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Chapter 3: Buying on Margin
1. Suppose you buy 100 shares of stock initially selling for $50, borrowing 25% of the necessary
funds from your broker, i.e. the initial margin on your purchase is 25%. You pay an interest rate
of 8% on margin loans.
a. How much of your own money do you invest? How much do you borrow from your
broker?
Initial Investment: $50 100 shares $5,000
=
b. What will you be your rate of return for the following stock prices at the end of a 1-year
holding period?
To change the holding period to 1 year (12 months):
[Change cells: 14 12]B=
i. $40
[Observe Cell: E9]
The rate of return is -28.00%.
2. Repeat question 1 assuming your initial margin was 50%. How does margin affect the risk and
return of your position?
Change the initial equity invested ($2,500) and the initial equity percentage (50%):
[Change cells: 4 2500; 10 50%]BB==
The new returns at the following price levels:
i. $40
