Investment and portfolio management
An investor recently opened a brokerage account with $400,000 of cash. They decide to purchase shares of NewCorp (NEWC). Prescribing to the philosophy of “go big or go home,” the investor decides to utilize the full margin borrowing capacity available through their broker. The investor may borrow from their broker at 8% per year and must have an initial margin of at least 50%. The maintenance margin is 25%. The current market price of NEWC is $160.00.
a. [4] Assume the investor utilizes their maximum margin potential. How many shares of NEWC can the investor purchase?
b. [4] Below what stock price will the investor receive a margin call?
c. [4] If the investor holds this position for 3 months and then sells the shares and repays the loan, what is the percentage profit (loss) if the market price of NEWC is $210.00 after 3 months?
d. [4] If the investor holds this position for 3 months and then sells the shares and repays the loan, what is the percentage profit (loss) if the market price of NEWC is $110 after 3 months?
e. [4] Compare your answers in C. and D. to the profit (loss) if the investor did not use the margin account and instead only purchased $400,000 worth of NEWC shares. Discuss the effect of leverage on returns.
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