Question

​​​​​​Please Answer parts C and D. Thank you.

1. On January 1, 1991, Earl Conway opened a margin account with a discount broker with initial and

maintenance margins of 60% and 35%.

1. (a) On January 1, he purchased 200 shares of AT&T at $30. How much cash did he send in if he took the maximum loan possible? What was the position of his account after this transaction?
2. (b) On February 1, the price of AT&T was $32. Earl placed an order to short sell 100 shares of IBM selling at $104 per share. His account was considered to be in good standing on February 1. Calculate the margin in his account after the short sale is completed. Did he have to send any cash for this transaction? If yes, how much? What was the position of the account after adding the cash?
3. (c) On April 1, the price of AT&T was $34 and IBM was selling at $101. What was the margin in the account?
4. (d) If Earl decided to liquidate his investments on April 1, what steps would he have taken? What would be the net proceeds to Earl assuming that there were no transaction costs or interest? What would be the net proceeds if the transaction costs were 1.5% of the trade value and the interest rate on the margin loan was 2.1% per quarter?

Answer 1

c
Share	AT&T	IBM
Purchase price	30	104
Purchase quantity	200	100
Purchase value	6000	10400
Initial margin	60%	60%
Initial margin	3600	6240
Maintenance margin	35%	35%
Maintenance margin	2100	3640
Price on 1st April	34	101
Position value	6800	10100
Maintenance margin required	2380	3535
Current margin available	4400	5940

Current margin available= initial margin + change (increase/ decrease) in position value. Since the current available margin is above the required maintenance margin, there will be no margin call.

d

When Earl liquidates his position, the broker will deduct his margin, cost of funding, transaction cost and any other costs from the selling price of the shares and return the remaining amount to Earl. The return will be calculated based on the initial margin as this is the actual value invested by Earl.

Share	AT&T	IBM
Purchase price	30	104
Purchase quantity	200	100
Purchase value	6000	10400
Initial margin	60%	60%
Initial margin	3600	6240
Funding by broker	40%	40%
Funding by broker	2400	4160
Maintenance margin	35%	35%
Maintenance margin	2100	3640
Price on 1st April	34	101
Position value	6800	10100
Case 1- no margin costs
Amount received on sales	6800	10100
less broker's funding	2400	4160
Amount received by Earl	4400	5940
Initial investment by Earl	3600	6240
Rate of return realized	22.22%	-4.81%
Case 2- with margin costs
Amount received on sales	6800	10100
less broker's funding	2400	4160
less broker's cost of funding 2.1%	50.4	87.36
	=2.1%*2400	=2.1%*4160
less transaction cost 1.5%	102	151.5
	=1.5%*6800	=1.5%*10100
Amount received by Earl	4247.6	5701.14
Initial investment by Earl	3600	6240
Rate of return realized	17.99%	-8.64%