Illustration Illustration 1 One Period Return with and without margin
An investor purchase aRs.100 stock on 55% margin and then its price doubled to Rs.200. the brokerage frm charged charged 10% interest or the loan on the margin investment. No cash dividend as received hile the investor held the stock. !hat as the investors" one period rate o return return on this transaction ith and ithout margin# net o all costs$ ho &our calculations and discuss h& the returns returns are not same ith and a nd ithout margins. olution 'ere given( )urchasing or starting price *)t+ -nitial argin /nding price *) t1+ -nterest or the loan ne period rate o return
,Rs.100 ,55% ,Rs.200 ,10% ,$
!e kno# !hen an investor purchases without using the margin # the one period return ill be as(
One- period rate of return = cash diidend
(Ending Price - Beginning Price) + !argin mone" paid for
Purchase Or# Or# One- period rate of return
,
,
=
(Pt+1 - Pt) +$ t+1 im % P t
*Rs.200 Rs.100+ Rs.0 Rs.100
1 or# 100%
!hen investor bought on margin# the one period rate o return is defned as(
1
One- period rate of return =(Ending Price - Beginning Price) +cash diidend& interest e%pense !argin mone" paid for Purchase
Or# One- period rate of return = interest fraction
(Pt+1 - Pt) +$
- Pt (1-im) %
t+1
im %
,
Pt
*Rs.200 Rs.100+ Rs.0 3 100*10.55+ 4
0.10 Rs.100 4 0.55 ,
1.67 or 16.7%
'ence# an -nvestor made a 16.7 % return hen the price o the stock he bought doubled. tated di8erentl&# margin transormed a 100% price rise into a 16.7% gain.
Note: Investor’s brokerage frm charged him a 10% interest rate or the Rs. 45 per share Rs. 100 !Rs.55" it #oaned to him.
9he rates o return ithout margin and ith margin are not e:ual due to the di8erence in their investment. 9he amount o investment is loer ith margin so# the rate o return is higher though it pa&s some interest as ell.
Illustration ' ollateral alue and actual margin in long position ;uck /ing opens a margin account at the local brokerage frm. ;ucks initial investment as to purchase 200 share o !oodbur&
2
b+ - !oodbur& stock subse:uentl& rises in price to Rs.70 per share# hat is the collateral in bucks account and hat is the actual margin in the buck s account$ c+ - ood bur& stock subse:uentl& alls in price to Rs. 65 per share# hat is the collateral in bucks account and hat is the actual margin in bucks account$
olution 'ere given( Numbers o shares , 200shares )urchase price o share ,Rs.=0 ;orroed amount , Rs.6000 a.
9he total market value o assets or 200 shares costing Rs.=0 each as the collateral in ;uck"s account at the time o purchase. -t means# collateral , Rs.=0 4200 shares , Rs.>000 arket value o assets 3 loan Actual margin , arket value o assets , Rs.=0 4 200shares 3 Rs. 6000 Rs. =04200shares , 0.725 or 72.5%
b. arket value o assets, *collateral+ , Rs. 70 4 200 shares , Rs. 12000 R.70 4200shares 3 Rs.6000 Actual margin , Rs.704 200shares
c.
