Question

You purchased 300 shares of common stock on margin for $60 per share. The initial margin is 60% and the stock pays no dividend. What would your rate of return be if you sell the stock at $45 per share? Ignore interest on margin.

Answer 1

Answer:

Rate of Return is -41.67%

Explanation:

If initial margin is 60%, then the borrowed amount is 40%

Rate of Return =Profit / Initial Investment

where

Profit = Total Return − Initial Stock Value − Transaction Costs − Interest

And

Total Return = Ending Market Value + Dividend

Amount = 300 shares x $60 = $18,000

$18,000 * 0.40 = $7,200 Loan

And

Initial investment would be:

Initial Investment = $18,000 * 0.60

Initial Investment = $10,800

Therefore, the loan amounts to $18,000 and the initial investment would be $10,800

Proceeds after selling stock and repaying loan = (300 shares * $45)

= $13,500

= Proceeds after selling stock and repaying loan - Loan amount

= $13,500 - $7,200

= $6,300

Computing rate of return as:

Rate of Return = ($6,300 - $10,800) / $10,800

= - $4,500 / $10,800

= -0.4166

= - 41.67%

Ignoring the interest of margin, the Rate of Return is -41.67%