Reference no: EM13863450
Let P be the price of a stock. The investor wants to purchase Q units of this stock. Suppose investor’s equity is E and assume that equity is strictly smaller than the value of the stock investor wants to purchase. As such, the investor receives a loan, L from the broker.
A. Give a formula that expresses E in terms of L, P and Q.
B. Give a formula that expresses the margin M in terms of L, P, and Q.
C. After the loan was made, suppose the price of the stock falls to λP, where 0 < λ < 1. Find the new margin, in terms of M and λ.
D. Now let the maintenance margin be c, where 0 < c < 1. Find the largest λ, call it λ ∗ , such that, given our initial margin M and maintenance margin c, whenever λ > λ∗ the broker will not issue a margin call.
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