Answer Key: Quiz 2

A.
1. When the purchase is made
Value of Asset−Liability ( 200 x 35 )−2,000
Margin= = =71.43 %
Value of Asset (200 x 35)
2. If the price of the stock rises to $45 per share
Value of Asset−Liability ( 200 x 4 5 )−2,000
Margin= = =77.78 %
Value of Asset (200 x 4 5)
3. If the price of the stock falls to $30 per share
Value of Asset−Liability ( 200 x 30 )−2,000
Margin= = =66.67 %
Value of Asset (200 x 30)
B.
4. If the stock price falls to $25, will the investor receive a margin call? Why?
*Investment is $60,000 (2,000 x $30)
*Liability is $30,000 ($60,000 x 50%) since initial margin is 50%
Therefore if price falls to $25, the margin is 40%, no margin call will be received.
Value of Asset−Liability ( 2,000 x 25 )−30 , 000
Margin= = =40 %
Value of Asset (2 , 0 00 x 2 5)
5. At what price will a margin call be received?
Margin call will be received if margin reaches the maintenance margin of 30%, to
identify the price to receive margin call:
Value of Asset−Liability
Margin=
Value of Asset
2,000 x−30,000
0.30=
2,000 x
2,000 x−30,000
(0.30=
2,000 x ) x

2,000 x 2−30,000 x
0.30 x=
2,000 x
0.30 x=x−15
x−0.30 x=15
0.70 x=15
x=$ 21.43
C. Annual Rate of Return
*Initial Investment is $24,000 (600 x 40)
*Liability is $10,800 [24,000 x (100% - 55%]
*Initial Equity is $13,200 (24,000 x 55%)
6. The stocks are sold for $45 per share at the end of the year
Equity Now −Equity Then
ARR=
Equity Then
 (Value of Asset + Dividends−Payment of Liab−Interest )−EquityThen
ARR=
EquityThen
(600 x 45)+(600 x 2)−(10,800)−(10,800 x 0.10)−13,200
ARR=
13,200
ARR=23.64 %
7. If the stocks are sold for $25 per share at the end of the year.

Equity Now −Equity Then

ARR=
Equity Then
(Value of Asset + Dividends−Payment of Liab−Interest )−EquityThen
ARR=
EquityThen
(600 x 25)+( 600 x 2)−(10,800)−(10,800 x 0.10)−13,200
ARR=
13,200
ARR=67.27 %
8. Calculate the return for (a) if the purchase had been made using cash instead of on the margin.
Equity Now −Equity Then
ARR=
Equity Then
(Value of Asset + Dividends−Payment of Liab−Interest )−EquityThen
ARR=
EquityThen
( 600 x 45 ) +(600 x 2)−(600 x 40)
ARR=
(600 x 40)
ARR=17.5 %
9. Calculate the return for (a) if the purchase had been made using cash instead of on the
margin.
Equity Now −Equity Then
ARR=
Equity Then
(Value of Asset + Dividends−Payment of Liab−Interest )−EquityThen
ARR=
EquityThen
( 600 x 25 ) +(600 x 2)−(600 x 40)
ARR=
(600 x 40)
ARR=−32.5 %
D.
*Proceeds from Short Sale is $9,000 (300 x 30). This is also the initial liability.
*Initial Margin Requirement is 50%, therefore additional asset is to be invested
amounting to $4,050. This is also the initial equity.
*For short sales, the value of liability is variable because it changes based on the value of
asset borrowed. Total Value of Asset remains the same unless additional investment is
made.
10. If the price of the stock rises to $45 per share, what is the actual margin in the account?
Total Value of Asset−Liability ( 9,000+4,050 ) −(300 x 45)
Margin= = =−3.33 %
Liability (300+ 45)
11. If the price of the stock falls to $15 per share, what is the actual margin in the account?
Total Value of Asset−Liability ( 9,000+4,050 )−(300 x 15)
Margi Margin= = =190 %
Liability (300+1 5)
12. Yes, loss in short sales happens when the price of the stocks borrowed increases and since
it can increase infinitely, loss is also infinite. Gain on the other side happens when the
price of the stocks falls. It is limited since the price of the stocks can only fall up to 0.