# CHAPTER 4—ORGANIZATION AND FUNCTIONING OF SECURITIES MARKETS

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

Jackie has a margin account with a balance of $150,000. If the initial margin deposit is 60 percent and Turtle Industries is currently selling at $50 per share:

28. How many shares of Turtle can Jackie purchase? Letting X = total investment, Jackie's share will represent 60 percent. Thus .60X = $150,000 and X = $150,000 ÷ .60 = $250,000. At $50 per share, she can purchase ($250,000 ÷ $50) = 5000 shares.

29. What is Jackie's profit/loss if Turtle's price after one year is $40? Profit = (40 − 50)(5000) = − $50,000

30. If the maintenance margin is 25 percent, to what price can Turtle Industries fall before Jackie receives a margin call? Margin = (Market Value − Debit Balance) ÷ Market Value, where Debit Balance = initial loan value = ($250,000 − $150,000) = $100,000 Market Value = Price × Number of Shares = 5000P

Thus 0.30 = (5000P − $100,000) ÷ (5000P) P = $26.67

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Heidi Talbott has a margin account with a balance of $50,000. If the initial margin deposit is 50 percent, and RC Industries is currently selling at $50 per share:

31. How many shares of RC can Heidi buy? Letting P = price and Q = quantity of shares, Heidi's share of the investment will = 50% of PQ. Thus 0.50PQ = $50,000 and PQ = $50,000/0.50 = $100,000

∴ At $50 per share, she can purchase ($100,000 ÷ $50) = 2000 shares.

32. What is Heidi's profit if RC's price rises to $80? Profit = (80 − 50)(2000) = $60,000

33. If the maintenance margin is 25 percent, to what price can RC Industries stock price fall before Heidi receives a margin call? Margin = (Market Value − Debit Balance) ÷ Market Value, where Debit Balance = initial loan value = ($100,000 − $50,000) = $50,000 Market Value = Price × Number of Shares = 2000P

Thus 0.25 = (2000P − $60,000) ÷ (2000P) P = $33.33

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Kathy Smith has a margin account with a balance of $60,000. If initial margin requirements are 80 percent, and Jackson Industries is currently selling at $40 per share:

34. How many shares of Jackson can Kathy buy? Letting P = price and Q = quantity of shares, Kathy's share will represent 80% of PQ. Thus 0.80X = $60,000 and X = $60,000 ÷ .80 = $75,000.

∴ At $40 per share, she can purchase ($75,000 ÷ $40) = 1875 shares.

35. What is Kathy's profit if Jackson's price rises to $50? Profit = (50 − 40)(1875) = $18,750

36. If the maintenance margin is 25 percent, to what price can Jackson Industries fall before Kathy receives a margin call? Margin = (Market Value − Debit Balance) ÷ Market Value, where Debit Balance = initial loan value = ($75,000 − $60,000) = $15,000 Market Value = Price × Number of Shares = 1875P Thus 0.25 = (1875P − $15,000) ÷ 1875P

P = $10.67

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You decide to sell 100 shares of Davis Industries short when it is selling at its yearly high of $35. Your broker tells you that your margin requirement is 55 percent and that the commission on the sale is $15. While you are short, Davis pays a $0.75 per share dividend. At the end of one year you buy your Davis shares (cover your short sale) at $30 and are charged a commission of $15 and a 6 percent interest rate.

37. What is your dollar return on the investment? Profit = $3500 − $3000 − $75 − $15 − $15 − (1 − 0.55)(3500)(0.06) = $300.50

38. What is your rate of return on the investment? Rate of Return = Profit ÷ Initial Investment Initial investment = (.55 × $3500) + $15 = $1,940

∴ Rate of Return = $300.50/$1,940 = 15.49%

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You decide to sell 100 shares of Topgun Enterprises Inc. short when it is selling at its yearly high of $42.25. Your broker tells you that your margin requirement is 60 percent and that the commission on the sale is $20. While you are short, Topgun pays a $0.85 per share dividend. At the end of one year you buy your Topgun shares (cover your short sale) at $44 and are charged a commission of $20 and a 5 percent interest rate.

