Question

1.) Suppose you buy 100 shares of Green Acre Industries on margin when the share price for Green Acre Industries share price is $33. One year later Green Acre Industries is trading at $40 a share. What is the return on your investment (expressed as a percent)? Assume that the initial margin requirement is 60%, Green Acre Industries does not pay a dividend, call money rates is 5.0% and the spread is 1.5%.

Answer 1

In general we will find the rate of return on stock using two methods:

First Method: Using Dividend

Where,

k - Rate of Return

D- Dividend

S- Recent stock price

g- Growth rate

Second Method : CAPM

The formula used in CAPM method to find required rate of return on stock is,

Where,

R_f - Risk free rate or Call money rate

(R_M-R_f) - Market Risk Premium or Spread

B- Beta or Initial Margin

Here in the given question though stock price was given, it is mentioned that Green Acre Industries did not pay any dividend and growth rate can not be calculated, so we have nothing to do with this information.

Hence we use the second method CAPM for calculating the return by substituting the given values in the above equation of CAPM

Therefore the return on investment is 5.9%.