You decide to purchase on margin 1000 shares of ABC stock currently trading at $25 each....

 

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You decide to purchase on margin 1000 shares of ABC stock currently trading at $25 each. Your initial margin is 50% and your broker allows you a buffer of 10% before making a margin call - i.e., the maintenance margin is 40%. (a) How much must you invest initially to purchase the shares and what is the amount you borrow from your broker? (b) How far can share price fall before a margin call is triggered? (3 marks) (3 marks) (c) Now assume that share price suddenly drops to $20. You received a margin call and you decided to deposit T-bills in your account to increase the margin; the T-bills added to your account will increase the total value of your margin account while NOT changing the value of the loan. (In other words, the total value of your account will be the sum of the value of 1000 shares plus the value of T-bills added and that of the loan will stay the same.) What is the total value of T-bills you need to put up, in order to get the margin back up to the maintenance margin of 40%? (3 marks) (d) If you do not take an action in time your broker will partly liquidate your position and repay the loan in order to (just) meet the maintenance margin requirement. How many shares (not the dollar amount) would the broker sell in order to get the margin back up to the maintenance margin of 40%? You decide to purchase on margin 1000 shares of ABC stock currently trading at $25 each. Your initial margin is 50% and your broker allows you a buffer of 10% before making a margin call - i.e., the maintenance margin is 40%. (a) How much must you invest initially to purchase the shares and what is the amount you borrow from your broker? (b) How far can share price fall before a margin call is triggered? (3 marks) (3 marks) (c) Now assume that share price suddenly drops to $20. You received a margin call and you decided to deposit T-bills in your account to increase the margin; the T-bills added to your account will increase the total value of your margin account while NOT changing the value of the loan. (In other words, the total value of your account will be the sum of the value of 1000 shares plus the value of T-bills added and that of the loan will stay the same.) What is the total value of T-bills you need to put up, in order to get the margin back up to the maintenance margin of 40%? (3 marks) (d) If you do not take an action in time your broker will partly liquidate your position and repay the loan in order to (just) meet the maintenance margin requirement. How many shares (not the dollar amount) would the broker sell in order to get the margin back up to the maintenance margin of 40%?

Answer rating: 100% (QA)

a To calculate the initial investment and the amount borrowed we need to consider the initial margin and the number of shares purchased The initial in... View the full answer