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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.)
- If you buy Fleetwood on margin with the maximum margin loan, what is the maximum number of shares you can buy?
- Suppose you bought the maximum number of shares of Fleetwood as in (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?
- How far can the price drop before you will receive a margin call?
- 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.
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