Assume you borrow $25,000 to buy a stock selling for $50 a share. Your account starts with an initial margin requirement of 50% and has a maintenance margin of 25%. A. At what price would you receive...

Assume you borrow $25,000 to buy a stock selling for $50 a share. Your account starts with an initial margin requirement of 50% and has a maintenance margin of 25%. A. At what price would you receive a margin call? B. If the price were to rise to $56 a share after one year and you are charged an interest rate of 6%, what would be your rate of return? C. Compared to an investor who purchased the same number of shares but used their own cash (so they did not borrow to buy the stock), would you earn a higher or lower return? Explain. What about if the stock price had fallen?


a. Margin call Price *(1-initial margin)/(1-maintenance margin) 50 (1-0.50)/(1-0.25) 33.33 margin call would be received at $ 33.33 b. Rate of return (return)/Initial Equity Value at end 25000*56 = 1400000 Interest 25000*50*50%*6% = 37500 interest is calculated on amount borrowed that is 25000*50*50% = 625000 Return 1400000-37500-625000 = 737500 Value at end - interest - amount borrowed repaid Return (737500/625000)-1 18% c. If an investor has not borrowed money there will be no interest, no money needs to be returned Return (1400000/1250000)-1 12% Here we can see the return is less because value of own equity was more here. Whereas in above case value of own equity is less as loan is taken. If the price of share would have fallen the return would have been lesser.