Question

Suppose XYZ Corp stock is currently selling for $40 a share. You invest $10,000 of your own money to buy on margin. The initial margin rate is 60% and the minimum maintenance margin is 30%. The interest rate on margin loan is 8%. The stock paid $1 in dividends per share and you paid $0.50 per share as commission.

1. If the stock price increases to $52 after one year, show the T-Account calculations for Margin calculations and calculate your rate of return

2. If the stock price falls to $32 after one year, show the T-Account for margin calculations and calculate your rate of return

3. How far does the price have to fall before you get a margin call?

Answer 1

Initial Margin is 60% and Maintenace Margin is 30%

Investment Amount of $10000 and the current price of stock is $40. So we can buy $10000/40= 250 Stocks of XYZ Corp.

Here the initial Margin shall be deposit = $10000*60% that comes to $ 6000

and Maintenance Margin Which have to maintain all the time = $10000*30% = $3000

Case 1

Stock Price is $ 52 after one Year

a.Initial Margin = $ 6000

b.Increase in Value= $ 52-40= $ 12 per stock that shall be added to Margin Account

ie. $12*250= $ 3000

c. Dividend income net of Commition =$1-$.05= $0.5 on 250 stock that comes to $ 125

d. interest on Initial Margin for one year = 6000*8%= $ 480

e Net Income = 3000+125-480 =$ $2645

$ 6000 of initial margin shall be refunded as it is as the price of stock increase during the year.

Case 2

If Price is $ 32

The price is decrease to $32 from $40 then the amount shall be deducted from the initial margin account

Hence $ 8*250= $2000 shall be deducted from the margin account

all the other calculation are same as above.

Case 3

The Mantenace margin is $ 3000 so if the price decrease below the price =3000/250= $12 then there have to add the amount in maintenace margin account