Chapter 3 – problem set

1. Suppose you short sell 100 shares of BEXIMCO, now selling at BDT 120 per share.
a. What is your maximum possible loss?

In principle, potential losses are unbounded, growing directly with increases in the price of BEXIMCO.

b. What happens to the maximum loss if you simultaneously place a stop-buy order at BDT 128?

If the stop-buy order can be filled at BDT 128, the maximum possible loss per share is BDT 8, or BDT
800 total. If the price of BEXIMCO shares goes above BDT 128, then the stop-buy order would be
executed, limiting the losses from the short sale.

2. A market order has:

a. Price uncertainty but not execution uncertainty.
b. Both price uncertainty and execution uncertainty.
c. Execution uncertainty but not price uncertainty.

(a) A market order is an order to execute the trade immediately at the best possible price. The emphasis in
a market order is the speed of execution (the reduction of execution uncertainty). The disadvantage of a
market order is that the price it will be executed at is not known ahead of time; it thus has price
uncertainty.

3. Assume you purchased 200 shares of ENVOYTEX common stock on margin at BDT 70 per share from your
broker. If the initial margin is 55%, how much did you borrow from the broker?

Value of shares = 200 shares * BDT 70 per share = BDT 14,000

Money borrowed from the broker = (1 – 0.55) * BDT 14,000 = BDT 6,300

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4. You want to purchase OLYMPIC stock at BDT 40 from your broker. If initial margin is 50% and you have BDT
4000 to invest, what is the maximum number of shares you can buy?

With your own money, you can buy BDT 4,000 BDT 40 per share = 100 shares
Initial margin = your investment = 50%
You can borrow (100% – margin) = (100% – 50%) = 50% from the broker.

With the borrowed money you can buy another 100 shares.

Maximum number of shares = 100 + 100 = 200 shares

5. Assume you sell short 100 shares of BRAC BANK common stock at BDT 45 per share, with initial margin at
50%. The stock paid no dividends during the period, and you did not remove any money from the account before
making the offsetting transaction. What would be your rate of return if you covered the short sale at BDT 40/share?

Assets Liabilities + Owners’ Equity

T-bill 4,500 Value of shares 4,500

Cash 2,250 Equity 2,250
6,750 6,750

If you covered the short sale at BDT 40/share, your loss would be (BDT 40 – BDT 45 or) BDT 5/share.

Total loss = BDT 5/share * 100 shares = BDT 500

Rate of return = total loss total investment = – 500 2,250 = 22.22%

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6. You purchased 100 shares of GLAXOSMITH common stock on margin at BDT 70 per share. Assume the initial
margin is 50% and the maintenance margin is 30%. Assume the stock pays no dividend; ignore interest on margin.
Below what stock price level would you get a margin call?

Assets Liabilities Owners’ Equity

Value of stock 7,000 Loan from broker 3,500
Equity 3,500
7000 7,000

Assume the price at which would you get the margin call is BDT P.
At P taka/share, the value of your stock would be 100 X P = BDT 100P.

(Note: If the price of the shares goes down (or up), the amount of loan from the broker would not change. Would a
broker forgive (or lower) your debt because you made bad investment decisions and lost money? So, your liability
(the loan from the broker) will still be BDT 3,500.)

A L OE
If A BDT 100P, then L OE BDT 100P

If L OE BDT 100P and L BDT 3,500, then OE A L = BDT 100P 3,500.

Assets Liabilities Owners’ Equity

Value of stock 100P Loan from broker 3,500
Equity 100P 3,500
100P 100P

At maintenance margin of 30%,

30% Equity value

30% (100P 3,500) 100P
30% 100P 100P 3,500
30P 100P 3,500
30P 100P 3,500
70P 3,500
P 3,500 70
P BDT 50

We would get a margin call when the stock price falls below BDT 50/share.

Verification (Note: no need to do this in the exam)

At P 50, 100P 100 50 5,000.

