07-Buying on Margin and Shortselling

07-Buying on Margin and Shortselling - BuyingonMarginand...

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Buying on Margin and  Short Selling BKM: 3.6 – 3.7  1
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Margin and Losses Lower bound for any stock: 0 Assets = Liabilities + Equity Equity = Assets - Liabilities Lower bound for assets = 0 Lower bound for equity = - Liabilities 2
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Margin Limits SEC mandates limitations on borrowing. Limit is defined in terms of “the margin”. P=Price of security S=Shares owned L=Value of Loan P(S) L - P(S) assets equity margin = = 3
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Margin Limits Initial margin must exceed 50% Maintenance margin set by broker MSFT example:  Buy 300 shares of MSFT at $50 per share Use 10,000 of equity and 5,000 borrowed Initial margin = (300*50-5000)/15000= 67% 4
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Margin Call Assume MSFT drops within a year by 40% Price=.60*50=30 Margin=[300*30-5000*1.10]/(300*30)=39% Assume maintenance margin=40% You will get a margin call Broker will mandate either that you close the position, or increase  margin. Assume broker mandates you increase margin position to 50% to  keep the position open. 5
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Three Possible Options to Satisfy  Margin Call Close out position Sell the MSFT stocks for $9,000 Pay back the loan of $5000+interest Reduce your loan – how much? The margin increases to [300(30)-X]/[300(30)] = 50% X=300*30-.5*300*30=4500 Must pay off 5000*1.1-4500=1000 6
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Margin Call Increase your position in MSFT How much? [S*30-5500]/S*30=.50
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This note was uploaded on 03/01/2012 for the course BUS M 410 taught by Professor Brianboyer during the Fall '10 term at BYU.

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07-Buying on Margin and Shortselling - BuyingonMarginand...

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