You are bullish on Telecom stock. The current market price is $250 per share, and you have $20,000 of your own to invest. You borrow an additional $20,000 from your broker at an interest rate of 8% per year and invest $40,000 in the stock. a. What will be your rate of return if the price of Telecom stock goes down by 7% during the next year? The stock currently pays no dividends. (Negative value should be indicated by a minus sign. Round your answer to the nearest whole number. Omit the "%" sign in your response.) Rate of return %b. How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30%? Assume the price fall happens immediately. (Round your answer to 2 decimal places. Omit the "$" sign in your response.) Margin call will be made at price $ or lower

Question

Sadie Webster

Business

21 February, 16:24

You are bullish on Telecom stock. The current market price is $250 per share, and you have $20,000 of your own to invest. You borrow an additional $20,000 from your broker at an interest rate of 8% per year and invest $40,000 in the stock. a. What will be your rate of return if the price of Telecom stock goes down by 7% during the next year? The stock currently pays no dividends. (Negative value should be indicated by a minus sign. Round your answer to the nearest whole number. Omit the "%" sign in your response.) Rate of return %b. How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30%? Assume the price fall happens immediately. (Round your answer to 2 decimal places. Omit the "$" sign in your response.) Margin call will be made at price $ or lower

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Answers (1)

Know the Answer?

Elvis · Answer 1

The rate of return on the investment if the price fall by 7% next year is - 22% which is shown below.

The price of Telecom would have to fall by $71.43 ($250-$178.57), before a margin call could be placed.

Lastly, if the price fall immediately, the margin price would $178.57 as shown below

Explanation:

Total shares bought=$40000/$250=160 shares

Interest on amount borrowed=8%*$20000=$1600

When the price falls by 7% the new price = $250 (1-0.07) = $232.50

Hence rate of return = (New price*number of shares-Interest-total investment) / initial investor's funds

= ($232.50*160-$40000-$1600) / $20000=-22%

Initial margin=investor's money/total investment=$20000/$40000=50%

maintenance margin=30%

Margin call price=Current price x (1 - initial margin) / (1 - maintenance margin)

=$250 * (1-0.5) / (1-0.3)

=$178.57