AD 717 OL

Margin Purchase / Short Sale Exercise

Homework Exercise 2

For simplicity in this exercise, ignore any interest costs, brokerage fees, etc. associated with the transactions

Margin Purchase

General Widgets shares are currently priced at $20. Janice believes that the price will increase over the next few months

Initial Margin Requirement is 50%.

Janice has $25000 to invest

A. Direct Purchase

1. How many shares of GW could she purchase directly?

1250 = 25000 / 20

2. If the price increases to $23 what would be her absolute gain?

$3750 = 1250 shares x ($23-20)

3. If the price increases to $23, what would be her percentage gain?

15% = 3750 / 25000

4. If the price decreases to $17, what would be the absolute and percentage loss? 1250 x (17-20) = -$3750 ; -3750 / 25000 = -15%

B. Margin Purchase

1. How many shares of GW could she purchase on margin using the maximum leverage? 2500 = 25000/ .50 / 20

2. If the price increases to $23 what would be her absolute gain?

$7500 = 2500 shares x (23-20)

3. If the price increases to $23 what would be her percentage gain?

30% 7500 / 25000

4. If the price decreased to $17, what would be her margin percentage?

((2500 x 17) – 25000 ) = 17500 (remaining equity)

17500 / 42500 = 41.2%

5. If the minimum maintenance margin is 40%, how far could the price fall before she receives a margin call?

40% = [(2500 x P) – 25000) / 2500 P Solving for P = $16.67

6. If the price decreased to $17, what would be the absolute and percentage loss? 2500 x (17 – 20) = -7500

-7500 / 25000 = - 30%

C. Short Sale (again, for simplicity ignore any interest costs, brokerage fees, etc)

General Widgets (GW) shares are currently priced at $20. Janice, who does not currently own the stock, believes that the price will decline over the next few months.

Initial Margin Requirement is 50%.

Maintenance Margin Requirement is 30%

Janice has $25000 to invest

1. Using the maximum leverage, how many shares of GW