Australia

Scenarios

Gearing/Margin Lending

Question

Max and Raelene were hoping to retire in 5 years' time but recently, they realised that in order to have sufficient income in their retirement years, they would need to work for an extra 7 years.

They are considering gearing as a means to accelerate their wealth creation possibilities over the next 7 years whilst they continue to work and have surplus cash flow.

Required

a.Explain how margin lending would work for Max and Raelene if they want to use their existing $80,000 jointly held shares as security for a $50,000 jointly-held margin loan.

b.If Max and Raelene were comfortable with a loan to value ratio (LVR) of 45%, how much would they be able to borrow based on their share portfolio currently being worth $80,000?

c.If the maximum Loan to Valuation Ratio offered by the margin lender was 75% prior to a margin call being issued, what two options would Max and Raelene have if the portfolio fell in value considerably and they received a margin call? Explain how such options would play out in reality.