Tutorial 7 (Week 9)

Ch08
PROFESSIONAL APPLICATION QUESTIONS:

8.1 What is the difference between positive and negative gearing?

8.2 What are the risks associated with gearing?
8.3 An investor wishes to buy some shares by using a combination of their own money and borrowed funds.
They are unsure whether they should take out a margin loan which is secured against the shares or take
out a mortgage against the family home. What are the advantages/disadvantages of each approach?
8.4 Outline three ways that an investor can satisfy a margin call.

PROFESSIONAL APPLICATION EXERCISES:

8.11 Your client, Jason, wants to start a share portfolio using the $50 000 in equity that he has already saved
and possibly combine this with some borrowed funds. Assume the following:
 interest rates at 8%
 grossed-up dividend income of 6%
 annual capital gain of 4%
 MTR 37%.
What will be Jason’s net return in both dollar and percentage terms for the following levels of gearing if
he sells the investment asset a year and 1 day after he buys it?
a. 100% equity ($50 000 in equity)
b. 50% equity ($50 000 in equity and $50 000 in debt)
c. 10% equity ($50 000 in equity and $450 000 in debt)
8.13 Your client, Malala, has the following portfolio which he has financed through a $200 000 margin loan.
What is her safety margin?

8.14 Assume that the stock market has suffered considerable falls. Malala’s portfolio from exercise 8.13 is
now:
 Her lender has made a margin call. Malala does not have any cash to meet the margin call nor does she
have any additional assets to pledge as security. For each of the shares in her portfolio, calculate how
much she would need to sell to satisfy the margin call.
8.17 Wal is a sheep farmer from out west. When he shears his flock in 3 months’ time he will have
approximately 9,000 kilograms of wool. The current price of the SFE Greasy Wool Futures 21 micron
contract is $11.20 per kilogram for delivery in three months. Wal decides to sell four SFE Greasy Wool
Futures 21 micron contracts at $11.20 per kilogram.
What is Wal’s gain/loss on the futures contract in dollar terms if in three months’ time the price of
wool is:
 $13.75
 $10.12
 $11.20
8.18 From exercise 8.17 what is Wal’s overall gain/loss when his physical position is netted against his
futures position for each of the prices listed above?