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What percentage return does each investor earn

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1. A stock sells for $10 per share. You purchase 100 shares for $10 a share (i.e., for $1,000), and after a year the price rises to $17.50. What will be the percentage return on your investment if you bought the stock on margin and the margin requirement was (a) 25 percent, (b) 50 percent, and (c) 75 percent? (Ignore commissions, dividends, and interest expense.)

2. Repeat Problem 1 to determine the percentage return on your investment but in this case suppose the price of the stock falls to $7.50 per share. What generalization can be inferred from your answers to Problems 1 and 2?

3. Investor A buys 100 shares of SLM Inc. at $35 a share and holds the stock for a year. Investor B buys 100 shares on margin. The margin requirement is 60 percent, and the interest rate on borrowed funds is 8 percent.

a) What is the interest cost for investor A?

b) What is the interest cost for investor B?

c) If they both sell the stock for $40 after a year, what percentage return does each investor earn?

d) In both cases, the value of the stock has risen the same. Why are the percentages returns different?

4. Ms. Tejal Gandhi has decided that the stock of SmallCap Inc is overvalued at $4 a share and wants to sell it short. Since the price is relatively low, short sales cannot be executed on margin, so Ms. Gandhi must put up the entire value of the stock when it is sold short.

a) What is the percentage loss if the price of the stock rises to $8?

b) What is the percentage loss if the price of the stock rises to $10?

c) What is the percentage gain if the company goes bankrupt and is dissolved?

d) What are the maximum percentage gain the short seller can earn and the largest percentage loss the short seller can sustain?

e) From the short seller's perspective, what are the best and worst case scenarios?

Reference no: EM13929375

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