CHAPTER 3: HOW SECURITIES ARE TRADED
Solutions to Suggested Problems
6. a. The market value of the stock is: 300 $40 = $12,000
The amount borrowed is $4,000. Therefore, equity value is $8,000.
Therefore, the initial margin = $8,000/$12,000 = 0.67, or 67%
b. If the share price falls to $30, then the value of the stock falls to $9,000. By the end of
the year, the amount of the loan owed to the broker grows to:
$4,000 1.08 = $4,320
Therefore, the equity value remaining in the investor’s account is:
$9,000 $4,320 = $4,680
The percentage margin is now: $4,680/$9,000 = 0.52, or 52%
Since the maintenance margin requirement is 30%, the investor will not receive a
margin call.
c. The rate of return on the investment over the year is:
(Ending equity in the account Initial equity)/Initial equity
= ($4,680 $8,000)/$8,000 = 0.415, or 41.5%
7. a. The initial margin amount was: 0.50 1,000 $40 = $20,000
So total assets are $60,000 ($40,000 from the sale of the stock and $20,000 put up for
margin).
After the $10 increase in the stock price, value of stocks are $50,000, an amount Old
Economy Traders are liable to pay to buy back the stocks. Moreover, Old Economy
Traders must pay the dividend of $2 per share to the lender of the shares, so that they
have to pay an additional $2,000.
So, remaining percentage margin = Equity value/Market value = (Total assets – Total
liabilities)/Market value = ($60,000 – $52,000)/$50,000 = 0.16, or 16%
b. Since the maintenance margin requirement is 30%, there will be a margin call.
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c. The equity in the account decreased from $20,000 to $8,000 in one year, for a rate of
return of: ($12,000/$20,000) = 0.6, or 60%
9. a. You buy 200 shares of Telecom for $10,000. These shares increase in value by 10%. So,
the value of the stock increases to $11,000. By the end of the year, the amount of the loan
owed to the broker grows to: $5,000 1.08 = $5,400
Therefore, the equity value remaining in the investor’s account is:
$11,000 – $5,400 = $5,600
The rate of return will be:
(Ending equity in the account Initial equity)/Initial equity
= ($5,600 – $5,000)/$5,000 = 0.12, or 12%
b. The value of the 200 shares is 200P. Equity is (200P – $5,000). You will receive a
margin call when:
200P $5,000
= 0.30 when P = $35.71 or lower
200P
10. a. Initial margin is 50% of $5,000, or $2,500.
b. Total assets are $7,500 ($5,000 from the sale of the stock and $2,500 put up for margin).
Liabilities are 100P. Therefore, equity is ($7,500 – 100P). A margin call will be issued when:
$7,500 100P
= 0.30 when P = $57.69 or higher
100P
15. a. You will not receive a margin call. You borrowed $20,000 and with another $20,000 of your
own equity you bought 1,000 shares of Disney at $40 per share. At $35 per share, the market
value of the stock is $35,000, your equity is $15,000, and the percentage margin is:
$15,000/$35,000 = 42.9%
Your percentage margin exceeds the required maintenance margin.
b. You will receive a margin call when:
1,000P $20,000
= 0.35 when P = $30.77 or lower
1,000P
