Question

1. In the buying on margin example, suppose that the initial margin is 60%. What is the investor's equity in the purchase?

2. In return example 1 suppose the margin is 60% instead of 50%. What is the investor's return from a margin purchase of 100 shares if the purchase price is $160, the selling price is $180, and the broker interest rate on the loan is 5%?

Answer 1

1. If initial margin is 60% means investor has to purchase 60% of the price of the security should be invested through investors' own funds. Therefore investor’s equity should be 60% in the purchase,

2. Purchase quantity = 100*160 = 16,000

Initial margin = 60%

Investors own funds = 0.6*16,000 = 9.600

Broker funds = 16000-9600 = 6,400

Sale proceeds = 100*180 = 18,000

5% interest = 0.05*6400 = $320

Investor has to return to broker = 6400+320 = 6,720

Sale proceeds for investor = 18000 -6720 = 11,280

Investors return = (11,280 -9,600)/9600 = 0.175 = 17.5%

Investors return = 17.5%