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Illustration 1 One Period Return with and without margin

An investor purchase aRs.100 stock on 55% margin and then its price
doubled to Rs.200. the brokerage firm charged 10% interest for the loan on
the margin investment. No cash dividend was received while the investor
held the stock. What was the investors one period rate of return on this
transaction with and without margin, net of all costs? Show your calculations
and discuss why the returns are not same with and without margins.
Solution
Here given:
Purchasing or starting price (Pt)
Initial Margin
Ending price (P t+1)
Interest for the loan
One period rate of return

=Rs.100
=55%
=Rs.200
=10%
=?

We know,
When an investor purchases without using the margin, the one period
return will be as:
One- period rate of return =
cash dividend

(Ending Price - Beginning Price) +


Margin money paid for

Purchase
Or, One- period rate of return

=
=

(Pt+1 - Pt) +D t+1


im x P t

(Rs.200 - Rs.100) + Rs.0


Rs.100

1 or, 100%

When investor bought on margin, the one period rate of return is defined
as:

One- period rate of return =(Ending Price - Beginning Price) +cash


dividend interest expense
Margin money paid for
Purchase
Or, One- period rate of return =
interest fraction

(Pt+1 - Pt) +D

t+1

- Pt (1-im) x
im x

Pt

(Rs.200 - Rs.100) + Rs.0 100(1-0.55)

0.10
Rs.100 0.55
=

1.736 or 173.6%

Hence, an Investor made a 173.6 % return when the price of the stock he
bought doubled. Stated differently, margin transformed a 100% price rise
into a 173.6% gain.
Note: Investors brokerage firm charged him a 10% interest rate for
the Rs. 45 per share (Rs. 100 Rs.55) it loaned to him.
The rates of return without margin and with margin are not equal due to the
difference in their investment. The amount of investment is lower with
margin so, the rate of return is higher though it pays some interest as well.

Illustration 2 Collateral value and actual margin in long position


Buck Ewing opens a margin account at the local brokerage firm. Bucks initial
investment was to purchase 200 share of Woodbury Corporation on margin
at Rs.40 per share. Buck borrowed Rs.3000 from a broker to complete the
purchase.
a) At the time of the purchase, what was the collateral in bucks account, and
what was the actual margin in bucks account?

b) If Woodbury stock subsequently rises in price to Rs.60 per share, what is


the collateral in bucks account and what is the actual margin in the buck s
account?
c) If wood bury stock subsequently falls in price to Rs. 35 per share, what is
the collateral in bucks account and what is the actual margin in bucks
account?
Solution
Here given:
Numbers of shares
= 200shares
Purchase price of share
=Rs.40
Borrowed amount
= Rs.3000
a.

The total market value of assets or 200 shares costing Rs.40 each was
the collateral in Bucks account at the time of purchase. It means,
collateral = Rs.40 200 shares = Rs.8000
Market value of assets loan
Actual margin =
Market value of assets
= Rs.40 200shares Rs. 3000
Rs. 40200shares
= 0.625 or 62.5%

b.
Market value of assets= (collateral) = Rs. 60 200 shares = - Rs.
12000
RS.60 200shares Rs.3000
Actual margin =
Rs.60 200shares
c.

= 0.75 or 75%

Market value of assets (collateral) = Rs.35 200shares = Rs.7000


Rs.35 200 shares Rs.3000
Actual margin=
Rs.35 200 shares
= 0.57143 or 57.143%

Illustration 3 Equity and Actual Margin in Short Position

Through a margin account candy Cumming short sells 200 shares of Madison
inc. stock for Rs.50 per share. The initial margin requirement is 45%.
a) If Madison stock subsequently rises to Rs.58per share, what is the equity
in candys account and what is the actual margin in candys account?
b) If Madison stock subsequently falls to Rs.42 per share, what is the equity
in candys account and what is the actual margin in candys account?
Solution
Here given:
Market price of stock
Numbers of shares
Initial margin requirement

=Rs.50
=200 shares
=45%

Here,
a. Equity, if price of stock rises to Rs.58
We have,
Equity = No. of shares Beginning price (1+initial margin) No. of
shares Ending price
Or, Equity = 200 shares Rs.50 (1+0.45) 200 shares Rs.58 =
Rs.2900
Now,
Actual Margin =

