Question

you will sell short 300 shares of MMM corporation class-A common stock to protect your capital gains position at the end of your firm's tax year(2/28/07). You agree to make this short sale at ''full'' 50% initial margin, and the broker-commissions' R US-enforces a 40% maintenance margin standard, and a $10,000 absolute equity minimum on short accounts.

7. If MMM is sold short @ $95/share (and you meet initial margin

   deposit requirements), opening account equity value is equal to:

a. $14,250   b. $28,500   c. $42,750   d. $32,000   e. $10,000        

8. Price rises to $104/share, changing your percentage margin to:

a. 45.67%    b. 40.53%    c. 37.02%    d. 25.41%    e. 81.05%        

9. Will you receive a margin call (remember to check both the

   percentage/absolute criteria)? What is the minimum call amount?

a. yes/$2700 b. yes/$930 c. yes/$1550 d. yes/$4050 e. no call/$0    

10. “Threshold” or “trigger” price (P^*) for this 3M trade- at which

   the broker’s(%)maintenance margin standard is reached- equals:

a. $79.16    b. $158.33 c. $88.21    d. $101.79    e. $106.55        

11. What is the rate of return on this “short margin” investment (assume no dividends, brokerage fees, interest, etc. is yet paid)?

a. +19.30%   b. -19.30% c. -8.33%    d. -18.95%   e. +9.47%

pleas show the process.

Answer 1

7) 300 shares of MMM corporation are sold short for $95 per share, which gives us a total of $28500

However, only 50% of the amount is maintained as the initial margin

= 50% * 28500

= $14250 (Option A is correct)

8) Price rises to 104$ per share,

Hence, the trader who has entered into a contract to sell short loses as he is now compelled to sell at a lower price, i.e, $95 per share when the market price is $104 per share

The difference is (104-95)$

= 9$ * 300

= 2700$

Thus the initial margin account falls by 2700$, i.e, 14250$-2700$

= 11550$

14250$ was 50% of the Initial Margin Account

11550$ is 50/14250*11550 = 40.53% (Simple Unitary Method)

(Option B is right)

9) No, we will not receive a margin call

A margin call is received when the initial margin falls below the maintenance margin account. However, the maintenance margin is 40% and we haven't breached that percentage

Hence, we will not receive a margin call

(Option D is correct)

10) If the price of the share rises to 106.55$, thus losing 11.55*300 on the short sale agreement

i.e, $3465

The Initial Margin account gets deducted by this amount, i.e 14250$ - 3465$

= $10,785

Applying the same logic,

if 14250$ corresponded to 50% of the IM

10785$ would correspond to 37.8%

Thus, it goes below the maintenance margin account and a margin call is made to bring the amount to the promised 50% initial margin by an amount that is referred to as the Variation Margin.

Hence, Option D is right as 106.55 is the Trigger Price for a margin call and breach of the maintenance margin standard

11) Rate of return on this investment =

Loss of 2700/14250

= -18.95%

as the trader loses 2700$ on his investment of 14250$ when the price of the share rises to 104$

Hence, Option D is correct