Reading 52: Organization and ...LOS g习题精选 return, process, initial, 2010, buying

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LOS g, (Part 1): Describe the process of buying a stock on margin, and compute the rate of return on a margin transaction.

Sonia Fennell purchases 1,000 shares of Xpressoh Inc. for $35 per share. One year later, she sells the stock for $42 per share. Xpressoh Inc. pays no dividends. The initial margin requirement is 50%. Fennell's one-year return assuming an all-cash transaction, and if she buys on margin (assume she pays no transaction or borrowing costs and has not had to post additional margin), are closest to:

All-cash

50% margin

A) 20% 80%

B) 20% 40%

C) 40% 80%

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All-cash return = 42/35 ? 1 = 20%

Margin return = (42 ? 35)/[(35)(0.5)] = 40%

 

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Assume 100 shares purchased at $75/share with an initial margin of 50%.

The initial cost to the investor is:

A) $7,500.

B) $3,750.

C) $0.

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$75/share × 100 shares = $7,500

50% margin means investor only pays ? of the $7,500

= $3,750.

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Now, assume that the stock rose to $112.50. The return on investment to the investor is:

A) 50%.

B) 100%.

C) 200%.

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(market value-initial own investment - margin loan repayment)/initial equity=($11,250 – $3,750 - $3,750) / $3,750 = 100%. (Assuming no interest on the call loan and no transactions fees.)

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An investor bought a stock on margin. The margin requirement was 60%, the current price of the stock is $80, and the investor paid $50 for the stock 1 year ago. If margin interest is 5%, how much equity did the investor have in the investment at year-end?

A) 67.7%.

B) 60.6%.

C) 73.8%.

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Margin debt = 40% × $50 = $20; Interest = $20 × 0.05 = $1.

Equity % = [Value – (margin debt + interest)] / Value

$80 - $21 / $80 = 73.8%

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Which of the following statements regarding margin accounts is most accurate?

A) The total equity in the margin account cannot fall below the initial margin requirement.

B) Maintenance margin refers to the amount of funds the investor can borrow.

C) Margin accounts can be used to purchase securities by borrowing part of the purchase price.

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Margin accounts are brokerage accounts that allow investors to borrow part of the purchase price from the broker.

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The initial margin is the:

A) minimum amount of funds that must be supplied when purchasing a security on margin.

B) equity represented in the margin account at any time.

C) amount of cash that an investor must maintain in his/her margin account.

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Margin is the amount of equity in the account at a given time. Initial margin is the amount of equity required initially to execute an order.

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Becky Kirk contacted her broker and placed an order to purchase 1,000 shares of Bricko Corp. stock at a price of $60 per share. Kirk wishes to buy on margin. Assuming the margin requirement is 40%, how much money does Kirk have to pay up front to make the purchase?

A) $60,000.

B) $24,000.

C) $36,000.

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The margin requirement represents the amount of money an investor must put down on the purchase. So Kirk must put $24,000 down ($60,000 x .40 = $24,000) and can borrow the balance.

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If an investor buys 100 shares of a $50 stock on margin when the initial margin requirement is 40%, how much money must she borrow from her broker?

A) $2,000.

B) $4,000.

C) $3,000.

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An initial margin requirement of 40% would mean that the investor must put up 40% of the funds and brokerage firm may lend the 60% balance. Therefore, for this example (100 shares) * ($50) = $5,000 total cost. $5,000 * 0.60 = $3,000.

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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%.

If the shares of stock later sold for $200 per share, what is the rate of return on the margin transaction?

A) 400%.

B) 100%.

C) 250%.

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One quick (and less than intensive) way to calculate the answer to this on the examination (and it is very important to save time on the examination) is to first calculate the return if all cash, then calculate the margin leverage factor and then finally, multiply the leverage factor times the all cash return to obtain the margin return.

Calculations:

Step 1: Calculate All Cash Return:

Cash Return % = [(Ending Value / Beginning Equity Position) – 1] × 100

= [(($200 × 200) / ($100 × 200)) – 1] × 100 = 100%

Step 2: Calculate Leverage Factor:

Leverage Factor = 1 / Initial Margin % = 1 / 0.40 = 2.50

Step 3: Calculate Margin Return:

Margin Transaction Return = All cash return × Leverage Factor = 100% × 2.50 = 250%

Note: You can verify the margin return as follows:

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

= [(([$200 × 200] – [$100 × 200 × 0.60]) / ($100 × 0.40 × 200)) – 1] × 100

= [ ((40,000 ? 12,000) / 8,000) ? 1] × 100 = 250%

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Mark Ritchie purchased, on margin, 200 shares of TMX Corp. stock at a price of $35 per share. The margin requirement was 50%. The stock price has increased to $42 per share. What is Ritchie’s return on investment before commissions and interest if he decides to sell his TMX holdings now?

A) 20%.

B) 10%.

C) 40%.

200 shares x $35 = $7000 Initial Market Value

$7000 x .50 = $3500 cash payment and $3500 borrowed.

The new market value of the stock after price increase is (200 x $42) = $8400. If Ritchie sold his holdings he would have $4900 ($8400 - $3500) left after the loan was paid. So Ritchie’s return on his original $3500 investment is:

$4900/3500 – 1 = 1.4 – 1.0 = 0.40 = 40%.

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Lynne Hampton purchased 100 shares of $75 stock on margin. The margin requirement set by the Federal Reserve Board was 40%, but Hampton’s brokerage firm requires a total margin of 50%. Currently the stock is selling at $62 per share. What is Hampton’s return on investment before commission and interest if she sells the stock now?

A) -40%.

B) -35%.

C) -17%.

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Hampton originally purchased 100 shares at $75 for a total value of $7500. Half of the value ($3750) was borrowed and Hampton paid cash for the other half. The current total market value of the stock is $6200. If Hampton sells her holdings she will have $2450 left after she pays off the loan. Hampton’s return on her original investment is:

$2450/3750 – 1 = 0.65 – 1 = -0.35 = -35%.