100P 3,500 5,000 3,500 1,500

Assets Liabilities Owners’ Equity

Value of stock 5,000 Loan from broker 3,500
Equity 1,500
5,000 5,000

Margin Equity value = 1,500 5,000 30%

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7. You sold short 100 shares of BERGERPBL common stock at BDT 45 per share. The initial margin is 50%. At
what stock price would you receive a margin call if the maintenance margin is 35%?

Note: In a short sale, if the broker has 50% margin requirement, the short seller must deposit 50% of the short sales
as collateral (in this case, T-bill). The short seller must replace the share she borrowed; therefore, the value of
shares is what she owes the broker. That means the liability in a short sale is the value of the shares which she sold
short.

Assets Liabilities Owners’ Equity

Cash 4,500 Value of shares 4,500
T-bill 2,250 Equity 2,250
6,750 6,750

Assume you would receive a margin call at price BDT P/share.

(Note: If the price of the shares goes up (or down), the amount of cash deposited in your account from the short sale
would not change. Neither would the value of the T-bills you kept as collateral. So, total assets would still be BDT
6,750)

Assets Liabilities Owners’ Equity

Cash 4,500 Value of shares 100P
T-bill 2,250 Equity 6,750 – 100P
6,750 6,750

At maintenance margin of 30%,

35% Equity value

35% (6,750 – 100P) 100P
35% 100P 6,750 – 100P
35P 6,750 – 100P
35P 100P
135P
P 5
P BDT 50

We would get a margin call when the stock price goes above BDT 50/share.

Verification (Note: no need to do this in the exam)

At P 50, 100P 100 50 5,000.

6,750 – 100P 6,750 5,000 1,750

Assets Liabilities Owners’ Equity

Cash 4,500 Value of shares 5,000
T-bill 2,250 Equity 1,750
6,750 6,750

Margin Equity value = 1,750 5,000 35%

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8. Sarah opens a brokerage account and purchases 300 shares of Aftab Auto at BDT 40 per share. She borrows BDT
4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%.

a. What is the margin in Sarah’s account when she first purchases the stock?

a. The stock is purchased for: 300 BDT 40 BDT 12,000

The amount borrowed is BDT 4,000. Therefore, the investor put up equity, or margin, of BDT 8,000.

b. If the share price falls to BDT 30 per share by the end of the year, what is the remaining margin in her account? If
the maintenance margin requirement is 30%, will she receive a margin call?

If the share price falls to BDT 30, then the value of the stock falls to BDT 9,000. By the end of the
year, the amount of the loan owed to the broker grows to:
BDT 4,000 1.08 BDT 4,320
Therefore, the remaining margin in the investor’s account is:
BDT 9,000  BDT 4,320 BDT 4,680
The percentage margin is now: BDT 4,680 BDT 9,000 0.52 52%
Therefore, the investor will not receive a margin call.

c. What is the rate of return on her investment?

The rate of return on the investment over the year is:

(Ending equity in the account  Initial equity) Initial equity
(BDT 4,680  BDT 8,000) BDT 8,000 0.415 41.5%

9. Rabbi opened an account to short sell 1,000 shares of Alif Textiles from the previous problem. The initial margin
requirement was 50%. (The margin account pays no interest.) A year later, the price of Alif Textiles has risen from
BDT 40 to BDT 50, and the stock has paid a dividend of BDT 2 per share.
a. What is the remaining margin in the account?

The initial margin was: 0.50  1,000 BDT 40 BDT 20,000

As a result of the increase in the stock price Rabbi loses:
BDT 10 1,000 BDT 10,000
Therefore, margin decreases by BDT 10,000. Moreover, Rabbi must pay the dividend of BDT 2 per
share to the lender of the shares, so that the margin in the account decreases by an additional BDT
2,000. Therefore, the remaining margin is:
BDT 20,000 – BDT 10,000 – BDT 2,000 BDT 8,000

b. If the maintenance margin requirement is 30%, will Rabbi receive a margin call?

The percentage margin is: BDT 8,000/BDT 50,000 0.16 16%

So there will be a margin call.

c. What is the rate of return on the investment?