39. What is your dollar return on the investment? Profit = $4225 − $4400 − $85 − $20 − $20 − (1 − 0.60)(4225)(0.05) = − $384.50

40. What is your rate of return on the investment? Rate of Return = Profit ÷ Initial investment Initial investment = (0.60 × $4225) + 20 = $2,555

∴ Rate of Return = − $384.50/$2,555.00 = − 15.05%

41. Suppose you buy a round lot of DG Solutions stock on 60% margin when it is selling at $55 a share. The broker charges a 10 percent annual interest rate and commissions are 3 percent of the total stock value on both the purchase and the sale. If at year end you receive a $1.10 per share dividend and sell the stock for 55 5/8, what is your rate of return on the investment? Rate of Return = Profit ÷ Initial investment

Profit = Total Return − Initial Stock Value − Transaction Costs − Interest Total Return = Ending Market Value + Dividend Value

= $5,562.50 + $110.00 = $5,672.50

Initial Stock Value = 100($55) = $5,500.00 Transaction Costs = (0.03)(5,500) + (0.03)(5,562.50) = $331.86 Interest = (0.10)(0.40)($5,500) = $220.00

∴ Profit = $5,672.50 − $5,500.00 − $331.86 − $220.00 = −$379.36

Initial investment

= Margin deposit + Commission

= (0.60)($5,500.00) + (0.03)($5,500.00) = $3,465

∴ Rate of Return = − $379.36/$3,465 = − .10948 = − 10.95%

42. Suppose you buy a round lot of HS Inc. stock on 55% margin when it is selling at $40 a share. The broker charges a 10 percent annual interest rate and commissions are 4 percent of the total stock value on both the purchase and the sale. If at year end you receive a $0.90 per share dividend and sell the stock for 35 5/8, what is your rate of return on the investment? Rate of Return = Profit ÷ Initial investment

Profit = Total Return − Initial Stock Value − Transaction Costs − Interest Total Return = Ending Market Value + Dividend Value

= $3562.50 + $90= $3652.50

Initial Stock Value = 100($40) = $4000 Transaction Costs = (0.04)(4000) + (0.04)(3562.50) = $302.50 Interest = (0.10)(0.45)($4000) = $180.00

∴ Profit = $3652.50 − $4000 − $302.50 − $180.00 = − $830.00

Initial investment

= Margin deposit + Commission

= (0.55)($4,000) + (0.04)($4,000) = $2,360

∴ Rate of Return = − $830.00/$2360 = − 0.3517 = − 35.17%

43. Suppose you buy a round lot of Altman Industries stock on 50% margin when it is selling at $35 a share. The broker charges a 10 percent annual interest rate and commissions are 5 percent of the total stock value on both the purchase and the sale. If at year end you receive a $1.00 per share dividend and sell the stock for $42.63, what is your rate of return on the investment? Rate of Return = Profit ÷ Initial Investment

Profit = Total Return − Initial Stock Value − Transaction Costs − Interest Total Return = Ending Market Value + Dividend

= $4263 + $100 = $4363

Initial Stock Value = 35(100) = $3,500.00 Transaction Costs = .05 × 3,500 + (0.05)(4,263) = $388.15 Interest = (0.10)(0.50)($3,500) = $175.00

∴ Profit = $4,363 − $3,500 − $175.00 − $388.15 = $299.85

Initial investment

= Margin deposit + Initial investment

= .50 × $3,500 + .05 × $3,500 = $1,925

∴ Rate of Return = $299.85/$1,925 = 15.58%

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You decide to sell short 200 shares of XCorp stock at a price of $75. Your margin deposit is 65 percent. Commission on the sale is 1.25%. While you are short, the stock pays a $1.75 per share dividend. Interest on margin debt is 5.25% per year.

