Question

• Now, it is late 2012, Ron sold all his TSLA share and now has a $500,000 (after paying back the broker’s loan and some other personal expenses). Ron started to feel more comfortable trading stocks and wants to navigate more trading strategies. He started to hear about short selling. Ron still do not fully understand how it works but he knows it is a way to make money when you are bearish about a certain stock. Ron is not into social media and strongly believes that social media stocks are significantly overvalued. His advisor tried to convince him not to let his personal preference determines his investment strategies, but Ron says “Hey, I tried it once with TSLA and it worked, I know it will work again!!”. So, Ron decided to short sell the new social media company Facebook (FB). Ros sold 10,000 shares of FB short at a price of $28 on December 1^st of 2012. The broker has a 50% margin requirement on short selling.

• Now it is May 1^st, 2013, the price of Facebook stock dropped to $24. Ron is super excited! He said to his broker “I told you, social media is a fad and will disappear within few months, this is going to be a penny stock in no time, and I am going to be rich!!” His broker did not agree to that and advised him to cover his position and get out of it before the price bounces again. Ron responded, “I know what I am doing, just step aside!”.

5) If the maintenance margin on short selling transactions is 30%, how far can FB price decline before triggering a margin call?

1. Any Price declines trigger a margin call
2. Price declines don’t trigger a margin call
3. The price must decline to $22.3 to trigger a margin call
4. The price must decline by 30% to trigger a margin call

6) How far could FB stock price rise before Ron received a margin call?

1. Price increase don’t trigger a margin call.
2. The price that would trigger a margin call is $ 32.3.
3. The price that would trigger a margin call is $ 27.7.
4. The price that would trigger a margin call is $ 41.3.

• Now, it is June 2014, the last few months have been like a nightmare to Ron. FB stock price has been consistently rising. Ron is a hard-headed and kept responding to margin calls by pouring cash into his account with an expectation of an “n” shape drop in the price. Ron started to lose hope, so he decided to cover his position at a price of $68 and just forget this bad experience. His advisor says “now it is my turn to say I told you!!! With hundreds of millions using social media around the world, it is not going nowhere!!!).

7. How much money does Ron have now (remember he had $ 500,000 before starting this short selling investment)?

1. $100,000
2. $220,000
3. $780,000
4. $140,000

Answer 1

5)OPTION B .

Ron had done a short sell on stocks, i.e; sold high in advance and will profit by buying low. Hence, price decline doesn't trigger margin call.

6) option D.

The 30% margin requirement signify that it will not trigger if the stock prices are below $36.4.(28+0.3*28). Since the prices rise above tgis, it triggered the margin call .

7) OPTION A.

Selling at 28, and buying at 68 would result in a loss of $ 40 per share. Hence a total of $400,000, gets eroded from it initial wealth of $500,000.

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