Exercise Sheet 2

Exercise 2.1
A margin account is used to buy 200 shares on margin at $35 per share.
$2000 is borrowed from the broker to complete the purchase. Determine the
actual margin:
a. When the purchase is made;
b. If the price of the stock rises to $45 per share;
c. If the price of the stock falls to $30 per share.
Solution 2.1
a. The value of the purchase is 200 35 = $7000: The initial margin is
7000 2000
7000

100 = 71:429%

b. The margin if the stock price rises is

45

200 2000
45 200

100 = 77:778

c. The margin if the stock price falls is

30

200 2000
30 200

100 = 66:667

Exercise 2.2
An investor buys 2000 shares at $30 each. The initial margin requirement
is 50% and the maintenance margin is 30%. Show that if the stock price falls
to $25, the investor will not receive a margin call. At what price will a margin
call be received?
Solution 2.2
If the initial margin is 50% then half of the investment is nanced by a loan
from the broker.
The investment costs
2000 30 = $60000
so the loan is $30000. The margin at a price of $25 is
25

2000 30000
25 2000

100 = 40%

The margin exceeds the maintenance margin so a margin call will not be received. The highest stock price at which a margin call will be received is
p

2000 30000
p 2000

100 = 30

A margin call is received at the price

p = $21:429:
1

Exercise 2.3
600 shares are purchased on the margin at the beginning of the year for $40
per share. The initial margin requirement was 55%. Interest of 10% was paid
on the margin loan and no margin call was ever faced. A dividend of $2 per
share is received. Calculate the annual return if:
a. The stock are sold for $45 per share at the end of the year;
b. If the stock are sold for $25 per share at the end of the year.
c. Calculate the return for (a) and (b) if the purchase had been made using
cash instead of on the margin.
Solution 2.3
The total value of the investment is
600

40 = $24000:

The initial margin requirement of 55% means that the value of loan from the
broker must satisfy
24000 L
100 = 55
24000
Hence
L = $10800
and the investor uses
24000

10800 = $13200

of their own funds. (Note that $10800 = 0:45 $24000:)

a. The return on the investment when the stock are sold at $45 can now be
found as
(45

600

10800) + 2

600
13200

0:1

10800

13200

100 = 23:636%

b. The return on the investment when the stock are sold at $25 is
(25

600

10800) + 2

600
13200

0:1

10800

13200

100 =

67:273%

c. Using cash to nance the investment the returns in the two cases are
45
25

600 + 2 600
24000
600 + 2 600
24000

24000
24000

100 = 17:5%
100 =

32:5%

Exercise 2.4
Using a margin account, 300 shares are short sold for $30 per share. The
initial margin requirement is 45%.
a. If the price of the stock rises to $45 per share, what is the actual margin
in the account?
2

b. If the price of the stock falls to $15 per share, what is the actual margin
in the account?
Is it true that the potential loss on a short sale is innite? What is the
maximum return?
Solution 2.4
The proceeds from the short sale are
300

30 = $9000:

With an initial margin requirement of 45% the investor has to deposit

9000

0:45 = $4050

with the broker.

a. The actual margin is given by
Actual Margin

=
=
=

Proceeds + Margin Payment - Value

Value
9000 + 4050 45 300
100
45 300
3:333

b. The actual margin is given by

Actual Margin

=
=

9000 + 4050 15
15 300
190

300

100

100