Question

Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams at $35 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 $35 to $41.50, and the stock has paid a dividend of $4.40 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

Solution :

Short Sell of Shares = 1000 @ $35 = $35000

Initial margin = 50% * 35000 = $17500

A year later price increases from 35 to 41.50, Loss to Old Economy Traders: 1000*(41.50-35)= $6500

Moreover, Old Economy Traders must pay the dividend of $4.40 per share to the lender of the shares = 1000 * 4.4 = 4400

a. Remaining margin = 17500 - 6500 - 4400= $6600

b-1. Margin on the short position =Equity / Value of shares owed

b-1. Margin on the short position =6600/(1000*41.50)= 15.90%

b-2. Yes. Maintenance margin fall below the margin requirement of 30%, Old Economy Traders will receive a margin call

c. Rate of return on the investment =  (Ending equity – Initial equity ) / Initial equity

Rate of return on the investment =  (6600 – 17500 ) / 17500= -62.29%