BFW3121 Investments and Portfolio Management

Tutorial Questions and Answers for Week 3

Chapter 2

1. Calculating Margin Carson Corporation stock sells for $17 per share, and you’ve decided to purchase as many shares as
you possibly can. You have $31,000 available to invest. What is the maximum number of shares you can buy if the initial
margin is 60 percent?

2. Margin You purchase 275 shares of 2nd Chance Co. stock on margin at a price of $53. Your broker requires you to
deposit $8,000. What is your margin loan amount? What is the initial margin requirement?

6. Margin Calls You buy 500 shares of stock at a price of $38 and an initial margin of 60 percent. If the maintenance margin
is 30 percent, at what price will you receive a margin call?

7. Margin Calls You decide to buy 1200 shares of stock at a price of $34 and an initial margin of 55 percent. What is the
maximum percentage decline in the stock before you will receive a margin call if the maintenance margin is 35 percent?

9. Margin Calls on Short Sales You short sold 1,000 shares of stock at a price of $36 and an initial margin of 55 percent. If
the maintenance margin is 35 percent, at what share price will you receive a margin call? What is your account equity at this
stock price?

13. Margin Call Suppose you purchase 500 shares of stock at $48 per share with an initial cash investment of $12,000. If
your broker requires a 30 percent maintenance margin, at what share price will you be subject to a margin call? If you want to
keep your position open despite the stock price plunge, what alternatives do you have?

14. Margin and Leverage In the previous problem, suppose the call money rate is 8 percent and you are charged a 2 percent
premium over this rate. Calculate your return on investment for each of the following share prices one year later. Ignore
dividends.

a. $56
b. $48
c. $32

Suppose instead you had simply purchased $24,000 of stock with no margin. What would your rate of return have been now?
Answers and Solutions for Chapter 2 and 3
Chapter 2

1. Maximum investment = $31,000 / .60 = $51,667

Number of shares = $51,667 / $17 per share = 3,039.22 (or 3,039) shares

2. Margin loan = ($53 × 275) – $8,000 = $6,575

Margin requirement = $8,000 / ($53 × 275) = .5489, or 54.89%

6. Amount borrowed = (500 × $38) - (500 × $38)(.60) = $7,600

Margin call price = ($7,600 / 500) / (1 –.3) = $21.71

7. Amount borrowed = (1,200 × $34)(1 – .55) = $18,360

Margin call price = ($18,360 / 1,200) / (1 –.35) = $23.54
Stock price decline = ($23.54 – $34) / $34 = –30.77%

9. Proceeds from short sale = 1,000($36) = $36,000

Initial deposit = $36,000(.55) = $19,800
Account value = $36,000 + 19,800 = $55,800
Margin call price = $55,800 / [1,000 + (.35 × 1,000)] = $41.33
Account equity = $55,800 – (1,000 × $41.33) = $14,470

13. Total purchase = 500 shares × $48 = $24,000

Margin loan = $24,000 – 12,000 = $12,000
Margin call price = $12,000 / [500 – (.30 × 500)] = $34.286

To meet a margin call, you can deposit additional cash into your trading account,
liquidate shares until your margin requirement is met, or deposit additional marketable
securities against your account as collateral.

14. Interest on loan = $12,000*0.10 = $1200

a. Proceeds from sale = 500($56) = $28,000

Dollar return = $28,000 – 12,000– 12,000– 1200 = $2800
Rate of return = $2800/ $12,000 = 23.33%
Without margin, rate of return = ($56 – 48) / $48 = 16.67%

b. Proceeds from sale = 500($48) = $24,000

Dollar return = $24,000 – 12,000– 12,000– 1,200 = –$1200
Rate of return = –$1200/ $12,000 = –10.00%
Without margin, rate of return = $0%

c. Proceeds from sale = 500($32) = $16,000

Dollar return = $16,000 – 12,000– 12,000– 1200 = –$9200
Rate of return = –$9200 / $12,000 = –76.67%
Without margin, rate of return = ($32 – 48) / $48 = –33.33%