44. At the end of one year you close out your short position by purchasing share of XCorp at $45 per share. The commission is 1.25%. What is your rate of return on the investment? Rate of return = [75 – 45 − 0.9375 − 0.5625 − 1.75 − (1 − .65)(75)(.0525)]/[(.65)(75) + 0.9375] = 51.06%

45. Suppose at the end of one year XCorp is selling at $90 per share and you cover your short position at this price. What is your rate of return on the investment? (Assume a 1.25% commission on the purchase.) Rate of return = [75 – 90 − 0.9375 − 1.125 − 1.75 − (1 − .65)(75)(.0525)]/[(.65)(75) + 0.9375] =− 40.64%

USE THE FOLLOWING INFORMATION FOR THE NEXT PROBLEM(S)

Shares of RossCorp stock are selling for $45 per share. Brokerage commissions are 2% for purchases and 2% for sales. The interest rate on margin debt is 6.25% per year. The maintenance margin is 30%.

46. At the end of one year shares of RossCorp stock are selling for $55 per share and the company paid dividends of $0.85 per share. Assuming that you paid the full cost of the purchase, what is your rate of return if you sell RossCorp stock? Rate of return = [55 – 45 + 0.85 − 1.10 − 0.90]/[45 + 0.90] = 19.28%

47. At the end of one year shares of RossCorp stock are selling for $35 per share and the company paid dividends of $0.85 per share. Assuming that you paid the full cost of the purchase, what is your rate of return if you sell RossCorp stock? Rate of return = [35 − 45 + 0.85 − 0.70 − 0.90]/[45 + 0.90] = − 23.42%

48. At the end of one year shares of RossCorp stock are selling for $55 per share and the company paid dividends of $0.85 per share. Assuming that you borrowed 25% of cost of the purchase, what is your rate of return? Rate of return = [55 – 45 + 0.85 − 1.10 − 0.90 − (1 − .75)(45)(.0625)]/[(0.75)(45) + 0.90] = 23.51%

49. At the end of one year shares of RossCorp stock are selling for $35 per share and the company paid dividends of $0.85 per share. Assuming that you borrowed 25% of cost of the purchase, what is your rate of return? Rate of return = [35 – 45 + 0.85 − 0.70 − 0.90 − (1 − .75)(45)(.0625)]/[(0.75)(45) + 0.90] = − 33.05%

50. Assume that you purchase 150 shares of RossCorp stock at $45 each by making a margin deposit of 55%. At what price would you receive a margin call? 0.30 = [(150)(P) − (0.45)(150)(45)]/[(150)(P)] P = $28.93

51. You own 50 shares of Auto Corporation that you purchased for $30 a share. The stock is currently selling for $50 a share and you placed a stop loss order at $45. If the stock price drops to $35 a share, what is your return on this investment? ($45 − $30)/$30 = $15/$30 = 0.50 or 50%

52. You purchased 100 shares of Highlight Company for $20 a share one year ago with a margin of 50%. The stock is currently selling for $28 a share and no dividends were ever paid. The broker charges an annual interest rate of 8% and a $100 commission on both the purchase and sale of these shares. What is your annual rate of return on this investment? Annual Rate of Return = Profit / Initial Investment

Profit

= Ending Market Value − Initial Stock Value − Commissions − Interest = (100*$28) − (100*$20) − (2*$100) − (0.08*0.5*100*$20)

= $2,800 − $2,000 − $200 − $80 = $520

Annual Rate of Return = $520/(.50*100*$20) = 520/(1,000 + 100) = 0.47 or 47%

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You sell 100 shares short of AMF Corporation when it is selling at $45 per share. Your margin requirement is 60% and the commission on the sale is $50 and the broker charges 10% annual interest. AMF Corporation paid a $0.50 per share dividend while you were short the stock. After one year you cover your short sale at $35 per share with a $50 commission for the purchase.

53. What is your total dollar return on this investment? Profit = $4,500 short sale − $3,500 cover − $50 for dividends − $100 for commissions

−(1 − .60)($4,500)(0.10) interest expense = $850 − $180 = $670

54. What is your annual rate of return on this investment? Return = Profit / Initial Investment = $670/(.6*$4,500 + $50) = $670/$2750 = 0.244