Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

You think that the stock of Fleetwood Corp is likely to rise within the next six months from its current price ($29.00 bid and $30.00

You think that the stock of Fleetwood Corp is likely to rise within the next six months from its current price ($29.00 bid and $30.00 ask), and you want to maximize the amount of profit from your investment.

So, you will use a margin account to borrow on margin in order to buy as many shares as you can. Your initial margin requirement is 55%, and you have $82,500 of your own money to invest in the shares. The minimum (maintenance) margin is 35%, and Fleetwood does not pay dividends. (Ignore interest for this problem.)

  1. If you buy Fleetwood on margin with the maximum margin loan, what is the maximum number of shares you can buy?
  2. Suppose you bought the maximum number of shares of Fleetwood as in (1).
    1. Assume that immediately after your purchase, Fleetwood's share price drops to $25.00 per share. Calculate your new margin. Will you receive a margin call?
    2. How far can the price drop before you will receive a margin call?
    3. If the stock price falls to $20, you calculate that you would get a margin call. If that happens, how much in additional funds would you need to add to your account to respond to the margin call?

Hints:

  • New funds needed = Original loan - Maximum loan given market value
  • Maximum loan = (1 - minimum margin) (Market value of shares)
  • When a margin call occurs, the margin balance must be bumped up to the minimum (maintenance) margin to avoid your broker selling some of your shares.

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image_2

Step: 3

blur-text-image_3

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Finance Applications and Theory

Authors: Marcia Cornett, Troy Adair

3rd edition

1259252221, 007786168X, 9781259252228, 978-0077861681

More Books

Students also viewed these Finance questions

Question

What is invested capital, and how is it measured?

Answered: 1 week ago