The initial margin requirement on a stock purchase is 50%. You fully use the margin allowed to purchase 10 shares of

Question

The initial margin requirement on a stock purchase is 50%. You fully use the margin allowed to purchase 10 shares of Tesla at $350. Call money rate is 8% p.a. and interests are compounded monthly. Maintenance margin is 30%. a) Calculate the holding period percentage return if the price drops to $330 four months later. (5 marks) b) Calculate the price level that you can receive margin call (Ignore margin interest). (3 marks) c) Calculate the additional cash required in the margin account so as to maintain margin level at 45% after receiving margin call. (3 marks) d) Describe and explain the trade-off between using margin account and cash account for stock investment (4 marks)

Help In Homework · Accepted Answer

a) own amount invested =$350/share *10 shares *50% = $1750 Money borrowed at 8%p.a. = $1750 Interest in 4 months = $1750*(1+0.08/12)^4 = $1797.14 Value of Investment =$330*10 =$3300 So, Value of Equity = $3300-$1797.14 = $1502.86 Holding period return = Value of equity now/amount invested -1 =1502.86/1750-1 =-0.1412 or -14.12% b) Let the stock price be $X below which margin call is given Value of Equity = $X*10 -$1750 Value of Shares = $X*10 So, for margin call (X*10-1750) /(X*10) < 30% => X< 250 So, $250 is the price level below which margin call will be received c) Additional Cash required to maintain margin at 45% = $250/share*10 shares * 15% (30% is already there ) =$375 d) Using margin account gives leverage of borrowed money and hence the profit and loss is much higher as compared to using the cash account. Return using margin account= return using cash account * Leverage (given as total investment/total equity)

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The initial margin requirement on a stock purchase is 50%

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