2) Margin requirements and returns Consider an economy with two hedge funds, short capital (SC) and long capital (LC), and two risky assets, assets A and B. Each hedge fund has $100 million of capital. The price of asset A is PA = $50 and the price of asset B is PB = $100. The margin required to short asset Ais ma = $5 and the rebate rate is equal to zero. The hedge funds can use a repo contract to finance a position in asset B, where the repo rate is equal to zero and the haircut is mg = $10. 1. SC is pessimistic about asset A and uses all its capital to finance a short position on asset A. What is the maximum number of shares SC can short? What is the minimum) percentage price change required to make SC to lose all its investment? If the price of asset A goes down next period by 5%, what is the return on SC's portfolio? What would be the return on SC's portfolio if mA = $50? 2. LC is optimistic about asset B and uses all its capital to finance a long position on asset B. What is the maximum number of shares LC can afford? What is the (minimum) percentage price change required to make LC to lose all its investment? If the price of asset B goes up next period by 5%, what is the return on LC's portfolio? What would be the return on LC's portfolio if mg = $100? 3. Discuss the role of margin requirements on magnifying the return of both long and short strategies 2) Margin requirements and returns Consider an economy with two hedge funds, short capital (SC) and long capital (LC), and two risky assets, assets A and B. Each hedge fund has $100 million of capital. The price of asset A is PA = $50 and the price of asset B is PB = $100. The margin required to short asset Ais ma = $5 and the rebate rate is equal to zero. The hedge funds can use a repo contract to finance a position in asset B, where the repo rate is equal to zero and the haircut is mg = $10. 1. SC is pessimistic about asset A and uses all its capital to finance a short position on asset A. What is the maximum number of shares SC can short? What is the minimum) percentage price change required to make SC to lose all its investment? If the price of asset A goes down next period by 5%, what is the return on SC's portfolio? What would be the return on SC's portfolio if mA = $50? 2. LC is optimistic about asset B and uses all its capital to finance a long position on asset B. What is the maximum number of shares LC can afford? What is the (minimum) percentage price change required to make LC to lose all its investment? If the price of asset B goes up next period by 5%, what is the return on LC's portfolio? What would be the return on LC's portfolio if mg = $100? 3. Discuss the role of margin requirements on magnifying the return of both long and short strategies