Since 1000P - Amt Borrowed = Equity then: (1000P - $35,000) / 1000P = 40% P = $58.33
Dee Trader opens a brokerage account, and purchases 300 shares of Internet Dreams at $40 per share. She borrows $4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%. a. What is the margin in Dee’s account when she first purchases the stock? b. If the share price falls to $30 per share by the end of the year, what is the remaining margin in her account? If the maintenance margin requirement is 30%, will she receive a margin call? c. What is the rate of return on her investment
3.7 SHORT SALES
Borrow Securities to sell them Sell first -- then buy! Margin is required (cost of short selling) Short position must be covered Investor expects price to decline
Broker Original Stock Holder New Stock Holder Short Seller 100 Shares 100 Shares 100 Shares
Return on Short Sale Short Sale Price Buy Back Price Per Share Investment (margin )
Example: An investor sells short 100 shares of stock at $100 per share. The margin requirement is 50% of the short sale. a. If the investor covers her short sale when the stock price declines to $70 per share, what is the return on the short sale? b. What is the return if there is no margin requirement?
Example: An investor sells short 100 shares of stock at $100 per share. The margin requirement is 50% of the short sale. c. If the investor covers her short sale when the stock price increases to $130 per share, what is the return on the short sale?
Investor’s account at time t = 0 Assets Liabilities + Equity Cash (sale) = P 0 *N Value of stocks = P 0 *N (borrowed) Cash (deposit) Equity or initial margin or initial margin Percentage of initial margin = (equity at time 0)/(value of stocks borrowed at time0)
Investor’s account at time t Assets Liabilities + Equity Cash (sale) = P 0 *N Value of stocks = P t *N (borrowed) Cash (deposit) Equity or current margin or initial margin at time t Percentage of margin at time t = (equity at time t)/(value of stocks borrowed at time t) As time elapses, the value of stock changes hence affecting the value of percentage margin
Example: An investor sells short 100 shares of stock at $100 per share. The initial margin requirement is 50% of the short sale. If the maintenance margin is 30%, what is the maximum stock price without a margin call on the short sale?
Z Corp 100 Shares 50% Initial Margin 30% Maintenance Margin $100 Initial Price Sale Proceeds $10,000 Margin & Equity 5,000 Stock Owed 10,000
Stock Price Rises to $110 Sale Proceeds $10,000 Initial Margin 5,000 Stock Owed 11,000 Net Equity 4,000 Margin % (4000/11000) 36%
How much can the stock price rise before a margin call? Since Initial margin plus sale proceeds = $15,000, then: ($15,000 - 100P) / (100P) = 30% P = $115.38
Old Economy Traders opened an account to short sell 1,000 shares of Internet Dreams from Question 3. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $40 to $50, and the stock has paid a dividend of $2 per share.
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- Spring '08