Question

Suppose that ZX Inc. is currently selling at $50 per share. You buy 200 shares, using $5,000 of your own money and borrowing the remainder of the purchase price from your broker. The rate on the margin loan is 5%.

What is the rate of return on your margined position (assuming again that you invest $5,000 of your own money) if ZX Inc. is selling after one year at (i) $54, (ii) $50, (iii) $46?

Answer 1

Total Price required to buy shares= 200 shares* $50/share = $10,000

Amount if loan borrowed = $10000 - $5000 = $5000

Interest on amount borrowed = $5000*5% = $ 250

(i) If shares are sold at $ 54

Net Return =$54*200shares - 10000-250(interest on borrowing)

=$10800-$10250 = $550

Rate of return = $550/5000 = 11%

(ii) If shares are sold at $50

Net Return = $ 50*200shares-10000-250

=$10000-$10250 = -$250

Rate of return = $-250/5000 = 5%

(iii) If shares are sold at $46

Net Return = $46*200shares-10000-250

=$9200- $10250= -$1050

Rate of return= -$1050/5000 = -21%