, 0.5 or 5%
arket value o assets *collateral+ , Rs.65 4200shares , Rs.000 Rs.65 4200 shares 3 Rs.6000 Actual margin, Rs.65 4200 shares , 0.51=6 or 5.1=6%
Illustration * Euit" and ,ctual !argin in hort Position
6
9hrough a margin account cand&
per share# hat is the e:uit& in cand&"s account and hat is the actual margin in cand&"s account$ b+ - adison stock subse:uentl& alls to Rs.=2 per share# hat is the e:uit& in cand&"s account and hat is the actual margin in cand&"s account$
olution 'ere given( arket price o stock Numbers o shares -nitial margin re:uirement
,Rs.50 ,200 shares ,=5%
'ere# a. /:uit&# i price o stock rises to Rs.5> !e have# /:uit& , No. o shares 4 ;eginning price 4 *1initial margin+ 3 No. o shares 4 /nding price
r# /:uit& , 200 shares 4 Rs.50 4 *10.=5+ 3 200 shares 4 Rs.5> , Rs.2?00 No# Actual argin ,
arket value o assets loan loan
r# Actual margin , 200 shares 4 Rs. 50 4 *10.=5+ 200shares 4 Rs.5> Rs.5> 4 200 shares , 0.25 or 25%
b. /:uit&# i price o stock alls to Rs =2 /:uit& , 200shares @Rs .50 4 *1 0.=5+ 200 shares 4Rs.=2 , Rs.7100 =
Actual margin ,
200shares 4 Rs.50 4*10.=5+ 3 200shares 4 Rs.=2 Rs.=2 4 200 shares
,
0.27 or 2.7%
Illustration !argin all ,nal"sis nooker arnovich bu&s on margin 1000shares o Rockord s&stems at Rs.70 per share. 9he initial margin re:uirement is 50% and the maintenance margin re:uirement is 60%. - the Rockord stock alls to Rs.50# ill snooker receive a margin call$ olution 'ere given( Number o shares purchase , 1000 shares tock price ,Rs.70 per share -nitial margin re:uirement ,50% aintenance margin re:uirement ,60% Becline in stock price ,Rs.50
.irst calculate the actual margin and this margin compare with initial margin/ arket value 3 loan Actual margin , market value , Rs. 50000 3 Rs.60000 Rs.50000 , 0.=0 or =0%
0oring notes2 arket value
, 1000shares 4 Rs. 50 , Rs.50000
Coan
,1000shares 4 Rs. 70 4 0.50 ,Rs.60000
9he snooker ill not receive a margin call because maintenance margin is less than actual margin i.e.60% D =0%.
5
,lternatiel"#
4Rs. 70
, Rs.=2.>5 9he snooker ill not receive a margin call because price Rs.50is still above the price Rs.=2.>5 i.e. Rs.50E Rs.=2.>5. to receive margin call the price should all belo Rs. =2.>5. Note( &ou can do an& one methodF all method gives &ou same results
Illustration 3 One Period return and margin call in short position
olution# 'ere given( tock price
,Rs.50 7
-nitial margin ,70% aintenance margin,60%
a.
rate o return , $ !e have# Rate o return
, starting price 3 ending price tarting price ,
*Rs.50 3 Rs.=0+ Rs.50
, 0.20 or 20% b. *1+ stock price that ill trigger a margin call. !e have# 9rigger )rice o stock
,
1 initial margin 1maintenance margin
4 selling price
*)t+ ,
,
1 0.70 1 0.60
4 Rs.50
Rs.71.56>
- the price increases above Rs. 71.56> a maintenance call ill be made.
b. *2+ rate o return
Rate o return
, starting price 3 ending price /:uit& deposit , *Rs.50 3 Rs. =0+ Rs.60 , 0.6666 or 66.66%
c. the ')R on 70% margin position margin is larger than the return on 100% margin. 9his occurs because the investor is alloed to deposit 70% o stock price and can invest the remaining mone& at 20%.
Illustration 4 !argin call in long Position Hou have borroed Rs. 20000 on margin to bu& shares to Bisne&# hich is no selling at Rs.>0 per share. Hour account start at the initial margin re:uirement o 50%the maintenance margin is 65%. 9o da&s later# the stock price alls to Rs.5 per share. a+ !ill &ou receive a margin call$ b+ 'o long price o Bisne& shares all beore &ou receive a margin call$
olution 'ere given( )osition , long position )urchase price or starting price *p 1+ ,Rs.>0 -nitial margin ,50% aintenance margin 65%
a. receive a margin call or not$ !e have#
Actual margin ,
,
arket value o assets 3 loan arket value o Assets
Rs.6500 3 Rs.20000 Rs.6500
,0.=77 or =7.7% !orking notes( arket value Coan
,500 shares 4 Rs.5 , Rs.6500 ,Rs.20000
ince the actual margin is =7.7%# hich is greater than the maintenance margin thereore# &ou ill not receive a margin call. b. 9riggering price o the stock 'ere given(
>
-nitial margin re:uired o investor , 50% aintenance margin re:uired b& brokerage frm ,65 )urchase price on margin ,Rs.>0per share )rice o stock that ill trigger a maintenance call( 9riggering )rice o stock , 1 3 initial margin 1 3 aintenance margin , 1 3 0.50 1 3 0.65
4 purchase price
4 Rs. >0
,Rs.71.5= - the price alls belo Rs. 71.5=# a margin call ill be made.
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