Question

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?
2. If the price increases to $23 what would be her absolute gain?
3. If the price increases to $23, what would be her percentage gain?
4. If the price decreases to $17, what would be the absolute and percentage loss?

B. Margin Purchase
1. How many shares of GW could she purchase on margin using the maximum leverage?
2. If the price increases to $23 what would be her absolute gain?
3. If the price increases to $23 what would be her percentage gain?
4. If the price decreased to $17, what would be her margin percentage?
5. If the minimum maintenance margin is 40%, how far could the price fall
before she receives a margin call?
6. If the price decreased to $17, what would be the absolute and percentage loss?

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 could Janice sell short?
2. If the price of GW declined to $18, how much would Janice have earned?
3. What would be Janice’s return on her investment?
4. If the price were to increase to $22, would Janice still meet the minimum maintenance margin requirement?
5. At what price would a margin call be triggered?

Solution Preview

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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?
Without using any margin, Janice can invest $25,000 directly to buy $25,000/$20 = 1,250 stocks of GW at $20 each. [$20 X 1,250 = $25,000.]

2. If the price increases to $23 what would be her absolute gain?
If the price increases by $3, Janice gains $3 X 1,250 = $3,750.

3. If the price increases to $23, what would be her percentage gain?
On a percentage basis, Janice gains $3,750 / $25,000 = .15 = 15%....

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