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Chapter#5all financial markets have regulations & trading practices

5-1. (a) Consider an investor who purchased a stock at $100 per share. The current market price is $125. At what price would a limit order be placed to ensure a profit of $30 per share? (b) What type of stop order would be placed to ensure a profit of at least $20 per share? (a) A limit order to sell is placed above the current market price. If the limit order is set at $130, the investor will realize a gross profit of at least $30 (ignoring transaction costs). (b) A sell stop order is placed below the market price. If the stop order is placed at $120, the investor should realize a profit of approximately $20 per share. Technically, to be certain of $20 per share, the stop order probably would have to be set slightly above $120 because a stop price is actually an activator that initiates a market order when the specified price is reached. 5-2. Assume that an investor sells short 100 shares of stock at $50 per share. At what price must the investor cover the short sale in order to realize a gross profit of $3000? $1000? a) To realize a gross profit of $3000 on 100 shares sold short at $50, the investor must cover at (ignoring transaction costs):

$5,000 -X = $ 3000 profit X is $2,000, which must be divided by 100 shares. $2000 = $20 100 ANSWER: $20 per share b) For a profit of $1000, the calculation is: $5,000 -X $ 1000 X is $4,000, which again must be divided by 100 shares. $4000 = $40 100 ANSWER: $40 per share.

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Chapter#5all financial markets have regulations & trading practices


5-3. Assume that an investor buys 200 shares of stock at $40 per share and the stock rises to $55 per share. What is the percentage return on the investors cash outlay, assuming an initial margin requirement of 50 percent? 40 percent? 60 percent? 200 shares at $40 per share is a total cost of $8000.

At 50% margin, the investor must put up $4000.

At 40% margin, the investor must put up $3200.

At 60% margin, the investor must put up $4800.

As the price increase to $55 per share.

Market value of securities - Amount borrowed Actual margin = Market value of securities $11,000- $4000 Actual margin = = $11,000 $11,000- $3200 Actual margin = = $11,000

$11,000- $4800 Actual margin = = $11,000

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Chapter#5all financial markets have regulations & trading practices


5-4. Assume an initial margin requirement of 50 percent and a maintenance margin of 30 percent. An investor buys 100 shares of stock on margin at $30per share. The price of the stock subsequently drops to $25. a) What is the actual margin at $25? b) The price now rises to $28. Is the account restricted? c) If the price declines to $24, is there a margin call? d) Assume that the price declines to $20. What is the amount of the margin call? At $18? The initial margin is 50% of $3000 is $1500. The other $1500 is borrowed from the broker.

Market value of securities - Amount borrowed Actual margin = Market value of securities

a) Market value = 100 $25 = $2500 Amount borrowed = 100 $30 = $3000 = 3000 $2500 - $1500 Actual margin = = =0.4 = 40% $2500 b) In a restricted account, the actual margin is between the initial margin (i.e., 50%) and the maintenance margin (i.e., 30%). The actual margin is when the price rise to $28 per share so market values is 100$28=$2800 now: =$1500

$2800 - $1500 Actual margin = = $2800 = 0.46 = 46%

Therefore, the account is restricted.

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Chapter#5all financial markets have regulations & trading practices


c) A margin call results when the actual margin declines below the maintenance margin. At a stock price of $24, market value is 100 $24 = $2400 the actual margin is: $2400 - $1500 Actual margin = = = 0.375 = 37.5% $2400 Because the actual margin is not below the maintenance margin of 30%, there is no margin call. d) At a stock price of $20, the market value is 100 $20 =$2000the actual margin is $2000 - $1500 Actual margin = = = 0.25 = 25%

$2000 Because the actual margin is below the maintenance margin of 30%, there is margin call. The amount of the margin call is calculated as:

a. Market value of securities - Amount borrowed Actual margin = Market value of securities

(x + $2000) - $1500 .3 = (x + $2000) .3(x + $2000) = x + 500 .3x + 600 = x + 500 . 3x + 600 500 = x . 3x + 100 = x 100 = x - .3x 100 = 0.7x

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Chapter#5all financial markets have regulations & trading practices


At a stock price of $18, the market value is 100 $18 = $1800the actual margin is:

$1800 - $1500 Actual margin = = = 0.167 = 16.6% $1800 Because the actual margin is below the maintenance margin of 30%, there is margin call. The amount of the margin call is calculated as: b. Market value of securities - Amount borrowed Actual margin = Market value of securities

(x + $1800) - $1500 .3 = (x + $1800) .3(x + $1800) = x + 300 .3x + 540 = x + 300 . 3x + 540 300 = x . 3x + 240 = x 240 = x - .3x 240 = 0.7x

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