Question

Calculating profits on margined and unmargined investments

Claire Gerber wants to buy 600 shares of Google, which is selling in the market for $536 a share. Rather than liquidate all her savings, she decides to borrow through her broker at 5 percent a year. Assume that the margin requirement on common stock is 50 percent. If the stock rises to $635 a share over the next year, calculate the dollar profit and percentage return that Claire would earn if she makes the investment with 50 percent margin. Contrast these figures to what she'd make if she uses no margin.

Calculate the dollar net profit. Round the answers to the nearest dollar.

Without Margin

With 50% Margin

$__________________ $______________________

Calculate the return on investment. Round the answers to two decimal places

Without Margin

With 50% Margin

______________% ________________%

Answer 1

Calculation of dollar net profit
Dollar net profit if shares purchased without margin = Sale value - Purchase Cost
Sale value = 600 shares x $635 per share = $381000
Purchase Cost = 600 shares x $536 per share = $321600
Dollar net profit if shares purchased without margin = $381000 - $321600 = $59,400
Dollar net profit if shares purchased with margin = Sale value - Purchase Cost - Interest cost
Interest cost = Purchase cost of share x Margin requirement in % x Per year Interest rate on borrowings
Interest cost = $321600 x 50% x 5% = $8040
Dollar net profit if shares purchased with margin = $381000 - $321600 - $8040 = $51,360
Calculation of return on investment
Return on Investment = Dollar net profit / Cash Investment
Return on Investment if shares purchased without margin = $59,400 / $3,21,600 = 18.47%
Return on Investment if shares purchased with margin = $51,360 / $1,60,800 = 31.94%