Case Problem 2.1 Dara’ Dilemma What to Buy?

QUESTIONS:

A. Evaluate each of these alternatives. On the basis of the limited information

presented, recommend the one you feel is best.

B. If Casinos International’s stock price rises to $60, what will happen under alternatives
2 and 3? Evaluate the pros and cons of these outcomes.

C. If the stock price drops to $45, what will happen under alternatives 2 and 3? Evaluate
the pros and cons of these outcomes.

Case Problem 2.2 Ravi Dumar’s High Fly Margin Account

QUESTIONS:

A. Discuss the concept of pyramiding as it applies to this investment situation.

B. What is the present margin position (in percent) of Ravi’s account?

C. Ravi buys the 1,000 shares of RS through his margin account (bear in mind that this
is a $20,000 transaction).
1. What will the margin position of the account be after the RS transaction if Ravi follows
the prevailing initial margin (50%) and uses $10,000 of his money to buy the stock?
2. What if he uses only $2,500 equity and obtains a margin loan for the balance
($17,500)?
3. How do you explain the fact that the stock can be purchased with only 12.5% margin
when the prevailing initial margin requirement is 50%?

D. Assume that Ravi buys 1,000 shares of RS stock at $20 per share with a minimum
cash investment of $2,500 and that the stock does take off and its price rises to $40 per
share in one year.
1. What is the return on invested capital for this transaction?
2. What return would Ravi have earned if he had bought the stock without margin—that
is, if he had used all his own money?

E. What do you think of Ravi’s idea to pyramid? What are the risks and rewards of this
strategy?