Question

You’ve just opened a margin account with $20,160 at your local brokerage firm. You instruct your broker to purchase 1,200 shares of Landon Golf stock, which currently sells for $28 per share. Suppose the call money rate is 7 percent and your broker charges you a spread of 1 percent over this rate. You hold the stock for five months and sell at a price of $35 per share. The company paid a dividend of $0.47 per share the day before you sold your stock. a. What is your total dollar return from this investment? (Do not round intermediate calculations. Round your answer to 2 decimal places.) b. What is your effective annual rate of return? (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places.)

Answer 1

Solution

Initial purchase = number of shares x price per share

= 1,200 x $28 = $33,600

Amount borrowed = initial purchase – margin account balance

= 33,600 – 20,160 = $13,440

Amount of interest charged by broker = 7% + 1% = 8%

Interest on loan = 13,440 x (1+ 0.08)^5/12 – 13,440 =$437.96

= 13,440 x 8% x 5/12 = $437.96

Dividend received = share x dividend per share

= 1,200 x $0.47 = $564

Proceeds from sale = shares x selling price

= 1,200 x $35 = $42,000

Total dollar return = proceeds from sale + dividend received – margin account balance – amount borrowed – interest

= 42,000 + 564 – 20,160 – 13,440 – 437.96 = $8,526.04

Rate of return for 5 months = total dollar return/margin amount = 8,526.04/20,160 = 0.4229

= 42.29%

Effective annual return = (1+0.4229)^12/5 – 1 = 133.14%

= 133.14%