You think that the stock of Fleetwood Corp is likely to rise within the next six months from its current price ($19.00 bid and $20.00 ask), and you want to maximize the amount of profit from your investment. So, you will use a margin account to borrow on margin in order to buy as many shares as you can. Your initial margin requirement is 45%, and you have $90,000 of your own money to invest in the shares. The minimum (maintenance) margin is 30%, and Fleetwood does not pay dividends. (Ignore interest for this problem.)If you buy Fleetwood on margin with the maximum margin loan, what is the maximum number of shares you can buy?Suppose you bought the maximum number of shares of Fleetwood as in (1).Assume that immediately after your purchase, Fleetwood’s share price drops to $18.00 per share. Calculate your new margin. Will you receive a margin call?How far can the price drop before you will receive a margin call? If the stock price falls to $14.00, you calculate that you would get a margin call. If that happens, how much in additional funds would you need to add to your account to respond to the margin call?Hints: New funds needed = Original loan – Maximum loan given market valueMaximum loan = (1 – minimum margin) (Market value of shares)When a margin call occurs, the margin balance must be bumped up to the minimum (maintenance) margin to avoid your broker selling some of your shares. *************** Solve 2c using Equity investment value = Investment value – Margin borrowingAdditional funds required = (Current margin – Maintenance margin) x Investment value

Margin: It represents the amount borrowed from the broker for the purpose of buying security. It is…

Answered: If you buy Fleetwood on margin with the…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter7: Common Stock: Characteristics, Valuation, And Issuance

Section: Chapter Questions

Problem 13P

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You think that the stock of Fleetwood Corp is likely to rise within the next six months from its current price ($19.00 bid and $20.00 ask), and you want to maximize the amount of profit from your investment.

So, you will use a margin account to borrow on margin in order to buy as many shares as you can. Your initial margin requirement is 45%, and you have $90,000 of your own money to invest in the shares. The minimum (maintenance) margin is 30%, and Fleetwood does not pay dividends. (Ignore interest for this problem.)

If you buy Fleetwood on margin with the maximum margin loan, what is the maximum number of shares you can buy?
Suppose you bought the maximum number of shares of Fleetwood as in (1).

Assume that immediately after your purchase, Fleetwood’s share price drops to $18.00 per share. Calculate your new margin. Will you receive a margin call?
How far can the price drop before you will receive a margin call?
If the stock price falls to $14.00, you calculate that you would get a margin call. If that happens, how much in additional funds would you need to add to your account to respond to the margin call?

Hints:

New funds needed = Original loan – Maximum loan given market value
Maximum loan = (1 – minimum margin) (Market value of shares)
When a margin call occurs, the margin balance must be bumped up to the minimum (maintenance) margin to avoid your broker selling some of your shares.

*************** Solve 2c using

Equity investment value = Investment value – Margin borrowing

Additional funds required = (Current margin – Maintenance margin) x Investment value

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