Question

Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams from the previous problem. The initial margin requirement was 50%. (The margin account pays no interest). A year later, the price of Internet Dreams has risen from $40 to $50, and the stock has paid a dividend of $2 per share.
A. What is the remainning margin in the account?
B. If the maintenance margin requirement is 30 percent, will Old Economy receive a margin call?
C. What is the rate of return on the investment?

Answer 1

Answer:

A. 38%

B. NO

C. -150%

Explanation:

A.Calculation for What is the remaining margin in the account

Remaining margin=(1,000 shares*$40 per share*50%) /[(1,000 shares*$50 per share )+ ($2 per share*1,000)]

Remaining margin=$20,000/($50,000+$2,000)

Remaining margin=$20,000/$52,000

Remaining margin=0.38*100

Remaining margin=38%

Therefore the remaining margin in the account will be 38%

B. In a situation where the maintenance margin requirement is 30 percent, Old Economy will NOT receive a margin call reason been that based on the above Calculation the margin is 38% which means that it is abovethe maintenance margin requirement of 30%.

C. Calculation for What is the rate of return on the investment

Rate of return=[(1,000 shares*$40 per share)-(1,000 shares*$50 per share )] -(1,000 shares*$40 per share*50%) ÷(1,000 shares*$40 per share*50%)

Rate of return=($40,000-$50,000) -$20,000 ÷ $20,000

Rate of return = (-$10,000 -$20,000)/$20,000

Rate of return =-$30,000/$20,000

Rate of return = -1.5*100

Rate of return = -150%

Therefore rate of return on the investment will be -150%