The equity in the account decreased from BDT 20,000 to BDT 8,000 in one year, for a rate of return of:
(BDT 12,000 BDT 20,000) 0.60 60%

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10. Mofiz opens a brokerage account and purchases 300 shares of Anlima Yarn at BDT 40 per share. He borrows
BDT 4,000 from his broker to help pay for the purchase. The interest rate on the loan is 8%.
a. If the share price falls to BDT 30 per share by the end of the year, what is the remaining margin in his account? If
the maintenance margin requirement is 30%, will he receive a margin call?

Purchase price 300 BDT 40 BDT 12,000

Loan BDT 4,000
Equity Value – Loan BDT 12,000 – BDT 4,000 BDT 8,000

At the end of the year, Value 300 BDT 30 BDT 9,000

Loan BDT 4,000
Interest on loan 8% of BDT 4,000 BDT 320
Equity BDT 9,000 – BDT 4,000 – BDT 320 BDT 4,680

Margin Equity Value 4,680 9,000 52.00%

Since the margin is above the maintenance margin, the investor will NOT receive a margin call.

b. What is the rate of return on his investment?

Rate of return (4,680 – 8,000) 8,000 –41.50%

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11. You are bullish on Apex footwear stock. The current market price is BDT 50 per share, and you have BDT 5,000
of your own to invest. You borrow an additional BDT 5,000 from your broker at an interest rate of 8% per year and
invest BDT 10,000 in the stock.
a. What will be your rate of return if the price of ABC stock goes up by 10% during the next year? The stock
currently pays no dividends.

Purchase price 200 BDT 50 BDT 10,000

Loan BDT 5,000
Interest on loan 8% of BDT 5,000 BDT 400

Value next year BDT 10,000 10% of 10,000 BDT 11,000

Equity BDT 11,000 5,000 – 400 BDT 5,600

Rate of return (5,600 5,000) 5,000 12.00%

b. How far does the price of Apex footwear have to fall for you to get a margin call if the maintenance margin is
30%? Assume the price fall happens immediately.

(200P 5,000) 200P 0.30

P BDT 35.71

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12. Sadia has a margin account with a balance of BDT 150,000. The initial margin deposit is 60 percent and Apex
Industries is currently selling at BDT 50 per share.
a. How many shares of Apex can Sadia purchase?

60% BDT 150,000

100% BDT 150,000 60 100 BDT 250,000

Price BDT 50/share

Number of shares that can be bought BDT 250,000 BDT 50/share 5,000

b. What is Sadia's profit/loss if Apex’s price after one year is BDT 40?

Loss per share BDT 40 BDT 50 BDT 10

Total loss 5,000 shares BDT 10 BDT 50,000

c. If the maintenance margin is 25 percent, to what price can Apex Industries fall before Sadia receives a margin
call?

(5,000P 100,000) 5,000P 0.25

P BDT 26.67

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13. You are bullish on Atlas Bangladesh stock. The current market price is BDT 50 per share, and you have BDT
5,000 of your own to invest. You borrow an additional BDT 5,000 from your broker at an interest rate of 8% per
year and invest BDT 10,000 in the stock.
a. What will be your rate of return if the price of Atlas Bangladesh stock goes up by 10% during the next year? The
stock currently pays no dividends.

You buy 200 shares of Atlas Bangladesh for BDT 10,000. These shares increase in value by 10%, or BDT
1,000. You pay interest of: 0.08 BDT 5,000 BDT 400.

The rate of return will be: (1,000 – 400) 5,000 0.12 12%

b. How far does the price of Atlas Bangladesh stock have to fall for you to get a margin call if the maintenance
margin is 30%? Assume the price fall happens immediately.

The value of the 200 shares is 200P. Equity is (200P – BDT 5,000). You will receive a margin call
when:
(200P 5,000) 200P 0.30

P BDT 35.71 or lower

14. You are bearish on Atlas Bangladesh and decide to sell short 100 shares at the current market price of BDT 50
per share.
a. How much in cash or securities must you put into your brokerage account if the broker’s initial margin
requirement is 50% of the value of the short position?

