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Margin Trading: Borrowing, the Price of Stock, Profit

Suppose you are bullish on Stock X and instruct your broker to buy 1,000 shares on margin, with a margin of 60%. The current price of a share of Stock X is \$30, the interest on loans is 5%, and the maintenance margin is 40%.

a) How much do you borrow from your broker?

b) How far can the stock price fall before a margin call?

c) If the price falls to \$15 and your broker issues a margin call. What can you do to solve this problem?

d) If the price of the stock rises to \$35 (falls to \$25) after one year and you decide to sell, how much is your profit? How much is your rate of return?

Solution Preview

a) How much do you borrow from your broker?

Margin purchases:

"In a margin purchase, the portion of the value of an investment that is not borrowed is called the margin.
"

Actual margin =Equity / Market Value = (Market Value - Loan) / Market Value

Data
Share price= \$30.00
Number of shares= 1,000
Margin= 60%
Interest cost = 5%
Time= 1 year
Margin call at =Maintenance margin= 40%

At commencement:
Amount required for the purchase= \$30,000 =1000 x \$30.
Amount provided by the investor= \$18,000 =60.% x \$1,000.
Amount provided by the broker (loan)= \$12,000 =\$30,000. - \$18,000.

Asssets
Stock \$30,000

Liabilities and Shareholders' ...