Question

a) You open up a 60% margin account to purchase $10,000 worth of IBM stock at $50 per share. Ignoring any interest charges for the margin account, at what price will the margin account be called, if the maintenance level is 25%?

b) This time you decide you want to short the IBM stocks from part 1. The initial margin and maintenance margins are still the same. If the stock price rises to $55, what is your return?

Answer 1

a)

PRICE AT WHICH MAINTAINANCE MARGIN WILL BE CALLED = 32.5

price per share = 50

purchase consideration = 10,000

no. of shares purchased = 10,000 / 50 = 200

initial margin = 60%

initial margin that must be keept before buying IBM worth 10,000@50 per share ( 200 shares) = 10,000 x 60% = 6,000

maintainance margin that must be kept to avoid immediate sell of shares is 25% of 10,000 = 2,500

that is maximum loss   = inital margin (6,000) - maintainance margin (2,500) = 3,500

at which price pf share maintaince margin will be called = 50 - (3,500 / 200) = 17.5

PRICE OF Maintainance margin = 50 - 17.5 = 32.5

b)

NEGATIVE RATE OF RETURN = 16.67%

since we have short IBM we have incurre a loss of 5 per share

TOTAL LOSS = 5 x 200 = 1,000

MARGIN KEPT = 10,000 x 60% = 6,000

rate of return (loss) = 1,000 / 6,000

= 16.67%