Question

Not long ago, Jack Edwards bought 200 shares of Almost Anything Inc. at $45 per share; he bought the stock on margin of 60%. The stock is now trading at $60 per share, and the Federal Reserve has recently lowered initial margin requirements to 50%. Jack now wants to do a little pyrimiding and buy another 300 shares of the stock. What is the minimum amount of equity that he'll have to put up in this transaction?

Answer 1

Securities' price = $45 x 200 shares = $9,000

Equity = $9,000 x .6 = $5,400

Debit = (1 - .6) = .4 x $9,000 = $3,600

New securities' price = $60 x 200 shares = $12,000 (for existing shares)

If Jack buys another 300 shares at $60, it will add a total of $18,000 of value to his account.

New securities' value = $18,000 (new shares) + $12,000 (old shares) =$30,000

Margin = (Value - Debit balance)/Value

.50 = ($30,000 - Debit balance)/$30,000

Minimal new equity = $15,000; maximum debit balance = $15,000

Current debt is $3,600; Amount of additional debit Jack can borrow is:

$15,000 - 3,600 = $11,400

Since he needs $18,000 for the additional purchase ($60 x 300 shares) and can only borrow

$11,400, he must add the remainder in equity. He needs to add: $18,000 - $11,400 = $6,600 in

new equity