Question

You decide to sell short 100 shares of Charlotte Horse Farms when it is selling at its yearly high of R56. Your broker tells you that your margin requirement is 45 percent and that the commission on the purchase is R155. While you are short the stock, Charlotte pays a R2.50 per share dividend. At the end of one year, you buy 100 shares of Charlotte at R45 to close out your position and are charged a commission of R145 and 8 percent interest on the money borrowed. What is your rate of return on the invesmtment

Answer 1

Value of shares = 100 shares * R56 = R5600 (at the beginning of year)

Initial Investment= Marginal Requirement+ Commission

              = (R5600 * 45%) + R155

               = R2520 +R155 = R2675

Money Borrowed= R5600 * 55% = R3080

Interest on money borrowed = R3080* 8%= R246.4

Dividends = 100 shares* R2.5 = R250

Transactional Cost (Commissions)= R155 + R145 = R300

Value of shares = 100 shares * R45 = R4500 (at the end of year)

Profit= Beginning Value – Ending Value – Transactional Costs – Interest - Dividend

R5,600 - R4,500 - R300 - R246.40 - R250 = R303.60

Rate of return = Profit/ Investment = R303.60/R2,675 = 11.35%

Note: Here, the short seller is not entitled to receive the dividend because he already sold the stock and buys it at a future date. Therefore, he is instead responsible for paying the dividend owed to the lender of the shorted stock that he borrowed.