1. Assuming the Delaneys would pay 12 percent a year on the broker’s loan associated with the margin account, determine their net annual return (expressed as a percentage of the amount they invest) if their stocks paid a current dividend of 5 percent and increased in market value by 20 percent. Make a similar calculation assuming a current dividend of 5 percent and a decrease in market value of 20 percent. (Ignore commissions in both your calculations.) What advice do you have for the Delaneys about leverage?
2. Suppose the broker has a maintenance margin requirement of 30 percent. Ignoring dividends and commissions, how low could the market value of the Delaneys’ holdings go before they would get a margin call? For simplicity in calculations, assume they bought 2,000 shares of only one stock at $10 a share.
3. What other advantage(s) might the Delaneys have with a margin account? Given their particular situation, do you recommend one for them? Explain.
Pat and Ed Delaney are married and have two children. Both have professional positions, and their joint income is over $100,000 a year. Their net worth is well over $150,000, and they have excellent liquidity with very little short-term debt.
The Delaneys want to start an investment program by investing in growth stocks. They believe their situation calls for the services of a full-service broker who will guide their selections. One of the brokers they interviewed urged them to open a margin account, since the amount they wanted to invest initially—$10,000—was not enough, in her opinion, to achieve adequate diversification. She put together a list of 10 stocks and urged the Delaneys to invest $2,000 in each one.