Question

Donald opened an account to short-sell 2,700 shares of XYZ at \$75 per share. The initial...

Donald opened an account to short-sell 2,700 shares of XYZ at \$75 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of XYZ has risen from \$75 to \$85, and the stock has paid a dividend of \$1.50 per share.

a. What is the remaining margin in the account? (Round your answer to the nearest whole dollar.)

b. If the maintenance margin requirement is 30%, will Donald receive a margin call?

• No

• Yes

c. What is the rate of return on the investment? (Round your answer to 2 decimal places. Negative value should be indicated by a minus sign.)

SOLUTION

1. Donald sell 2,700 shares of \$75. Its account will be credited with (2,700*\$75) 202,500 and it also have amrgin requirement of 50% which is (202,500*50%) = 101,250

Initial assets in its account = 202,500 + 101,250 = 303,750

Share price rose to \$85 and it should also pay back dividend of \$1.50 per share.

Total liability = (2,700*\$85) + (2,700*\$1.50) = 229,500 + 4,050 = 233,550

Remaining margin = 303,750 - 233,550 = 70,200

2a. Margin ratio = 70,200 / 229,500 = 31%

2b. Margin ratio is more than required margin of 30%, so it will not receive call.

3. Rate of return = (Return - Initial own investment) / Initial own investment

= (70,200-101,250) / 101,250 = -31%