Question

Casey is considering buying stock on margin. She wants to buy $85,000 in stock; she will put 30% down and borrow the remaining $59,500 at 10% interest. (a) if Casey’s investment goes up by 45 percent after one year, and she pays off her loan, how much will she make in dollars? What percent rate of return does this represent? (b) If Casey’s investment instead drops by 18 percent, how much will she lose in dollars? In terms of a percentage loss how much will she lose?

Answer 1

a]

Initial investment = value of stock purchased * margin %

Initial investment = $85,000 * 30%

Initial investment = $25,500

Ending value of stock = value of stock purchased * (1 + increase %)

Ending value of stock = $85,000 * (1 + 45%)

Ending value of stock = $123,250

Interest on loan = amount borrowed * interest rate

Interest on loan = $59,500 * 10% = $5,950

Amount earned in $ = Ending value of stock - value of stock purchased - Interest on loan

Amount earned in $ = $123,250 - $85,000 - $5,950

Amount earned in $ = $32,300

% rate of return = Amount earned in $ / Initial investment

% rate of return = $32,300 / $25,500

% rate of return = 126.67%

b]

Initial investment = value of stock purchased * margin %

Initial investment = $85,000 * 30%

Initial investment = $25,500

Ending value of stock = value of stock purchased * (1 - decrease %)

Ending value of stock = $85,000 * (1 - 18%)

Ending value of stock = $69,700

Interest on loan = amount borrowed * interest rate

Interest on loan = $59,500 * 10% = $5,950

Amount lost in $ = Ending value of stock - value of stock purchased - Interest on loan

Amount lost in $ = $69,700 - $85,000 - $5,950

Amount lost in $ = -$21,250

% rate of return = Amount lost in $ / Initial investment

% rate of return = -$21,250 / $25,500

% rate of return = -83.33%