Question

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3. You are bearish on MRTC and decide to sell short 2,500 shares at the current market price of $50 per share. a. How much in cash or securities must you put into your brokerage account if the broker's initial margin requirement is 60% of the value of the short position? b. If you earn no interest on the funds in your margin account, what will be your rate of return after one year if MRTC is selling at $45 per share? Assume that MRTC pays no dividends. c. How high can the price of the stock go before you get a margin call if the maintenance margin is 35% of the value of the short position? (10 marks)

Answer 1

a]

cash to put into account = number of shares * market price per share * initial margin %

cash to put into account = 2,500 * $50 * 60%

cash to put into account = $75,000

b]

As the shares are shorted, a decrease in the price will result in a gain.

Gain in margin account = decrease in market price per share * number of shares

Gain in margin account = ($50 - $45) * 2,500

Gain in margin account = $12,500

Rate of return = gain in margin account / cash to put into account

Rate of return = $12,500 / $75,000

Rate of return = 16.67%

c]

Maintenance margin = number of shares * market price per share * initial margin %

Maintenance margin = 2,500 * $50 * 35%

Maintenance margin = $43,750

Initial margin amount = $75,000

Decrease in margin amount to trigger margin call = Initial margin amount - Maintenance margin

Decrease in margin amount to trigger margin call = $75,000 - $43,750 = $31,250

Increase in share price to trigger margin call = Decrease in margin amount to trigger margin call / number of shares

Increase in share price to trigger margin call = $31,250 / 2,500

Increase in share price to trigger margin call = $12.50