PART 2 - Buying Stock on Margin (12 Marks)

Background

*MARGIN ACCOUNTS-A margin account is a type of investment account which allows you to borrow money from your Broker to pay for new purchase for the account. In such cases, the client pays only a portion of the purchase price, and the investment dealer lends the balance of the purchase price to the client. Interest is charged on the loan.

*NOTE: The word MARGIN refers to the amount of funds the investor must personally provide. The broker lends the remainder to the investor.

The maximum loan from the broker is up to 50% of the current market value of the borrowed shares.

As the current value of the shares changes each day, so does the maximum loan amount.

Question-Determining the Amount of the Margin Call

Assume that today, your client buys 1,000 shares of ABC Company on margin at a loan rate of 50%.

ABCs current share price is $25 per share.

(a) REQUIRED

How much money does the client have to deposit into their margin account to settle the purchase?

(b) Lets assume 2 months later there is a decrease in the price of the shares to $22 per share.

REQUIRED:

I. Now that the share price has fallen to $22 per share, what is the maximum amount that the dealer can lend your client?

II. What is the amount of the margin call to the client? (Remember, the margin call is the additional money that the client must deposit to his account).