Market value of assets - loan


loan

Or, Actual margin = 200 shares Rs. 50 (1+0.45) - 200shares


Rs.58
Rs.58 200 shares
= 0.25 or 25%

b. Equity, if price of stock falls to Rs 42


Equity = 200shares [Rs .50 (1+ 0.45)] - 200 shares Rs.42 =
Rs.6100
4

Actual margin =

200shares Rs.50 (1+0.45) 200shares Rs.42


Rs.42 200 shares

0.726 or 72.6%

Illustration 4 Margin Call Analysis


Snooker arnovich buys on margin 1000shares of Rockford systems at Rs.60
per share. The initial margin requirement is 50% and the maintenance
margin requirement is 30%. If the Rockford stock falls to Rs.50, will snooker
receive a margin call?
Solution
Here given:
Number of shares purchase
= 1000 shares
Stock price
=Rs.60 per share
Initial margin requirement
=50%
Maintenance margin requirement
=30%
Decline in stock price
=Rs.50
First calculate the actual margin and this margin compare with
initial margin.
Market value loan
Actual margin
=
market value
= Rs. 50000 Rs.30000
Rs.50000
= 0.40 or 40%
Working notes:
Market value

= 1000shares Rs. 50
= Rs.50000

Loan

=1000shares Rs. 60 0.50


=Rs.30000

The snooker will not receive a margin call because maintenance margin is
less than actual margin i.e.30% < 40%.

Alternatively,
Calculation of the margin call price and compare this price with Rs.50.
1 Initial margin
Price of stock
=
1 maintenance margin
purchase price
= 1 -0.50
1-0.30

Rs. 60

= Rs.42.857
The snooker will not receive a margin call because price Rs.50is still above
the price Rs.42.857 i.e. Rs.50> Rs.42.857. to receive margin call the price
should fall below Rs. 42.857.
Note: you can do any one method; all method gives you same results

Illustration 5 One Period return and margin call in short position


Consider the following information:
Stock price per share
Rs.50
Margin requirement
60%
Maintenance margin
30%
Ignoring transaction cost and taxes:
a) Assumes that an investor takes a short position with a cash deposit equals
to 100% of the requirement (It means without using the margin).
Calculate the rate of return if the investor covers (purchases) the stock at
Rs 40 after one year.
b) Assumes that an investor takes a short position with a cash deposit equals
to 60% (i.e. initial margin) of the Sales value. (1) Calculate the stock price
that will trigger a margin call.
(2) Calculate the rate of return if
the investor covers (purchase) the stock at Rs.40 after one year.
c) Explain why the rates of return in parts (a) and (b) are different.

Solution,
Here given:
Stock price

=Rs.50
6

Initial margin
=60%
Maintenance margin=30%
a.

rate of return = ?
We have,
Rate of return

= starting price ending price


Starting price
=

(Rs.50 Rs.40)
Rs.50

= 0.20 or 20%
b. (1) stock price that will trigger a margin call.
We have,
Trigger Price of stock

1+ initial margin
1+maintenance margin

selling price

(Pt)
=
=

1+ 0.60
1+ 0.30

Rs.50

Rs.61.538

If the price increases above Rs. 61.538 a maintenance call will be


made.
b. (2) rate of return
Rate of return

= starting price ending price


Equity deposit
= (Rs.50 Rs. 40)
Rs.30
= 0.3333 or 33.33%

c. the HPR on 60% margin position margin is larger than the return on 100%
margin. This occurs because the investor is allowed to deposit 60% of stock
price and can invest the remaining money at 20%.
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Illustration 6 Margin call in long Position


You have borrowed Rs. 20000 on margin to buy shares to Disney, which is
now selling at Rs.80 per share. Your account start at the initial margin
requirement of 50%the maintenance margin is 35%. Two days later, the
stock price falls to Rs.75 per share.
a) Will you receive a margin call?
b) How long price of Disney shares fall before you receive a margin call?
Solution
Here given:
Position
= long position
Purchase price or starting price (p1)
=Rs.80
Initial margin
=50%
Maintenance margin
35%
a. receive a margin call or not?
We have,
Actual margin =
=

Market value of assets loan


Market value of Assets

Rs.37500 Rs.20000
Rs.37500

=0.4667 or 46.67%
Working notes:
Market value
Loan

=500 shares Rs.75 = Rs.37500


=Rs.20000

Since the actual margin is 46.67%, which is greater than the maintenance
margin therefore, you will not receive a margin call.
b. Triggering price of the stock
Here given:
8

Initial margin required of investor


= 50%
Maintenance margin required by brokerage firm
=35
Purchase price on margin
=Rs.80per share
Price of stock that will trigger a maintenance call:
Triggering Price of stock =
1 initial margin
1 Maintenance margin
= 1 0.50
1 0.35

purchase price

Rs. 80

=Rs.61.54
If the price falls below Rs. 61.54, a margin call will be made.