Question

Richard is a student at University and is now taking the Security Analysis and Portfolio Management course. He has a brokerage account and wants to apply what he learns in class to the real world. After much analysis, he decides to sell short 100 shares of VTX at the current market price of $80 per share. The broker’s initial margin requirement is 60%. Please help solve the following questions for Richard.

a) How much in cash or securities must Richard put into his brokerage account?

b) One month later, the price has risen from $80 to $90 per share. Would Richard receive a margin call if the broker’s maintenance margin requirement is 40%? Please explain.

c) During the month, the stock has paid a dividend of $0.5 per share. If Richard now buys 100 shares at $90 to cover his short position, and pays 50 cents per share in commissions for each transaction, what would be his rate of return during the whole investment period?

Answer 1

a) No. of VTX share shorted= 100

Current market price=$80 per share

Broker’s initial margin requirement = 60%

Cash or securities value= 100*$80*60%

=$ 4800

b) Margin available at the beginning = $ 4800

One month later price rises, then Available margin will be =$4800-100*$10

=$3800

Maintenance margin requirement is 40%

Margin call will be received when margin fall below 40%=100*$80*40% i.e.$3200

Since margin available is more then required margin so margin call will not be made.

c) commissions for each transaction = $0.5

Call cover at $90, so net profit or loss =$(80-0.5)-$(90+0.5) i.e.-11

A dividend payment of ($0.5*100) was withdrawn from the account. = 50

Rate of return=(-11*100-50)/4800 i.e. -21.875%

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