Dear All- I am sharing a problem and its solution as given by the book. I have a query regarding the same. My question is at the end of the problem.
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Given the following information:
Shares purchased -1000
Purchase price per share- $100
Annual dividend per share- $2
Initial margin requirement - 40%
Call money rate - 4%
Commission per share- 0.05
Stock price after one year- $110
Calculate (1) the leverage ratio and (2) the investor’s return on the margin transaction
(return on equity) if the stock is sold at the end of one year.
Answer:
1. The leverage ratio = 1 I 0.40 = 2.5.
2. The total purchase price is 1 ,000 x $ 1 00 = $ 100,000. The investor must
post initial margin of 40o/o x $ 100,000 = $40,000. The remaining $60,000 is
borrowed. The commission on the purchase is 1 ,000 x $0.05 = $50. Thus, the
total initial equity investment is $40,050.
At the end of one year, the stock value is 1 ,000 x $ 1 10 = $ 1 10,000, for a gain of
$9,950. Dividends received are 1 ,000 x $2.00 = $2,000. Interest paid is $60,000 x
4o/o = $2,400. The commission on the sale is 1 ,000 x $0.05 = $50.
The gain on the transaction in one year is $9,950 + $2,000 - $2,400 - $50 = $9,500.
The return on the equity investment is $9,500 I $40,050 = 23.72%.
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MY question is:
where did we get $ 9950. Is it $110000- $100000- $ 50 (Commission)?
If yes then how do we get $9500 (As per question: $9,950 + $2,000 - $2,400 - $50 = $9,500.)
Why have we deducted $ 50 two times here?
Is the answer wrong?
Your help will be deeply appreciated.
THanks
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Given the following information:
Shares purchased -1000
Purchase price per share- $100
Annual dividend per share- $2
Initial margin requirement - 40%
Call money rate - 4%
Commission per share- 0.05
Stock price after one year- $110
Calculate (1) the leverage ratio and (2) the investor’s return on the margin transaction
(return on equity) if the stock is sold at the end of one year.
Answer:
1. The leverage ratio = 1 I 0.40 = 2.5.
2. The total purchase price is 1 ,000 x $ 1 00 = $ 100,000. The investor must
post initial margin of 40o/o x $ 100,000 = $40,000. The remaining $60,000 is
borrowed. The commission on the purchase is 1 ,000 x $0.05 = $50. Thus, the
total initial equity investment is $40,050.
At the end of one year, the stock value is 1 ,000 x $ 1 10 = $ 1 10,000, for a gain of
$9,950. Dividends received are 1 ,000 x $2.00 = $2,000. Interest paid is $60,000 x
4o/o = $2,400. The commission on the sale is 1 ,000 x $0.05 = $50.
The gain on the transaction in one year is $9,950 + $2,000 - $2,400 - $50 = $9,500.
The return on the equity investment is $9,500 I $40,050 = 23.72%.
————————————————————
MY question is:
where did we get $ 9950. Is it $110000- $100000- $ 50 (Commission)?
If yes then how do we get $9500 (As per question: $9,950 + $2,000 - $2,400 - $50 = $9,500.)
Why have we deducted $ 50 two times here?
Is the answer wrong?
Your help will be deeply appreciated.
THanks