Question

You are bullish on Telecom stock. The current market price is $55 per share, and you have $6,700 of your own to invest. You borrow an additional $4,850 from your broker at an interest rate of 9.5% per year and invest $11,550 in the stock.

Required:

(a)	What will be your rate of return if the price of Telecom stock goes up by 25% during the next year?

(b)

How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30%? Assume the price fall happens immediately.

The price of the stock

$

Answer 1

a) Return on stock = $55 x 25% = $13.75 per share

No. of shares purchased = Amount invested / Share price = $11,550 / $55 per share = 210 shares

Total return on stock = $13.75 x 210 = $2,887.50

Interest paid on amount borrowed = $4850 x 9.5% = $460.75

Net return = $2887.50 - $460.75 = $2,426.75

Rate of return = (Net return / Own Amount invested) x 100 = ($2,426.75 / $6,700) x 100 = 36.22%

b) Maintenance margin can be calculated as -

Maintenance margin = (Share value - liabilities) / Share value

Let the share value be "S".

30% = (S - $4,850) / S

or, 0.30S = S - $4,850

or, 0.70S = $4,850

or, S = $6,928.57142857

Now, this is value of the 210 shares at which you will get a margin call.

Share price = $6,928.57142857 / 210 shares = $32.993197 or $32.99