Question

Megan bought 200 shares of stock at a price of $10 a share. She used her 70% margin account to make the purchase. She sold her shares after a year for $12 a share. Ignoring margin interest and trading costs, answer all of the questions:

1. How much money did Megan need to put into the account before she can borrow from the broker to make the purchase? How much can she borrow from the broker?

2. After the purchase, the stock’s price increased from $10 to $12, what would be Megan’s new margin position (ratio)?

3. What is her dollar returns if she sells the stock at this new price? And what would be her percentage return on this investment?

4. Suppose Megan foresaw the stock price would decline in the next year. So, instead of buying it, she short sold short 200 shares of the stock at $10. In order to do this, she was required to use her 70% margin account. What is her dollar return if the stock price increased to $12?

Answer 1

How much money did Megan need to put into the account before she can borrow from the broker to make the purchase?

Margin required =70%

Trade Value=200 shares*$10/share=$2000

Amount Megan need to put into account =70%*$2000=$1,400

How much can she borrow from the broker?

Amount borrowed =2000-1400=$600

Megan’s new margin position (ratio)

Value of shares=200*$12=$2400

Margin Balance =2400-600=$1800

New margin position=1800/2400=0.75

Ratio in percentage=75%

Her dollar returns if she sells the stock at this new price

Sales Value=$2400

Borrowed amount to be returned=$600

Amount left=2400-600=$1800

Amount invested=$1400

Dollar Return =1800-1400=$400

Her percentage return on this investment?

Percentage return=(400/1400)*100%=28.57%

4. If she short sold:

Investment in margin=$1400

Dollar return if the stock price increased $12=(10-12)*200=-$400

Loss of $400