Question

You purchase 200 shares for $70 a share ($14,000), and after a year the price falls to $65. Calculate the percentage return on your investment if you bought the stock on margin and the margin requirement was (ignore commissions, dividends, and interest expense):

25 percent.

40 percent.

75 percent.

Answer 1

Current Stock price = $70

No of shares purchased = 200

Total purchase price = Current Stock price * No of shares purchased

Total purchase price = $70 * 200

Total purchase price = $14,000

End of year Stock price = $65

End of the year value of securities = End of year Stock price * No of shares purchased

End of the year value of securities = $65 * 200

End of the year value of securities = $13,000

Gain / Loss = End of the year value of securities - Total purchase price

Gain / Loss = $13,000 - $14,000

Gain / Loss = - $1000

a) Margin requirement = 25%

Initial margin posted = Margin requirement * Total purchase price

Initial margin posted = 25% * $14,000

Initial margin posted = $3500

Funds borrowed = Total purchase price - Initial margin posted

Funds borrowed = $14,000 - $3,500

Funds borrowed = $10,500

Return on the investment = Gain / Loss / Initial margin posted

Return on the investment = -$1,000 / $3500

Return on the investment = -28.57%

b) Margin requirement = 40%

Initial margin posted = Margin requirement * Total purchase price

Initial margin posted = 40% * $14,000

Initial margin posted = $5600

Funds borrowed = Total purchase price - Initial margin posted

Funds borrowed = $14,000 - $5,600

Funds borrowed = $8,400

Return on the investment = Gain / Loss / Initial margin posted

Return on the investment = -$1,000 / $5,600

Return on the investment = -17.86%

c) Margin requirement = 75%

Initial margin posted = Margin requirement * Total purchase price

Initial margin posted = 75% * $14,000

Initial margin posted = $10,500

Funds borrowed = Total purchase price - Initial margin posted

Funds borrowed = $14,000 - $10,500

Funds borrowed = $3,500

Return on the investment = Gain / Loss / Initial margin posted

Return on the investment = -$1,000 / $10,500

Return on the investment = -9.52%