Reading 52 question 2 2010, question, investment, completely, understand

rgonzalez

Hi guys,

This question is from the 2010 cfa book.

Q: suppose you buy a round lot of Margin Industries stock on 55% margin when the stock is selling at $20 a share. The broker charges a 10% annual interest rate and commissions are 3% of the total stock value on both the purchase and sale. A year later you receive a $0.50 per share dividend and sell the stock for $27. What is your rate of return on the investment?

A:44.74%

So I completely understand all the steps except for one. For the investors portion of the investment, the solution is also factoring in the 3% commission on the purchase.

Total investment (as per the book solution)= (.55 x 2000) + (.03 x 2000) = $1160

44.74% = 519/1160 (solution) vs 47.27% = 519/1100 (my understanding).

I would think it's only $1100 because the commission is going to the broker on both the purchase and sale.

In the solution, total transaction cost is $141 = [(.03 x 2000) + (.03 x 2700)] and I agree with that. I just don't understand why the $60 is being added to the total investment which is screwing up my rate if return %.

Please help clarify. Thank you.

G

hassan

Because, after all, it's money you're doling out to acquire the position. And what you're trying to calculate is the return from entering and exiting the position inclusive of all costs.

ruchita

Ahhh, I get it. Thanks for the clarification.