Question

Problem:

On January 1, 2018, an investor is considering buying 120 shares of MUFC, which current price is $45 per share. The investor sets a margin of 50% and assumes that there are no brokerage costs. Later, on January 1, 2019, due to a very good first half of the premier league season, the stock rises to $55 per share.

1. What is debit balance in this transaction as of January 1, 2018?
2. At the initial date, how much equity capital must the investor provide to make this margin transaction?
3. At January 1, 2019, what is the investor’s new margin position?
4. If a minimum maintenance margin of 30% is put in place, calculate the margin percentage and show whether the investor would have excess equity, would be restricted, or would be subject to a margin call when the stock price takes the following value:
   1. 40
   2. 65
   3. 30

Answer 1

Debit balance in this transaction will be = 120 x 45 = $5400.

The investor needs to provide half of it = 0.5 x 5400 = $2700.

Since it's a gain, the margin account will increase by = (55-45) x 120 = 1200. So, the new margin account position will be = 2700 + 1200 = $3900.

a. If stock price becomes 40, net loss (from 45) = (45-40) x 120 = $600. Since the account had $2700 in place, it now has $2100 which will be = 2100/(120 x 40) = 43.75% of the total. Hence, there will be no margin call.

b. If the price has increased, it's a profit for the investor and there will be no margin call. New margin account balance = 2700 + (65-45) x 120 = $5100. There will be excess equity.

c. If it goes to $30, net loss = (45-30) x 120 = 1800. So, new margin account balance = 2700 - 1800 = 900, which is 900/(120 x 30) = 25% of the total. Hence, there will be a margin call.