LiquidAssets10

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

---

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

LiquidAssets10

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.

---

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

LiquidAssets10

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%. The price below which the investor would receive a margin call is closest to:

A) 17.33.

B) 19.45.

C) 15.25.

---

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

LiquidAssets10

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.

---

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

LiquidAssets10

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

A) The Federal Reserve sets the maximum maintenance margin.

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

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

---

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

LiquidAssets10

Toby Jensen originally purchased 400 shares of CSC stock on margin at a price of $60 per share. The initial margin requirement is 50% and the maintenance margin is 25%. CSC stock price has fallen dramatically in recent months and it closed today with a sharp decline bringing the closing price to $40 per share. Will Jensen receive a margin call?

A) No, he meets the minimum maintenance margin requirement.

B) Yes, he does not meet the minimum maintenance margin requirement.

C) No, he meets the minimum initial margin requirement.

---

Total original value held by Jensen is 400 x $60 = $24,000.
Amount of equity is 50% ($24,000) = $12,000.
Current total value is 400 x $40 = $16,000.
So Jensen’s equity is $16,000 - $12,000 = $4,000 which is 4,000/16,000 = 25% of the total market value.

LiquidAssets10

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.

---

Trigger price (margin purchases) = Po (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.

LiquidAssets10

An investor sold a stock short and is worried about rising prices. To protect himself from rising prices he would place a:

A) limit order to buy.

B) stop order to buy.

C) stop order to sell.

---

A limit order to buy is placed below the current market price.
A limit order to sell is placed above the current market price.
A stop (loss) order to buy is placed above the current market price.
A stop (loss) order to sell is placed below the current market price.
A stop order becomes a market order if the price is hit.

LiquidAssets10

An order placed to protect a short position is called a:

A) stop loss sell.

B) protective call.

C) stop loss buy.

---

A short position profits from declines in stock price and experiences losses as the price rises. A stop loss buy is a limit order that is placed above the market price. When the stock price reaches the stop price, the limit order is executed curtailing further loses.

LiquidAssets10

Stop loss sell orders are:

A) placed to protect a short position.

B) executed on an uptick only.

C) placed to protect the gains on a long position.

---

Stop loss sell orders are limit sell orders that are placed below market price. When the share price drops to the designated price, a sell order is executed protecting the investor from further declines