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Using the following assumptions, calculate the rate of return on a margin transaction for an investor who purchases the stock and the stock price at which the investor would have received a margin call.

• Market Price Per Share: $32
• Number of Shares Purchased: 1,000
• Holding Period: 1 year
• Ending Share Price: $34
• Initial Margin Requirement: 40%
• Maintenance margin: 25%
• Transaction and borrowing costs: $0
• The company pays no dividends

Margin Return

Margin Call Price

A) 6.3% $25.60

B) 15.6% $25.60

C) 15.6% $17.07

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Part 1: Calculate Margin Return:

Margin Return %

= [((Ending Value – Loan Payoff) / Beginning Equity Position) – 1] × 100
= [(([$34 × 1,000] – [$32 × 1,000 × 0.60]) / ($32 × 0.40 × 1,000)) – 1] × 100
= 15.6%

Alternative (Check): Calculate the all cash return and multiply by the margin leverage factor.
[(34,000 – 32,000) / 32,000] × [1 / 0.40] = 6.35% × 2.5 = 15.6%

Part 2: Calculate Margin Call Price:

The formula for the margin call price is:
Margin Call = (original price) × (1 - initial margin) / (1 - maintenance margin)
= $32 × (1 - 0.40) / (1 - 0.25) = approximately $25.60

honeycfa

An investor purchases 200 shares of Merxx on margin. The shares are trading at $40. Initial and maintenance margins are 50% and 25%.

If the investor sells the stock when the price rises to $50 at year-end, the return on the investment would be closest to:

A) 50.00%.

B) 25.00%.

C) 18.75%.

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Profit = 10,000 – 8,000 = 2,000
Return = 2,000 / 4,000 = 50%

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If the company pays a dividend of $0.75, the return on the investment would be closest to:

A) 39.55%.

B) 53.75%.

C) 15.75%.

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Dividends income = (0.75) × (200) = $150
Profit = 10,000 – 8,000 + 150 = 2,150
Return = 2,150 / 4,000 = 53.75%

honeycfa

When using margin to invest in equities, which of the following defines initial margin and what level will the margin be brought back to in the event of a margin call?

                 Initial margin                                     Margin call action

A) minimum amount of equity required of the investor a deposit must be made to bring the margin back to the maintenance margin

B) amount of borrowed funds in the transactions a deposit must be made to bring the margin back to the maintenance margin

C) minimum amount of equity required of the investor     a deposit must be made to bring the margin back to the initial margin

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The initial margin requirement refers to the minimum amount of equity required of the investor.

With equities, if the margin falls below the maintenance margin, funds must be deposited to bring it back up to the maintenance margin level.

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LOS g, (Part 2): Define maintenance margin and determine the stock price at which the investor would receive a margin call.

An investor buys 1,000 shares of a non-dividend-paying stock for $18. The initial margin requirement is 40% and the maintenance margin is 30%. After one year the investor sells the stock for $24 per share. The investor's rate of return on this investment (ignoring borrowing and transactions costs and taxes), and the price at which the investor would receive a margin call, are closest to:

       Rate of return    Margin call

A) 83%   $15.43

B) 83%   $21.00

C) 33%   $15.43

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To obtain the result:

Part 1: Calculate Margin Return:

Margin Return % = [((Ending Value  - Loan Payoff) / Beginning Equity Position) – 1] * 100 =

= [(([$24 × 1,000] – [$18 × 1,000 × 0.60]) /  ($18 × 0.40 × 1,000)) – 1] × 100 =

= 83.33%

Alternative (Check): Calculate the all cash return and multiply by the margin leverage factor.

                          = [(24,000 – 18,000)/18,000] × [1 / 0.40] = 33.33% × 2.5 = 83.33%

Part 2: Calculate Margin Call Price:

Since the investor is long (purchased the stock), the formula for the margin call price is:

          Margin Call = (original price) × (1 – initial margin) / (1 – maintenance margin)

   = $18 × (1 – 0.40) / (1 – 0.30) = $15.43

 

honeycfa

An investor buys 400 shares of a stock for $25 a share. The initial margin requirement is 50%, and the maintenance margin requirement is 25%. At what price would an investor receive a margin call?

A) $16.67.

B) $21.88.

C) $30.00.

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Margin call trigger price = [25(1 - 0.5)] / (1 - 0.25) = 16.67.

honeycfa

An investor purchases 100 shares of Lloyd Computer at $26 a share. The initial margin requirement is 50%, and the maintenance margin requirement is 25%. At what price would the investor receive a margin call?

A) 19.45.

B) 17.33.

C) 15.25.

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26 * (1 - 0.5)/(1 - 0.25) = $17.33.

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An investor buys 200 shares of ABC at the market price of $100 on full margin. The initial margin requirement is 40% and the maintenance margin requirement is 25%.

At what price will the investor get a margin call?

A) $112.

B) $48.

C) $80.

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In a long stock position, the equation to use to determine a margin call is:

long = [(original price)(1 ? initial margin %)] / [1 ? maintenance margin %]
       = $100(1 ? 0.4) / (1 ? 0.25) = $80

honeycfa

Which of the following statements about the maintenance margin requirement is least accurate?

A) The purpose of the maintenance margin requirement is to protect the broker in the event of a large stock decline.

B) Generally the maintenance margin requirement is lower than the initial margin requirement.

C) The Federal Reserve sets the maximum maintenance margin.

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The Federal Reserve sets the minimum maintenance margin and individual investment companies may set higher margins if they wish.

honeycfa

Byron Campbell purchased 300 shares of Crescent, Inc., stock at a price of $80 per share. The purchase was made on margin with an initial margin requirement of 50%. Assuming the maintenance margin is 25%, the stock price of Crescent, Inc. has to fall below what level for Campbell to receive a margin call?

A) $53.33.

B) $20.00.

C) $40.00.

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Trigger price (margin purchases) = P_o (1 – initial margin) / (1 – maintenance margin).
$80(1-.5)/(1-.25) = 40/.75 = $53.33.
P = $53.33
If Crescent, Inc. falls below $53.33 then Campbell will get a margin call.