Margin Trading Example

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Margin Trading
Example
• Using only a portion of the proceeds for an
investment
• Borrow remaining component
• Margin arrangements differ for stocks and
futures
Stock Margin Trading
• Greatest margin
– Currently 30%
– Set by the securities commissions
• Minimum margin
– Minimum level the equity margin can be
(called “maintenance” in USA)
• Margin call
– Call for more equity funds
Margin Trading - Initial Conditions
X Corp
50%
30%
1000
Initial Position
Stock $70,000
$70
Initial Margin
Minimum Margin
Shares Purchased
Borrowed
$35,000
Equity
$35,000
Margin Trading - Minimum Margin
Stock price falls to $60 per share
New Position
Stock $60,000 Borrowed $35,000
Equity
$25,000
Margin% = $25,000/$60,000 = 41.67%
Margin Trading - Margin Call
• How far can the stock price fall before a
margin call?
1,000  P  $35,000
1,000  P
 30%
Therefore, P = $50
Note: 1,000xP – Amount Borrowed = Equity
Leveraging effect of margin
purchases
• You buy 200 shares of XYZ at $100, expecting
a 30% appreciation of the stock in one year:
– Initial margin: 50%
– Financed by a 9% loan for one year
– Expected net return: 51%
• A 30% drop in the price, though, brings a
negative rate of return of -69%.
Short Sales
• Purpose: to profit from a decline in the price
of a stock or security
Mechanics
• Borrow stock through a dealer
• Sell it and deposit proceeds and margin in an
account
• Close out the position: buy the stock and
return it to the owner
Short Sale - Initial Conditions
Z Corp
50%
30%
$100
100 Shares
Initial Margin
Minimum Margin
Initial Price
Sale Proceeds
Margin & Equity
Stock Owed
$10,000
$ 5,000
$10,000
Short Sale - Minimum Margin
Stock Price Rises to $110
Sale Proceeds
$10,000
Initial Margin
$ 5,000
Stock Owed
$11,000
Net Equity
$ 4,000
Margin % (4,000/11,000) = 36%
Short Sale - Margin Call
• How much can the stock price rise before a margin
call?
$15, 000  $100 P
 30%
100 P
So, P = $115.38
Note: $15,000 = Initial margin + sale proceeds
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