Question

1. You go on margin 8-to-1 and subsequently the underlying investment rises in value by 17%. There are no dividends or other cash flows resulting from this investment. By what percent did your equity change? Write your answer out to two decimals; for example, you should write 40% as .40 and 150% as 1.50.

2. You went on margin 1-to-2 (margin = 66.7%) by borrowing $10,000 and using $20,000 of your own money for a $30,000 investment. Since then, the return on the investment has been -30%. What is your new margin? Go out to the nearest percent and put your answer in decimals.

3. You went on margin 3-to-1. What return on the underlying investment will exactly double your equity? Write your answer out to three decimals; for example, write 25.2% as .252 or 6.1% as .061.

4. You have $28072 equity in a $100000 investment where the maintenance margin is 30%. You get a margin call and decide to meet it by purchasing more shares using only your own money - no more borrowing. What is the minimum amount of money that you have to spend on new shares for your account to become legal again? Round to the nearest dollar.

Answer 1

1)

Change in Equity = Change in Value of Investments*Margin in times = 17%*8 = 136% = 1.36

2)

New Value of Investment = Original Value-30% = 30000-30% = $21000

New Margin = (New Value-Borrowings)/New Value = (21000-10000)/21000 = 11000/21000 = 52.38% = 52% = 0.52

3)

Return Required to Double Money = Return required to double money (without margin)/Margin in times = 100%/3 = 33.33% = 0.333

4)

Let value of new shares to be purchased be x.

Therefore, After new purchase, Margin will be (28072+x) and Value of Investment will be (100000+x) and x should be such that Margin becomes 30% of Investment.

Therefore,

28071+x = 0.3(100000+x)

28071+x = 30000+0.3x

0.7x = 1929

Therefore, Minimum Amount of Money = x = $2755.71 = $2756