100 shares BDT 50/share BDT 5,000

Margin requirement = 50%

I must deposit 50% of BDT 5,000 0.50 BDT 5,000 BDT 2,500

b. How high can the price of the stock go before you get a margin call if the maintenance margin is 30% of the value
of the short position?

Total assets are BDT 7,500 (BDT 5,000 from the sale of the stock and BDT 2,500 put up for margin).
Liabilities are 100P. Therefore, equity is (BDT 7,500 – 100P). A margin call will be issued when:

(7,500 – 100P) 100P 0.30

P BDT 57.69 or higher

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15. Suppose that Bata Shoe currently is selling at BDT 40 per share. You buy 500 shares using BDT 15,000 of your
own money, borrowing the remainder of the purchase price from your broker. The rate on the margin loan is 8%.
a. What is the percentage increase in the net worth of your brokerage account if the price of Bata Shoe immediately
changes to: (i) BDT 44; (ii) BDT 40; (iii) BDT 36? What is the relationship between your percentage return and the
percentage change in the price of Bata Shoe?

The total cost of the purchase is: BDT 40  500 = BDT 20,000
You borrow BDT 5,000 from your broker, and invest BDT 15,000 of your own funds. Your margin
account starts out with equity of BDT 15,000.
a. (i) Equity increases to: (BDT 44  500) – BDT 5,000 = BDT 17,000

Percentage gain = BDT 2,000/BDT 15,000 = 0.1333 = 13.33%

(ii) With price unchanged, equity is unchanged.

Percentage gain = zero

(iii) Equity falls to (BDT 36  500) – BDT 5,000 = BDT 13,000

Percentage gain = (–BDT 2,000/BDT 15,000) = –0.1333 = –13.33%

The relationship between the percentage return and the percentage change in the price of the stock is
given by:

% return = % change in price  (Total investment investor’s initial equity)

= % change in price  1.333

For example, when the stock price rises from BDT 40 to BDT 44, the percentage change in price is 10%,
while the percentage gain for the investor is:

% return = 10%  (BDT 20,000 BDT 15,000) = 13.33%

b. If the maintenance margin is 25%, how low can Bata Shoe’s price fall before you get a margin call?

The value of the 500 shares is 500P. Equity is (500P – BDT 5,000). You will receive a margin call
when:

(500P – BDT 5,000) 500P = 0.25  when P = BDT 13.33 or lower

c. How would your answer to (b) change if you had financed the initial purchase with only BDT 10,000 of your own
money?
The value of the 500 shares is 500P. But now you have borrowed BDT 10,000 instead of BDT 5,000.
Therefore, equity is (500P – BDT 10,000). You will receive a margin call when:

(500P – BDT 10,000) 500P = 0.25  when P = BDT 26.67 or lower

With less equity in the account, you are far more vulnerable to a margin call.

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d. What is the rate of return on your margined position (assuming again that you invest BDT 15,000 of your own
money) if Bata Shoe is selling after 1 year at: (i) BDT 44; (ii) BDT 40; (iii) BDT 36? What is the relationship
between your percentage return and the percentage change in the price of Bata Shoe? Assume that Bata Shoe pays
no dividends.

By the end of the year, the amount of the loan owed to the broker grows to:
BDT 5,000  1.08 = BDT 5,400
The equity in your account is (500P – BDT 5,400). Initial equity was BDT 15,000. Therefore, your
rate of return after one year is as follows:

(i) [(500 BDT 44) – BDT 5,400 – BDT 15,000] BDT 15,000 = 0.1067 = 10.67%

(ii) [(500 BDT 40) – BDT 5,400 – BDT 15,000] BDT 15,000 = –0.0267 = –2.67%

(iii) [(500 BDT 36) – BDT 5,400 – BDT 15,000] BDT 15,000 = –0.1600 = –16.00%

The relationship between the percentage return and the percentage change in the price of Bata Shoe is
given by:

 Total investment   Funds borrowed 

% return =  % change in price     8%  
 Investor' s initial equity   Investor' s initial equity 

For example, when the stock price rises from BDT 40 to BDT 44, the percentage change in price is
10%, while the percentage gain for the investor is:

% return = [10%  (BDT 20,000 BDT 15,000)] – [8% ((BDT 5,000 BDT 15,000)] = 10.67%

e. Continue to assume that a year has passed. How low can Bata Shoe’s price fall before you get a margin call?

