Question

Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams at $65 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $65 to $76.50, and the stock has paid a dividend of $9.80 per share.

a. What is the remaining margin in the account?

b-1. What is the margin on the short position? (Round your answer to 2 decimal places.)

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

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

Answer 1

a.) The initial margin was: $65 ×1,000 ×0.50 = $32,500.As a result of the $11.50 increase in the stock price, Old Economy Traders loses: $11.50 ×1,000 shares =$11,500.

Moreover, Old Economy Traders must pay the dividend to the lender of the shares: $9.80×1,000 shares = $9,800.

The remaining margin in the investor’s account therefore decreases to: $32,500 – $11,500 – $9,800 =$11,200.

b-1). Margin on short position = Equity /Value of shares owed= $11,200/$76.50/1000= .1464 =14.64%.

b-2). Because the percentage margin falls below the maintenance level of 30%, there will be a margin call.

c.) Ending equity- initial equity/ initial equity = $11,500- $32,500/ $32,500 = -.6462 = -64.62%