Question

An investor with an initial equity of $15,000 sees a good investment opportunity to purchase stocks of Walmart (WMT) buying with 50% on margin from his broker. If the stock is currently trading at $100:

1. How many stocks he will be able to purchase?
2. If the broker Maintenance Margin Required is 30%, at which stock price of WMT the investors would receive a margin call? Show formula and calculation.
3. What would be the return on this investment 1 year later, if the WMT price increases to $112? And, if stock price is $92? Consider an annual borrowing interest rate of 4%. Show all calculations.
4. What is the leverage factor (effect) of buying on margin for this investment for when WMT increases $112? Show all calculations.

Answer 1

How many stocks he will be able to purchase?

Own Equity = $15000

Borrowed Funds = Own Funds * (1 - Initial Margin) / initial Margin = $15000 * 0.50 / 0.50 = $15000

# of Stocks that can be purchased = (Own Equity + Borrowed Funds) / Share price

# of Stocks that can be purchased = 30000 / 100

# of Stocks that can be purchased = 300 Shares

If the broker Maintenance Margin Required is 30%, at which stock price of WMT the investors would receive a margin call? Show formula and calculation.

(Shares * Margin Call price - Borrowed Funds) / (shares * Margin call price) = maintenance margin

(300 * Margin Call price - 15000) / (300 * Margin call price) = 30%

300 * Margin Call price - 15000 = 90 * margin call price

Margin Call Price = 15000 / 210 = $71.43

What would be the return on this investment 1 year later, if the WMT price increases to $112? And, if stock price is $92? Consider an annual borrowing interest rate of 4%. Show all calculations.

ROI when sale price is $112 = (Sale Value - Purchase value - Interest) / Own Equity

ROI when sale price is $112 = (300 * 112 - 30000 - 600) / 15000

ROI when sale price is $112 = 20.00%

ROI when sale price is $92 = (Sale Value - Purchase value - Interest) / Own Equity

ROI when sale price is $92 = (300 * 92 - 30000 - 600) / 15000

ROI when sale price is $92 = -12%

What is the leverage factor (effect) of buying on margin for this investment for when WMT increases $112? Show all calculations.

Return when the share are purchased without margin = (Sale Value - Purchase price) / Purchase value = $3600 / 30000 = 12%

Due to Leverage effect the return on invested has been increased from 12% to 20%

Leverage Factor = return with margin / return without margin = 20%/12% = 1.1.67

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