Suppose that xtel currently is selling

3-18

You are bullish on Telecom stock. The current market price is $50 per share, and you have $5,000 of your own to invest. You borrow an additional $5,000 from your broker at an interest rate of 8% per year and invest $10,000 in the stock. a. What will be your rate of return if the price of Telecom stock goes up by 10% during the next year? (Ignore the expected dividend.) b. How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30%? Assume the price fall happens immediately.

Price per share

Equity invested

Borrowed funds

Interest rate

Total investment $ - 0

Price change

Margin required

Solution

a. Shares bought ERROR:#DIV/0!

Value change $ - 0

Interest payment $ - 0

Rate of return ERROR:#DIV/0!

b. Margin call price ERROR:#DIV/0!

3-22

You’ve borrowed $20,000 on margin to buy shares in Ixnay, which is now selling at $40 per share. Your account starts at the initial margin requirement of 50%. The maintenance margin is 35%. Two days later, the stock price falls to $35 per share. a. Will you receive a margin call? b. How low can the price of Ixnay shares fall before you receive a margin call?

Borrowed funds

Price per share

Initial margin

Maintenance margin

New stock price

Solution

a. Total investment $ - 0

Shares purchased ERROR:#DIV/0!

New value ERROR:#DIV/0!

Equity value ERROR:#DIV/0!

Margin ERROR:#DIV/0!

b. Margin call price ERROR:#DIV/0!

3-23

On January 1, you sold short one round lot (that is, 100 shares) of Snow’s stock at $21 per share. On March 1, a dividend of $3 per share was paid. On April 1, you covered the short sale by buying the stock at a price of $15 per share. You paid 50 cents per share in commissions for each transaction. What is the value of your account on April 1?

Shares short sell

Price per share

Dividend

Buyback price

Commission / share

Solution

Net proceeds from short sale $ - 0

Dividend payment $ - 0

Buyback proceeds $ - 0

New account balance $ - 0

3-25

Suppose that you sell short 500 shares of XTel, currently selling for $40 per share, and give your broker $15,000 to establish your margin account. a. If you earn no interest on the funds in your margin account, what will be your rate of return after one year if Intel stock is selling at (i) $44; (ii) $40; (iii) $36? Assume that XTel pays no dividends. b. If the maintenance margin is 25%, how high can XTel’s price rise before you get a margin call? c. Redo parts (a) and (b), but now assume that XTel also has paid a year-end dividend of $1 per share. The prices in part (a) should be interpreted as ex-dividend, that is, prices after the dividend has been paid.

Price per share Price per share $ - 0

Shares short sell Shares short sell - 0

Equity in margin acct Equity in margin acct $ - 0

Maintenance margin Maintenance margin 0.00%

Dividend Dividend

Share value $ - 0 Share value $ - 0

Borrowed funds $ - 0 Borrowed funds $ - 0

Solution

a. c.

i. New stock price = i. New stock price = $ - 0

Change in value $ - 0 Change in value $ - 0

Rate of return ERROR:#DIV/0! Rate of return ERROR:#DIV/0!

ii. New stock price = ii. New stock price = $ - 0

Change in value $ - 0 Change in value $ - 0

Rate of return ERROR:#DIV/0! Rate of return ERROR:#DIV/0!

iii. New stock price = iii. New stock price = $ - 0

Change in value $ - 0 Change in value $ - 0

Rate of return ERROR:#DIV/0! Rate of return ERROR:#DIV/0!

b.

Margin call price ERROR:#DIV/0! Margin call price ERROR:#DIV/0