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Buying on Margin

The accompanying spreadsheet can be used to measure the return on investment for buying stocks on

margin. The model is set up to allow the holding period to vary in months. The model also calculates the

price at which you would get a margin call for a specified maintenance margin.

The initial equity investment, initial stock price, the estimated ending stock price, cash dividends paid on

the stock during the holding period, the initial margin percentage, the maintenance margin percentage, the

rate on the margin loan and the holding period in months are entered. The spreadsheet calculates the

number of shares controlled, the holding period return and the price at which you would get a margin call

for a specified maintenance margin. The amount of equity that you will invest along with the margin

percentage determines the number of shares that you will purchase on margin. The model is initially set

with the maximum allowable margin of 50%.

eturn on investment is calculated with consideration of capital gain on loss, dividends received and

margin interest paid for the holding period. The return on investment is presented in !ell "##. The return

on stock trade that would be made without borrowing is presented in !ell "#$.

The data table function calculates return on investment for a range of ending stock prices that range from

#0 to &0 in increments of 5. The returns are displayed in !ells '( through ')*. The comparable

returns on an all equity investment in stock are displayed in !ells +( through +)*. The impact that margin

trading has on volatility in returns is shown by comparing these ranges.

Questions

ou have #0,000 to invest in the shares of -omega -ncorporated. The stock is currently selling at a priceof (0 per share. ou estimate that the stock will be selling at a price of 0 in one year. /ince -omega isa growth stock, no cash dividends are expected over the next year. The rate on margin loans is currently*%.

). hat would be the expected return on the investment assuming that you used the maximumallowable margin of 50%1

#. 2t what price would you get a margin call assuming the maintenance margin was 30%1

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3. !onstruct two data tables that compare the return on investment for a margin trade and a tradewith no margin for ending stock prices that range from )0 to *0 in increments of 5.

(. hat would be the expected return on investment if you were to use an initial margin of &0%rather than the maximum allowable margin of 50%1

5. +ow far could the stock price fall with an initial margin of &0% assuming the maintenancemargin remains at 30%1

. !onstruct two data tables that compare the return on investment for the margin trade and atrade with no margin for ending stock prices that range from )0 to *0 in increments of 5.!ompare the results to the ranges for question 3.