The value of the 500 shares is 500P. Equity is (500P – BDT 5,400). You will receive a margin call
when:

(500P – BDT 5,400) 500P = 0.25  when P = BDT 14.40 or lower

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16. Suppose that you sell short 500 shares of BBS Cables, currently selling for BDT 40 per share, and give your
broker BDT 15,000 to establish your margin account.
a. If you earn no interest on the funds in your margin account, what will be your rate of return after 1 year if BBS
Cables stock is selling at: (i) BDT 44; (ii) BDT 40; (iii) BDT 36? Assume that BBS Cables pays no dividends.

The gain or loss on the short position is: (–500  ΔP)

Invested funds = BDT 15,000

Therefore: rate of return = (–500  ΔP) 15,000
The rate of return in each of the three scenarios is:

(i) rate of return = (–500  BDT 4) BDT 15,000 = – 0.1333 = –13.33%

(ii) rate of return = (–500  BDT 0) BDT 15,000 = 0%

(iii) rate of return = [–500  (–BDT 4)] BDT 15,000 = 0.1333 = 13.33%

b. If the maintenance margin is 25%, how high can BBS Cables’ price rise before you get a margin call?

Total assets in the margin account equal:

BDT 20,000 (from the sale of the stock) + BDT 15,000 (the initial margin) = BDT 35,000
Liabilities are 500P. You will receive a margin call when:

(BDT 35,000 – 500P) 500P = 0.25  when P = BDT 56 or lower

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17. You have borrowed BDT 20,000 on margin to buy shares in Confidence Cement, which is now selling at BDT
40 per share. Your account starts at the initial margin requirement of 50%. The maintenance margin is 35%. Two
days later, the stock price falls to BDT 35 per share.
a. Will you receive a margin call?

You will not receive a margin call. You borrowed BDT 20,000 and with another BDT 20,000 of your
own equity you bought 1,000 shares of Confidence Cement at BDT 40 per share. At BDT 35 per
share, the market value of the stock is BDT 35,000, your equity is BDT 15,000, and the percentage
margin is: BDT 15,000 BDT 35,000 = 42.9%

Your percentage margin exceeds the required maintenance margin.

b. How low can the price of Confidence Cement shares fall before you receive a margin call?

You will receive a margin call when:

(1,000P – BDT 20,000) 1,000P = 0.35  when P = BDT 30.77 or lower

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18. On January 1, you sold short one round lot (that is, 100 shares) of Golden Son stock at BDT 21 per share. On
March 1, a dividend of BDT 2 per share was paid. On April 1, you covered the short sale by buying the stock at a
price of BDT 15 per share. You paid 50 cents per share in commissions for each transaction. What is the value of
your account on April 1?

The proceeds from the short sale (net of commission) were: (BDT 21  100) – BDT 50 = BDT 2,050
A dividend payment of BDT 200 was withdrawn from the account.
Covering the short sale at BDT 15 per share costs (with commission): BDT 1,500 + BDT 50 = BDT 1,550
Therefore, the value of your account is equal to the net profit on the transaction:
BDT 2,050 – BDT 200 – BDT 1,550 = BDT 300

Note that your profit (BDT 300) equals (100 shares  profit per share of BDT 3). Your net proceeds per share
was:

BDT 21 selling price of stock

–BDT 15 repurchase price of stock

–BDT 2 dividend per share

–BDT 1 2 trades  BDT 0.50 commission per share

BDT 3

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