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Both Andrew and Linda have $1,000 of funds to invest in the market. Andrew wants to trade the stocks by margin purchase, which requires initial margin ratio of 50% and interest charge of 10%. Linda wants to trade the stocks by short sale, which requires initial margin ratio of 50% and no other fee charge.
Required:
a. If Andrew uses all his funds as initial margin to buy one of the stocks, what is the maximum total $ return and rate of return achievable on his investment?
b. If Linda uses all her funds as initial margin to short sell one stock and buy the other stock with the proceeds from short sale, what is the maximum total $ return and rate of return achievable on her investment?
c. Assume David has unlimited funds and does not want any leverage trading (margin purchase and short sale). What is the expected rate of return and risk (standard deviation) of David's global minimum risk portfolio with the investments in the two stocks? Assume the correlation coefficient of returns between the two stocks is 0%.
d. What are the purposes for margin purchase and short sale respectively? Discuss their risk in comparison with other normal trading.
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