Buying on Margin

Worksheet on buying on margin and selling short. Buying on Margin => Buying on margin means borrowing to buy securities. => Margin refers to the part not borrowed. => Margin = [ (current value of the securities) – (amount borrowed)]/(current value of securities)  If the initial margin is 40%, and you are buying 100 shares at $20/share, how much money do you have to have to provide? You need to provide 40% of $2,000, or $800. Your account is: ____________________________________ $2,000 Stock | $1,200 Debt | $800 Equity  If the price increases to $30, what is the margin now? Your account is: ___________________________________________ $3,000 Stock | $1,200 Debt | $1,800 Equity Margin = ($3,000‐$1,200)/$3,000 = 0.60  If you sell at a price of $30 one year from now and the margin interest rate was 10%, what was your rate of return? (3,000‐1.1*1,200 ‐ 800)/800 =  The maintenance margin is 10%. At what price would you have a margin call? (100*P ‐ $1,200)/100*P = 0.1 90P = $1,200 P = $13.33 Selling Short => Selling short means to borrow securities in order to sell them now. => You must provide cash or securities (margin) which is added to your account => Margin = [ (assets in account) – (current value of securities)]/(current value of securities)  If the initial margin is 40%, and you are selling 100 shares at $20/share, how much money do you have to provide and how much is in your account? Your Account ___________________________________________ $2,000 Cash | $2,000 (Value of 100 shares) $800 Cash (for marg) | $800 Equity  If the price increases to $25, what is the margin now? Your T‐account ___________________________________________ $2,000 Cash | $2,500 Shares (Value of 100 shares) $800 Cash | $300 Equity  If you close your account one year from now, buying at a price of $25 (assume that margin interest rate was 10% on the initial value of shares borrowed, no interest was earned on cash in your account and no dividends were paid), what was your rate of return? ($2,800 ‐ 2,500 ‐200 ‐ 800)/800 = ‐0.875  The maintenance margin is 10%. At what price would you have a margin call (ignoring interest)? (2,800 ‐ 100*P)/100*P = 0.1 110P = $2,800 P = $25.45 Problems 1) If the initial margin is 50%, and you are buying 200 shares at $30/share, how much money do you have to have to provide? 2) If the price decreases to $20, what is the margin now? 3) If you sell at a price of $20 one year from now and the margin interest rate was 10%, what was your rate of return? 4) The maintenance margin is 15%. At what price would you have a margin call? 5) If the initial margin is 50%, and you are selling 200 shares short at $30/share, how much money do you have to provide and how much is in your account? 6) If the price decreases to $20, what is the margin now? 7) If you close your account one year from now, buying at a price of $20 (assume that margin interest rate was 10% on the initial value of shares borrowed, no interest was earned on cash in your account and a $1/share dividend was paid), what was your rate of return? 8) The maintenance margin is 15%. At what price would you have a margin call (before interest and dividends)? Answers 1) $3,000 2) 25% 3) ‐76.7% 4) 17.65 5) $3,000; $9,000 6) 125% 7) 40% 8) $39.13