Question

Dée Trader opens a brokerage account and purchases 300 shares of Internet Dreams at $32 per share. She borrows $4,600 from her broker to help pay for the purchase. The interest rate on the loan is 6%.

a. What is the margin in Dée’s account when she first purchases the stock?

b-1. If the share price falls to $21 per share by the end of the year, what is the remaining margin in her account? (Round your answer to 2 decimal places.)

b-2. If the maintenance margin requirement is 30%, will she receive a margin call? No or Yes

c. What is the rate of return on her investment? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

Answer 1

The stock is purchased for $32 x 300 shares = $9,600.
Given that the amount borrowed from the broker is $4,600, Dee's margin is the initial purchase price net borrowing: $9600 - $4,600 = $5,000.

b If the share price falls to $21, then the value of the stock falls to $6300. By the end of the year, the amount of the loan owed to the broker grows to:
Principal x (1 + Interest rate) = $4,600 x (1 + 0.06) = $4,876.
The value of the stock falls to: $21 x 300 shares = $6300.

The remaining margin in the investor's account is:
Margin on long position = "(Equity in account-Loan amount)/Value of stock"
= "($6300 ? $4,876)/$6300 = 0.226 = 22.6%
Therefore, the investor will receive a margin call.

c Rate of return = (Ending equity in account ? Initial equity in account)/Initial equity in account
= ($1424 ? $5000)/5000= - 0.7152 = - 71.52%