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You bought 1000 shares of ABC stock on margin at the beginning of April 2012 at...

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Finance

You bought 1000 shares of ABC stock on margin at the beginningof April 2012 at $4.80 per share. You deposited a 50% margin whichwas higher than the initial margin of 40%. The prime rate ofinterest was 2.5% and your broker charged 125 basis points abovethe prime rate on margin loan (assume simple interest rate). Thestock paid a cash dividend of $0.12 per share in February andAugust of 2012. Your broker charged a flat fee of $7.95pertrade.

1) What was your EAR if you sold the stock for $6.12 at the endof the year?

2) what was your EAR if you did not borrow from hour broker?

Answer & Explanation Solved by verified expert
3.7 Ratings (688 Votes)

1) Cost of Shares=1000*$4.80 $4,800
Amount of margin deposited $2,400 (50%*4800)
Amount of Loan $2,400
Interest rate charged by broker=2.5+1.25 3.75%
9 months (April-December) interest $67.50 2400*3.75%*(9/12)
Broker Charges for two trades(buy and Sell) $15.90 (7.95*2)
Total amount to be paid to broker=2400+67.5+15.9 $2,483.40
Initial Investment $2,400
Amount Received after 9 months=1000*$6.12 $6,120
Dividend of August 2012=0.12*1000 $120.00
Dividend of February will not be received by the investor
Since Purchase was made in April 2012
Total amount received $6,240 (6120+120)
Amount payable to broker $2,483.40
Net amount received $3,756.60
Effective Annual Return (EAR)=(3756/2400)-1 0.56525
EAR 56.53%
2) EAR if amount is not borrowed
Investment =1000*4.8 $4,800
Amount Received $6,240
Less:Brokerage $15.90
Net amount received $6,224.10 (6240-15.90)
EAR=(6224.10/4800)-1 0.2966875
EAR if amount is not borrowed 29.67%

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Transcribed Image Text

You bought 1000 shares of ABC stock on margin at the beginningof April 2012 at $4.80 per share. You deposited a 50% margin whichwas higher than the initial margin of 40%. The prime rate ofinterest was 2.5% and your broker charged 125 basis points abovethe prime rate on margin loan (assume simple interest rate). Thestock paid a cash dividend of $0.12 per share in February andAugust of 2012. Your broker charged a flat fee of $7.95pertrade.1) What was your EAR if you sold the stock for $6.12 at the endof the year?2) what was your EAR if you did not borrow from hour broker?

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