Briefly discuss the investors incentives

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Reference no: EM133291114

The SPACE share price is $40 now and its dividend is $2 per share in the year. The Dealer in the market is ready to lend shares to investors for short sale, and lend money to investors for purchase by margin. The interest rate is 5% per year for money loan only and zero for share loan. The initial margin ratio is 40% for either short sale or purchase by margin.

Required:

Question 1: Suppose that Christina is bearish on the SPACE share and she short sells 3,000 shares at the beginning of the year. Suppose also the share price is $30 at the end of the year. (1) What is the remaining margin ratio in Christina's account? (2) What is the rate of return of Christina's investment?

Question 2: Suppose that David is bullish on the SPACE share and he buys 3,000 shares by margin at the beginning of the year. Suppose also the share price is $30 at the end of the year. (1) What is the remaining margin ratio in David's account? (2) What is the rate of return of David's investment? (3) If the maintenance margin is 15%, at what market price David will receive a margin call? Assume the price fall happens immediately (the interest and dividend are not accrued).

Question 3: At the beginning of the year after the initial trading, what are the total asset and equity (margin) respectively in Christina's account? What the total asset and equity (margin) respectively in David's account?

Question 4: Briefly discuss the investors' incentives/motivations when they trade securities by short sale and purchase on margin respectively.

Reference no: EM133291114

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