Question

You purchase 1,000 shares of 2nd Chance Co. stock on margin at a price of $46. Your broker requires you to deposit $25,000.
A. Suppose you sell the stock at a price of $50. What is your return? What would your return have been had you purchased the stock without margin?
B. What is your return if the stock price is $44 when you sell the stock? What would your return have been had you purchased the stock without margin?

Answer 1

Answer:

A. 16% (with margin), 8.70% (without margin)

B. Loss 8% (with margin), Loss 4.35% (without margin)

Explanation:

Buyer incurs a margin which represents safety amount which he is required to deposit with the broker before he becomes eligible to trade. The purpose of margin is to honor the contract in case the buyer defaults or tries to escape liability in the event of loss.

(A).  Profit without margin = ($ 50 - $46)/$46 × 100 = 8.70%

Profit with margin = $\frac{(50\ -\ 46)1000\ shares }{25000}$  = 16%

(B).  Loss with margin = $\frac{(46\ -\ 44)1000\ shares}{25000}$ = 8%

Loss without margin = ($46 - $44)/$46 × 100 = 4.35%

Note: Profit = Sale price - Cost

         Loss= Cost - Sales

The base is taken to be the initial price of $46 which is the purchase price.