Question

Assume that IBM stock is currently selling for $50 per share.  Assume that you will purchase 200 shares. You have $3,000 of your own to invest and you will borrow an additional $7,000 from your broker at an interest rate of 5% per year (assume no service charge for the loan).  The Maintenance Margin is 20%.   If IBM’s stock price falls to $40 per share over the year (at the end of the year), what is your rate of return if you buy on margin? Assume that IBM pays no dividends over the year.

a.  -20%

b.  -78.33%     

c.  -100%

d.  -21.66%

e.  -66.66%

Answer 1

Correct answer: b. -78.33%

No. of shares purchased on margin = 200

Current share price = $50

Borrowed amount = $7,000

Interest rate on borrowed amount = 5%

Interest amount on borrowed amount = 7000*5% = $350

Own amount invested = $3,000

Stock price at year end = $40

Loss in shares value = 200*(40-50) = -$2,000

Total Loss (including interest paid to broker) = -2000-350 = -$2,350

Thus, rate of return(r) ( if you buy on margin ) would be:

answered by: anonymous