Old Economy Traders opened an account to short sell 2,700 shares of Internet Dreams at $75 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $75 to $85, and the stock has paid a dividend of $1.50 per share. a. What is the remaining margin in the account? (Round your answer to the nearest whole number.) b. If the maintenance margin requirement is 30%, will Old Economy receive a margin call? Yes No c. What is the rate of return on the investment? (Round your answer to 2 decimal places. Negative value should be indicated by a minus sign.)

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Business

Boston

30 April, 16:18

Old Economy Traders opened an account to short sell 2,700 shares of Internet Dreams at $75 per share. The initial margin requirement was 50%. (The margin account pays no interest.) A year later, the price of Internet Dreams has risen from $75 to $85, and the stock has paid a dividend of $1.50 per share. a. What is the remaining margin in the account? (Round your answer to the nearest whole number.) b. If the maintenance margin requirement is 30%, will Old Economy receive a margin call? Yes No c. What is the rate of return on the investment? (Round your answer to 2 decimal places. Negative value should be indicated by a minus sign.)

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Nancy Owens · Answer 1

(a) Remaining margin in the account = $70,200

(b) No, Old Economy Traders will not receive margin call as margin ratio 30.5% is more than required margin of 30%.

(c) Rate of return on the investment = - 31%

Explanation:

(a) Formula for amount credited:

amount credited = = total shares * amount per share

As Old Economy Traders opened an account to short sell 2,700 shares of Internet Dreams at $75 per share therefore Old Economy Traders is credited with the following amount.

amount credited = 2,700 * 75

amount credited = 2,02,500

Formula for margin:

Margin = amount credited * initial margin requirement

As the initial margin requirement = 50% therefore

Margin = 2,02,500 * 0.5

Margin = 1,01,250

Formula for total initial assets:

total initial assets = amount credited + margin

therefore by putting the values in the above formula, we get

total initial assets in its account = $2,02,500 + $1,01,250

= $3,03,750

As a year later, the price of Internet Dreams has risen from $75 to $85 so Old Economy Traders needs to buy 2,700 shares at $85 each along with a payback of $1.50 per share therefore,

amount credited = 2,700 * 85 = 2,29,500

total liability = $2,29,500 + (2,700 * $1.50)

total liability = $2,33,550

Now the Old Economy Traders remaining margin = total initial assets - total liability

remaining margin = $3,03,750 - $2,33,550

remaining margin in the account = $70,200

(b) Margin ratio:

The margin ratio measures the portion of every dollar that company earn and keep as profit.

Formula for Old Economy Traders margin ratio:

margin ratio = remaining margin / amount credited

margin ratio = 70,200 / 2,29,500

margin ratio = 0.305

Converting the result to percentage, we get

margin ratio = 30.5 %

Therefore Old Economy Traders will not receive margin call as margin ratio is more than required margin of 30%.

(c) Rate of return:

The rate of return is the profit or loss company make on an investment.

Formula for Rate of return:

Rate of return = (return - initial investment) / initial investment

Therefore by putting the values in the above formula, we get

Rate of return = ($70,200 - $1,01,250) / $1,01,250

Rate of return = - $31050 / $1,01,250

Rate of return = - $0.31

Converting the result to percentage, we get

Rate of return on the investment = - 31%