An investor buys $16,000 worth of a stock priced at $20 per share using 60% initial margin.The broker charges 8% on the margin loan and requires a 35% maintenance margin.The stock pays a $0.50 per share dividend in one year and then the stock is sold at $23 per share.What was the investor's rate of return?

Question

Quizplus · Accepted Answer

1) The investor puts 60% of $16,000 = $9,600 down and borrows the rest.
2) The number of shares bought = $9,600/$20 = 480 shares.
3) The maintenance margin is 35%, so the investor has to maintain equity of at least 35% of the value of the stock = 0.35 x ($20 x 480) = $33,600
4) If the value falls below the maintenance margin, the broker will issue a margin call.
5) One year later, the investor receives a total dividend of $0.50 x 480 = $240.
6) The value of the stock at the end of the year is $23 x 480 = $11,040.
7) The investor sells the stock for $11,040, and uses $6,240 of it to repay the margin loan.
8) The interest charged on the margin loan is 8% x $6,400 = $512.
The investor's profit would be:

Profit = ($11,040 - $6,240 - $512 - $16,000) / $16,000 = 0.2383 or 23.83%

Therefore, the correct answer is (C) 23.83%.

An Investor Buys $16,000 Worth of a Stock Priced at $20