Question #6: Margin [26 Points]

Use the following scenario to answer Parts (a) (c)

You open up a trading account with Merrill Lynch and purchase 300 shares of Kroger (KR) at $55.60 per share. Suppose that the initial margin percentage is 65% and that your broker charges you a margin interest rate of 5%.

(a) What is the amount that you must deposit into your account in order to buy 300 shares of Kroger on margin? [4 Points]

(b) Suppose that you deposited the amount in Part (a) and borrowed the balance to purchase the 300 shares of Kroger. What will be your rate of return if the price of Kroger stock falls to $52.75 by next year and you sell the shares? You may ignore any expected dividend payments. [Hint: Make sure to take into account the margin interest rate in your calculations.] [8 Points]

(c) How far would the price of Kroger shares have to fall before you receive a margin call if the maintenance margin is 30%? [6 Points]

Use the following scenario to answer Parts (d) (e)

You open up a trading account with Merrill Lynch. You have decided to sell short 1,000 shares of Diageo (DEO) at a price of $36. Assume that the initial margin percentage is equal to 55% and the maintenance margin is equal to 35%.

(d) How much would you have to deposit into the margin account to open this position? [2 Points]

(e) At what share price will you receive a margin call? [6 Points]