Question

Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams at $120 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 $120 to $131.20, and the stock has paid a dividend of $20.00 per share.

a. What is the remaining margin in the account?

b. What is the margin on the short position? (Round your answer to 2 decimal places.)

c. What is the rate of return on the investment? (Negative value should be indicated by a minus sign. Round your answer to 2 decimal places.)

Answer 1

Answer of Part 1:

P0 = $120

P1 = $131.20

N = 1,000

Dividend per share = $20

Initial Margin Requirement = 50% * N * P0
Initial Margin Requirement = 50% * 1,000 * $120
Initial Margin Requirement = $60,000

Payoff from short position = (P0 – P1 – D) * N
Payoff from short margin = ($120 - $131.20 - $20) * 1,000
Payoff from Short Margin = -$31,200

Remaining Margin = Initial Margin + Payoff from the short position
Remaining Margin = $60,000 - $31,200
Remaining Margin = $28,800

Answer of Part b:

Value of short shares today = N * P1
Value of short shares today = 1,000 * $131.20
Value of short shares today = $131,200

Short Margin = Remaining Margin / Value of Short shares today
Short Margin = $28,800 / $131,200
Short Margin = 0.2195 or 21.95%

Answer of Part C:

Rate of Return = Payoff from short position / Initial Margin
Rate of Return = -$31,200 / $60,000
Rate of Return = -0.52 or -52%