Question

1.You invested $2000 in a mutual fund with a front-end load of 5.75% at the beginning of 2005. If the securities in which the fund invested increased in value by 11% and 5%, respectively for 2005 and 2006. The fund's expense ratio was constant at 1.25%. What is your total return if you sold your shares of the fund at the end of 2006?

2.ABC company’s stock is currently selling at $100 per share. You have $12,000 in your pocket but want to buy 200 shares. You can borrow the remainder of the purchase price from your broker at an annual rate of 5% on the margin loan.

1. a) What happens to your net worth (i.e. return) in your brokerage account if the price of ABC company increases to $110 after one year?

2. b) If the maintenance margin is 30%, how low can ABC’s price drop in one year before you get a margin call?

3. c) Explain why you may want to buy on margin. Is there any disadvantage of this strategy?

Answer 1

Solution:

1.Net Amount invested=$2000-($2000*5.75%)

=$1,885

First year end value=$1885*(1+Growth rate)

=$1885*(1+0.11)

=$2092.35

First year expense=$2092.35*1.5%=$31.39

Net year end balance=$2092.35-$31.39=$1997.96

Second year end value=$1997.96*(1+0.05)

=$2097.86

Expense for secomd year=$2097.86*1.5%=$31.47

Net year end balance=$2097.86-$31.47

=$2066.39

Total return=Closing balance-fund invested

=$2066.39-$1,885=$181.39

Return(%)=($181.39/$1,885)*100

=9.62%