Question

Yesterday, you bought 100 shares at $25 each, borrowing $1,000. Given the initial margin requirements, $1,000 is the maximum amount you could borrow to finance this purchase.

a) Calculate the initial margin requirement. Show the formula you used.

b) Today, the price of the securities you bought yesterday dropped to P. The maintenance margin is 25%. Calculate the approximate price P (two-digit approximation) that would trigger a margin call. Show the formula you used.

Answer 1

Answer (a):

Purchase value = Number of shares * Purchase price

= 100 * $25

= $2,500

Maximum borrowing = $1,000

Investor's own money (Equity) required = 2500 - 1000 = $1,500

Initial margin requirement =  Investor's own money / Purchase value = 1500 / 2500 = 60%

Initial margin requirement = 60%

Answer (b):

The maintenance margin is = 25%

Margin call price = Initial Purchase price * (1 - Initial margin) / (1 - Maintenance margin)

= 25 * (1 - 60%) / (1 - 25%)

= $13.33

Price P (two-digit approximation) that would trigger a margin call = $13.33