Simulation Exercise

Margin Lending

Background

Juliette and Jason are in their mid 40's, and married with 4 teenage children.They have $50,000 in surplus funds which they would like to invest into company ABC as they believe this to be a solid company with healthy dividends. Although purchasing shares in only one company does not offer diversification, and will increase the risk of the investment, Juliette and Jason are diversified in their superannuation funds and this keeps it simple for illustrative purposes. The problem is that Juliette has a much greater tolerance for risk than her husband.She is prepared to borrow 70% of the value of the total investment. Jason on the other hand is only prepared to borrow 50% of the value of the total investment.

ABC shares are currently trading at $5 per share.

As their adviser, you have already explained to them how margin lending works.

They want to know how heavily exposed they will be in the event that the market falls by 20%.

Complete the following questions to show Juliette and Jason the impact on a margin loan if they adopt Juliette's more aggressive strategy compared to Jason's more conservative strategy.

Assumptions

Current loan interest rate is 6.4%

Maximum lender loan to value ratio is 70%

Buffer is 6%

Required:

Using Juliette's strategy of investing $50,000 of their own funds, and taking out a margin loan with a loan to value ratio of 70%:

1.What will be the total amount of the margin loan?

2.Using Juliette's strategy, how many ABC shares can they purchase using this strategy (ignoring brokerage)?

3.If, the very next day, the price of ABC shares drops 20% to $4 per share, what is the new LVR using Juliette's strategy?

Using Jason's strategy of investing $50,000 of their own funds, and taking out a margin loan with a loan to value ratio of 50%:

4.What will be the total amount of the margin loan?

5.Using Jason's strategy, how many ABC shares can they purchase using this strategy (ignoring brokerage)?

6.If, the very next day, the price of ABC shares drops 20% to $4 per share, what is the new LVR using Jason's strategy?

7.Explain to Juliette and Jason, the consequences of the different outcomes depending on whether they use Juliette's strategy or Jason's strategy.

Background Juliette and Jason are in their mid 40's, and married with 4 teenage children. They have $50,000 in surplus funds which they would like to invest into company ABC as they believe this to be a solid company with healthy dividends. Although purchasing shares in only one company does not offer diversification, and will increase the risk of the investment, Juliette and Jason are diversified in their superannuateon funds and this keeps it simple for illustrative purposes. The problem is that Juliette has a much greater tolerance for risk than her husband. She is prepared to borrow 70% of the value of the total investment. Jason on the other hand is only prepared to borrow 50% of the value of the total investment. ABC shares are currently trading at $5 per share. As their adviser, you have already explained to them how margin lending works. They want to know how heavily exposed they will be in the event that the market falls by 20%. Complete the following questions to show Juliette and Jason the impact on a margin loan if they adopt Juliette's more aggressive strategy compared to Jason's more conservative strategy. Assumptions Current loan interest rate is 6.4% Maximum lender loan to value ratio is 70% Buffer is 6% Required: Using Juliette's strategy of investing $50,000 of their own funds, and taking out a margin loan with a loan to value ratio of 70%: 1. What will be the total amount of the margin loan? 2. Using Juliette's strategy, how many ABC shares can they purchase using this strategy (ignoring | brokerage)? DFP 2 ML Assignment_171010 MONARCH INSTITUTE Units covered: FNSASICR503 B. If, the very next day, the price of ABC shares drops 20% to $4 per share, what is the new LVR using Juliette's strategy?Using Jason's strategy of investing $50,000 of their own funds, and taking out a margin loan with a loan to value ratio of 50%: 4. What will be the total amount of the margin loan? 5. Using Jason's strategy, how many ABC shares can they purchase using this strategy (ignoring brokerage)? 6. If, the very next day, the price of ABC shares drops 20%% to $4 per share, what is the new LVR using Jason's strategy? DEP 2 ML Assignment_171010 MONARCH INSTITUTE Units covered: FINSASICR503 7. Explain to Juliette and Jason, the consequences of the different outcomes depending on whether they use Juliette's strategy or Jason's strategy