Question

(i) An investor is considering buying XYZ Corp. stock on margin. His stockbroker informed him that 100 shares of XYZ Corp. cost $42 a share. The margin requirement was 60 percent with an interest rate of 4.5 percent on borrowed funds, and commissions on the purchase and sale were 4%. One year after the investor invested in stock XYZ corp. paid an annual dividend of $1.55 a share. The price of the stock also rose to $70 in one year.

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a. What is the percentage earned on the investment if the stock is bought for cash (i.e., the investor did not use margin)?

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b. What is the percentage earned on the investment if the stock is bought on margin?

PLEASE SHOW WORK

Answer 1

a). Purchase price = $42*100

= $4200

Commission on purchased of stocks = 4%*$4200

= $168

Initial investment = $4200+$168

= $4368

Proceeds from sale = $70*100

= $7000

Commission paid on sales = 4%*$7000

= $280

Dividend income = $1.55*100

= $155

Total return = (Proceeds on sales - Initial investment - Sales commission)+ Dividend income

= ($7000-$4368-$280)+$155

= $2507

Percentage earned on investment = (Total return/Initial investment)*100

= ($2507/$4368)*100

= 57.39%

b). Equity investment = 60% of purchase price

= 0.60*$4200

= $2520

Borrowed amount = $4200-$2520

= $1680

Interest on borrowing = 4.5% of $1680

= 0.045*$1680

= $75.60

Initial investment = Equity investment + Commission paid on purchase

= $2520+$168

= $ 2688

Total return = Proceeds from sale - Initial investment - Sales commission - Interest on borrowing - Loan payoff + Dividend income

= $7000-$2688-$280-$75.60-$1680+$155

= $2431.40

Percentage return on investment =($2431.40/$2688)*100

= 90.45%