Question

Dale the farmer and his brother Jake decide to sell the family farm. They will use the proceeds to invest in the stock market. As they can not agree on an investment choice, they split their money. Dale buys stock “bull” with his half million “bull” currently sells for $45 per share

STEP BY STEP SHOW:

A) What is Dale’s return if the stock price after one year is 35,43, or 53 dollars per share?

B) If Dale decides that he wants to earn money faster and his broker will allow him to buy on the margin. His broker requires a 50% initial margin and he charges a 3% annual fee on the loan amount. If Dale invests all that he can, what is Dale’s return if the stock price after one year is 35,43, or 53 dollars per share?

C) Jake is certain his brother is always wrong so he decides to short “bull”. His broker requires a 50% initial equity position, which does not gain interest. What is Jake’s return if the stock price after one year is 35,43, or 53 dollars per share?

Answer 1

1) Dale return after 1 year

Stock price , 35 = (35-45)/45 = -22.22%

Stock price , 43 = (43-45)/45 = -4.44%

Stock price , 53 = (53-45)/45 = 17.78%

2)With 0.5m in cash and initial margin of 50%, Dale can buy stocks worth 1m with 0.5m in debt.

Total no. of Bull shares he bought = 1m/45 = 22,222

At 35, total loss = (35 - 45) x 22,222 - 3% x 500,000 = -237,220

At 43, total loss = (43 - 45) x 22,222 - 3% x 500,000 = -59,444

At 53, total profit = (53 - 45) x 22,222 - 3% x 500,000 = 162,776

3) Jake can also take position of 1m with 0.5m in cash and 50% margin. So, he short 22,222 shares of Bull.

At 35, total profit = -(35 - 45) x 22,222 = 222,220

At 43, total profit = -(43 - 45) x 22,222 = 44,444

At 53, total loss = -(53 - 45) x 22,222 = -177,776