Question

Andrew wants to purchase 76 shares of Elephant Corp, currently trading at $110. Andrew will contribute $3,511.20 toward the purchases and borrow the remainder from a broker. What is the price to which shares can fall before a margin call is triggered, assuming a maintenance margin of 0.29?

Answer 1

Given,

No of shares- 76

Share price - 110

Hence,

Total Investment = No of shares * Share price

= 76*110

=8360

Investors own fund = 3511.20, therefore remaining fund will come from margin money.

Hence,

Margin Loan= Total Investment-Investors one funds

= 8360-3511.20

=4848.80

Now, it is given that margin call will be generated at 0.29

We have formula to calculate the Account Value at which margin call will be generated by broker,

Account Value = Margin Loan/(1-Margin Call)

= 4848.8/(1-0.29)

= 6829.29

$6829.29 is the Account Value, below this value the margin call will be generated.

To convert the accoun value to share price, we need to divide it by number of shares,

= 6829.29/76

=$89.85

From above calculation, one can conclude that share price must not fall below $89.85 else margin call will be generated.