Submitted by: Submitted by casanovajr
Views: 331
Words: 468
Pages: 2
Category: Business and Industry
Date Submitted: 11/20/2011 02:14 AM
Buying on Margin
Initial margin (IM) = 60%
100 sh @ $50 = $5,000 ( 0.6 = $3,000 down ($2,000 loan)
B/S
Asset $5,000 Loan $2,000
(P ( SH) Equity $3,000 (A – L)
If price falls to $40:
( B/S
Asset $4,000 Loan $2,000
Equity $2,000
Actual % margin (AM) = Equity/Asset =
2,000/4000 = 50%.
The broker sets a MM (maintenance margin)
If AM < MM, the broker will issue a ‘margin call’ ( Daily ‘marking to market’ : Investor should add new cash or security to the margin account.
• Undermargined: AM < MM
• Overmargined: AM > IM (unrestricted) (> MM)
• Restricted: MM < AM < IM
Undermargined ( Margin call
MM (maintenance margin) = 30% (minimum margin)
Suppose price falls to $25 (from $50):
AM = (2,500 – 2,000) / 2,500 = 500 / 2,500
= 20% < 30% = MM
How far could stock price fall before the investor get a margin call?
AM = Equity / Asset = (P ( SH – Loan)/(P ( SH) ( MM
Example: P = ?, SH = 100; Loan = $2,000; MM = 0.30
(100 ( P - 2,000)/ (100 ( P) = 0.30
P = 2,000/70 = $28.57.
Overmargined:
Suppose price goes up to $60 (from $50)
AM = 4,000 / 6,000 = 67% > IM (= 60%)
B/S
Asset $6,000 Loan $2,000
Equity $4,000
( You can withdraw cash from your account until
AM = 60%.
Example: AM = (6,000 – 2,000 – X) / 6,000 = 0.60 = IM
X = $400 (can borrow $400 from the account)
B/S
Asset $6,000 Loan $2,400
Equity $3,600
Why buy stocks (or bonds) on margin?
To achieve greater upside potential; but expose to great downside risk
Example:
Start with $5,000; P0 = $50; Expect P1 = $65
Borrow $5,000 and Buy SH = 200;
An interest rate on...