Question

Dee Trader opens a brokerage account and purchases 300 shares of Internet Dreams at $40 per share. She borrows$4,000from her broker to help pay for the purchase. The interest rate on the loan is 8%.a. What is the margin in Dee's account when she first purchases the stock?b. If the share price falls toS30 per share by the end of the year, what is the remaining margin in her account? If themaintenance margin requirement is30%, will she receive a margin call?c. What is the rate of return on her investment?

Answer 1

Answer:

A. The stock is purchased for $40 x 300 shares = $12,000.

Given that the amount borrowed from the broker is $4,000, Dee's margin is the initial purchase price net borrowing: $12,000 - $4,000 = $8,000.

B. If the share price falls to $30, then the value of the stock falls to $9,000. By the end of the year, the amount of the loan owed to the broker grows to:

Principal x (1 + Interest rate) = $4,000 x (1 + 0.08) = $4,320.

The value of the stock falls to: $30 x 300 shares = $9,000.

The remaining margin in the investor's account is:

Margin on long position = "Equity in account " /"Value of stock"

= "$9,000 － $4,320" /"$9,000" = 0.52 = 52%

Therefore, the investor will not receive a margin call.

C. Rate of return = "Ending equity in account － Initial equity in account" /"Initial equity in account"

= "$4,680 － $8,000" /"$8,000" = - 0.4150 = - 41.50%