Question

Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams at $60 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $60 to $69.50, and the stock has paid a dividend of $7.80 per share.

a.	What is the remaining margin in the account?

Remaining margin

$

b-1.	What is the margin on the short position? (Round your answer to 2 decimal places.)

Short margin

%

b-2.

If the maintenance margin requirement is 30%, will Old Economy receive a margin call?

	Yes
	No

c.	What is the rate of return on the investment? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

Rate of return

%

Answer 1

a). The initial margin was: $60 ×1,000 ×0.50 = $30,000.

As a result of the $9.50 increase in the stock price, Old Economy Traders loses:

$9.50 ×1,000 shares =$9,500.

Moreover, Old Economy Traders must pay the dividend of $7.80/ share to the lender of the shares:

$7.800×1,000 shares = $7,800.

The remaining margin in the investor’s account therefore decreases to:

$30,000 - $9,500 - $7,800 =$12,700.

b.Margin on short position =Equity/value of share owed

  =[$12,700 / $69.50]/ 1,000 = 0.1827, or 18.27%

Because the percentage margin falls below the maintenance level of 30%, there will be a margin call.

c.The rate of return=[Ending equity - Initial equity] / Initial Equity

=[$12,700 - $30,000] / $30,000 =-$17,300 / $30,000 = -0.5767, or -57.67%