In: Accounting
Suppose you buy 100 shares of stock initially selling for $50, borrowing 25% of the necessary funds from your broker; that is, t he initial margin on your purchase is 25%. You pay an interest rate of 8% on margin loans. a. How much of your own money do you invest? How much do you borrow from your broker? b. What will be your rate of return for the following stock prices at the end of a one-year holding period?
(i) $40,
(ii) $50,
(iii) $60.
money invest is $3750
amount of loan owned to broker = $1350
when selling price is $40 rate of return = - 29.33%
when selling price is $50 rate of return = - 2.67%
when selling price is $60 rate of return = 24%
Explanation:
given data
No of share = 100
initial selling = $50
borrow = 25%
initial margin purchase = 25%
interest rate = 8%
to find out
How much money invest and How much borrow from broker and rate of return at end of 1 year at (i) $40, (ii) $50, (iii) $60
solution
we know total investment is here
total investment = No of share × initial selling per share
total investment = 100 × 50
total investment = $5000
so
borrow fund is = 0.25 × 5000 = $1250
and Equity invest = total investment - borrow fund
equity invest = 5000 - 1250 = $3750
and
amount of loan own to broker at the end of year is
amount of loan = borrow fund × ( 1 + rate )
amount of loan = 1250 ( 1 + 0.08)
amount of loan owned to broker = $1350
and
selling price here after 1 year is $40
so rate of return is = ........................1
rate of return is =
rate of return = - 29.33%
and
selling price here after 1 year is $50
put here value
rate of return is =
rate of return = - 2.67%
and
selling price here after 1 year is $60 so from equation 1
put the value
rate of return is =
rate of return = 24%
rate of return = 24%