This margin requirement (the proportion of totaltransaction value that must be paid in cash) If it is 40 percent (allowing loans of 60 percent of thevalue)

100 percent (allowing no borrowing). Lower margin requirements allow you to borrow more

The leverage factor = 1/percent margin. If margin req. = 0.6, find leverage factor

leverage factor = 1/0.6=1.67 Thus, the rate of return on the stock= rate of return x leveragefactor

Problem 1 The initial margin requirement is 60 percent(allowing loan 40%).

You have $40,000 to invest in a stock sellingfor $80 a share.

Ignoring taxes and commissions and interest. Show in detail the impact on your rate of returnif the stock rises to $100 a share and if itdeclines to $40 a share assuming (a) you pay cash for the stock, (100% marginrequirement) and

(b) you buy it using maximum leverage.

(a) you pay cash for the stock Number of shares you could purchase = $40,000/$80 = 500 shares.

The leverage factor for a 60 percent margin requirement is =1/percentage margin requirement = 1/.60 = 5/3

Thus, the rate of return on the stock if it is later sold at $100 ashare = 25.00% x 5/3 = 41.67%.

The rate of return on the stock if it is sold for $40 a share:= -50.00% x 5/3 = -83.33%.

Problem 2 Lauren has a margin account and deposits $50,000.Assuming the prevailing margin requirement is 40 percent(can borrow 60%), commissions are ignored, and TheGentry Shoe Corporation is selling at $35 per share:

a. How many shares of Gentry Shoe can Lauren purchaseusing the maximum allowable margin?

b. What is Laurens profit (loss) if the price of Gentrysstock (1) Rises to $45? (2) Falls to $25?

c. If the maintenance margin is 30 percent, to what price canGentry Shoe fall before Lauren will receive a margin call?

$50,000 deposit must represent 40% of her totalinvestment.

Thus, $50,000 = .4x then x = $125,000. Since the shares are priced at $35 each, Lauren canpurchase $125,000 / $35 = 3,571 shares (rounded).

(1) If stock rises to $45/share, Laurens total return is: 3,571 shares x $45 = $160,695. Total profit = $160,695 - $125,000 = $35,695(2) If stock falls to $25/share, Laurens total return is: 3,571 shares x $25 = $89,275. Total loss = $89,275 - $125,000 = -$35,725.

Check NS MPS total Worth 3571 30 107130 loan eq maint. Margin 75000 32130 0.29991599

Problem 3 Suppose you buy a round lot of Maginn Industries stockon 55 percent margin when the stock is selling at $20 ashare. (Round lot holders are holders of 100 shares ormore)

The broker charges a 10 percent annual interest rate, and commissions are 3 percent of the total stock value onboth the purchase and sale.

A year later, you receive a $0.50 per share dividend andsell the stock for 27.

What is your rate of return on the investment?

The rate of return on investment = profit / initialinvestment

Where profit = Ending Value - Beginning Value +Dividends - Transaction Costs (sale & purchase) Interest

Initial Investment=Margin req. + commission (purchase) Suppose Round lot = 100 shares Beginning Value of Investment = $20 x 100 shares =$2,000

Investment = margin requirement + commission. = (.55 x $2,000) + (.03 x $2,000) = $1,100 + $60 = $1,160

The Ending Value of Investment = $27 x 100 shares= $2,700

Dividends = $.50 x 100 shares = $50.00 Transaction Costs (Commission)= (.03 x $2,000) + (.03 x $2,700)

= $60 + $81 = $141 Debt amount = 0.45*$2000 Interest = .10 x (.45 x $2,000) = $90.00 Profit = Ending Value - Beginning Value + Dividends -

Transaction Costs Interest Profit = $2,700 - $2,000 + $50 - $141 - $90 = $519 The rate of return on your investment of $1,160 is:

$519/$1,160 = 44.74%

Problem 4 You decide to sell short 100 shares of Charlotte HorseFarms when it is selling at its yearly high of 56.

Your broker tells you that your margin requirement is 45percent and that the commission on the purchase is $155.

While you are short the stock, Charlotte pays a $2.50 pershare dividend.

At the end of one year, you buy 100 shares of Charlotte at45 to close out your position and

are charged a commission of $145 and 8 percent interest on the money borrowed. What is your rate of return on the investment?

Profit on a Short Sale = Beginning Value - Ending Value -Dividends -Trans. Costs - Interest

Beginning Value of Investment = $56.00 x 100 shares = $5,600(sold under a short sale arrangement)

Your investment = margin requirement + commission= (.45 x $5,600) + $155= $2,520 + $155 = $2,675

Dividends = $2.50 x 100 shares = $250 Ending Value of Investment = $45.00 x 100 = $4,500

(Cost of closing out position) Transaction Costs = $155 + $145 = $300 Interest = .08 x (.55 x $5,600) =$246.4 Profit = $5,600 - $4,500 - $250 - $300 - $246.40 = $303.6 The rate of return on investment $303.60/$2,675 = 11.35%

Problem 5 You own 200 shares of Shamrock Enterprises thatyou bought at $25 a share.

The stock is now selling for $45 a share. a. If you put in a stop loss order at $40, discussyour reasoning for this action.

b. If the stock eventually declines in price to $30 ashare, what would be your rate of return with andwithout the stop loss order?

Slide339Problem 1(a) you pay cash for the stock Number of shares you could purchase = $40,000/$80 = 500 shares.Problem 2Slide342Slide343CheckProblem 3Slide347Slide348Problem 4Slide350Problem 5