Answered: You sold short 100 shares of Kraft…

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter7: Common Stock: Characteristics, Valuation, And Issuance

Section: Chapter Questions

Problem 8P

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Question

You sold short 100 shares of Kraft Heinz Co. common stock on margin at $83.55 per share.
Assume the initial margin is 50% and the maintenance margin is 30%.
One year later, the stock price closes at $59.61, and it has paid cash dividends of $2.50 per share.
What is your return on equity? Ignore margin interest.

Expert Solution

Step 1

Short sale price, P0 = $ 83.55

Short sale quantity, Q = 100

Proceeds from short sale, S = P0 x Q = 83.55 x 100 = $ 8,355

Step 2

Initial margin to be maintained = 50%

Money to be deposited int he account = your equity portion = 50% of proceeds from short sale = 50% x $ 8,355 = $ 4,177.50

Step 3

One year later:

The stock price closes at $59.61 = P1, and
it has paid cash dividends of $2.50 per share = D

Ypur net income = NI = Gain / (Loss) on short sale = (P0 - P1 - D) x N = (83.55 - 59.61 - 2.50) x 100 = $ 2,144

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