

Amount need to be invested by Harmony = $2800

Stock Price rises to $66
Amount of Stock = 100 * 66 = $6600

Profit($) = $6600 - $5600 = $1000

Percentage return that Harmony would earn if she makes the investment with 50% margin:

(1000/2800)*100 = 35.7143 %

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If she uses no margin and borrows money at 9% interest.

Amount need to be borrowed = $5600

Now, Borrowed amount need to be repaid with 9% Interest at the year end.

So Amount need to be repaid = $5600 (1 + 0.09) = $6104

Stock price at end of Year = $66

Amount of Stock = 100 * 66 = $6600

Profit($) = $6600 - $5600 = $1000

But actual realized profit after paying borrowed amount,
Profit($) = $6600 - $6104 = $496

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If she uses margin then Profit = $1000

If she borrows(at 9%) money then Profit = $496