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 $18.00 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 $14.00, 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?

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
icon
Related questions
Question

You think that the stock of Fleetwood Corp is likely to rise within the next six months from its current price ($19.00 bid and $20.00 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 45%, and you have $90,000 of your own money to invest in the shares. The minimum (maintenance) margin is 30%,  and Fleetwood does not pay dividends. (Ignore interest for this problem.)

  1. If you buy Fleetwood on margin with the maximum margin loan, what is the maximum number of shares you can buy?
  2. Suppose you bought the maximum number of shares of Fleetwood as in (1).
    1. Assume that immediately after your purchase, Fleetwood’s share price drops to $18.00 per share. Calculate your new margin. Will you receive a margin call?
    2. How far can the price drop before you will receive a margin call? 
    3. If the stock price falls to $14.00, 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. 

 

*************** Solve 2c using 

Equity investment value = Investment value – Margin borrowing
Additional funds required = (Current margin – Maintenance margin) x Investment value
Expert Solution
steps

Step by step

Solved in 7 steps

Blurred answer
Knowledge Booster
Functions of Investment Banks
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
  • SEE MORE QUESTIONS
Recommended textbooks for you
Essentials Of Investments
Essentials Of Investments
Finance
ISBN:
9781260013924
Author:
Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:
Mcgraw-hill Education,
FUNDAMENTALS OF CORPORATE FINANCE
FUNDAMENTALS OF CORPORATE FINANCE
Finance
ISBN:
9781260013962
Author:
BREALEY
Publisher:
RENT MCG
Financial Management: Theory & Practice
Financial Management: Theory & Practice
Finance
ISBN:
9781337909730
Author:
Brigham
Publisher:
Cengage
Foundations Of Finance
Foundations Of Finance
Finance
ISBN:
9780134897264
Author:
KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:
Pearson,
Fundamentals of Financial Management (MindTap Cou…
Fundamentals of Financial Management (MindTap Cou…
Finance
ISBN:
9781337395250
Author:
Eugene F. Brigham, Joel F. Houston
Publisher:
Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Corporate Finance (The Mcgraw-hill/Irwin Series i…
Finance
ISBN:
9780077861759
Author:
Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:
McGraw-Hill Education