Question

You decide to sell 300 shares of elk company short when it is selling at its yearly high of $75.50. Your broker tells you that your margin requirement is 65%. While you are short, Elk pays a $1.75 per share dividend. At the end of the year you buy your shares at $68.75 and pay a 12% interest rate in the amount borrowed. What is your rate of return on the investment?

Answer 1

Value of investment = No. of shares * price per share

= 300 * $75.50

= 22,650

Amount invested = Value of investment * margin requirement

= $22,650 * 65%

= $14,722.50

Dividend Amount = No. of shares * dividend per share

= 300* $1.75

= $525

Interest = [Value of investment * ( 1 - margin requirement) ] * interest rate

= [22,650*(1- 0.35)] * 12%

= 7,927.50 * 12%

= $951.3

Ending value( value of buy shares) = No. of shares * price per share

= 300 * 68.75

= $20,625

Profit = Value of investment(sold) - Dividend Amount - Interest - value of buy shares

= 22,650 - 525 - 951.3 - 20,625

= 548.70

Rate of return on the investment = Profit / Amount invested

= 548.70 / 14,722.50

= 3.73%