Using the following assumptions, calculate the rate of return on a margin transaction for an investor who purchases the stock and the stock price at which the investor who shorts the stock will receive a margin call.
What of the following choices is closest to the correct answer? The margin transaction return is:
Click on the arrows to vote for the correct answer
A. B. C. D.D
To obtain the result:
Part 1: Calculate Margin Return:
Margin Return % = [((Ending Value - Loan Payoff) / Beginning Equity Position) "" 1] * 100
= [(([$22 * 1,000] "" [$25 * 1,000 * 0.50]) / ($25 * 0.50 * 1,000)) "" 1] * 100
=-24.00%.
Alternative (Check):Calculate the all cash return and multiply by the margin leverage factor.
= [(22,000 "" 25,000)/22,000] * [1 / 0.50] = -12.00% * 2.0 = -24.00%
Part 2:Calculate Margin Call Price:
Since the investor isshort(sold the stock), the formula for the margin call price is:
Margin Call = (original price) * (1 + initial margin) / (1 + maintenance margin)
= $25 * (1 + 0.50) / (1 + 0.25) =$30.00