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Margin Call

Toby Jensen originally purchased 400 shares of CSC stock on margin at a price of $60 per share. The initial margin requirement is 50% and the maintenance margin is 25%. CSC stock price has fallen dramatically in recent months and it closed today with a sharp decline bringing the closing price to $40 per share. Will Jensen receive a margin call?

A)

Yes, he does not meet the minimum maintenance margin requirement.

B)

No, he meets the minimum maintenance margin requirement.

C)

No, he meets the minimum initial margin requirement.

I know the margin call formula = P0 * (1-Initial/1-Maintenance)

Solving this I get = $60*(1-..5/1-.25) = $40.

The correct answer was C. I guessed A, was I wrong because he was not below the maintenance margin? Instead exactly equal? Just want to be sure I didn’t miss anything.

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C is not correct; the initial margin has no bearing on whether or not a margin call is made.

Where did  you get this question?

Simplify the complicated side; don't complify the simplicated side.

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Hey C is the correct answer.

The stem says that the closing price is close to 40, so it’s not below 40. $40 is actually the margin call price.

[Ei + (Pt - P0)] / Pt = maintenance margin %    <—- where: Ei = initial equity per share. and Pt= margin call price

[(0.5 * 60) + (Pt - 60) ] / Pt  = 0.25     

Pt= 40.

So if the price drops to, or below 40, then that will trigger a margin call. Here the price falls close to 40, but not to 40. Therefore C is correct. 

Analyst0718 wrote:
The stem says that the closing price is close to 40, so it’s not below 40.

No, it doesn’t.

Reread the stem.

Analyst0718 wrote:
Hey C is the correct answer.

C is not correct.

Once again, the initial margin has nothing to do with whether or not the investor gets a margin call; that depends only on the maintenance margin.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

That is what I thought. I got the question from the Kaplan Q Bank.

wichertj wrote:
That is what I thought. I got the question from the Kaplan Q Bank.

I hate this kind of junk.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

I would go with B.Usually, when price falls below 40 in this case, the margin call amount would equal to meet initial margin requirement. Maybe, that s why q bank referred C as correct opt. 

C is correct. Your initial margin is used to calculate your initial equity $ per share, which is the 0.6 x 50 = 30.  This is your starting point. I agree with you 100% that the margin call price is based on your maintenance margin, but you have to start with your amount of equity per share that is dictated by your initial margin. Look at my calc, note how i used 25%, or the maint. margin to the right side of the equation. This is how the book does it, and that’s why C is the right answer

Analyst0718 wrote:
C is correct. Your initial margin is used to calculate your initial equity $ per share, which is the 0.6 x 50 = 30.  This is your starting point. I agree with you 100% that the margin call price is based on your maintenance margin, but you have to start with your amount of equity per share that is dictated by your initial margin. Look at my calc, note how i used 25%, or the maint. margin to the right side of the equation. This is how the book does it, and that’s why C is the right answer.

C is not correct.

You get a margin call based on whether or not you meet the maintenance margin, not the original margin.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

Ok, I see what you’re referring to now. C is worded wrong, got it. 

Analyst0718 wrote:
Ok, I see what you’re referring to now. C is worded wrong, got it.

Whew!

wink

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

My apologies. 

Analyst0718 wrote:
My apologies.

For what?  Being stressed four days before the exam?

No apology necessary.

Simplify the complicated side; don't complify the simplicated side.

Financial Exam Help 123: The place to get help for the CFA® exams
http://financialexamhelp123.com/

someone correct me if im wrong, but from my understanding:

you are buying 400 shares on margin, where the initial margin requirement is 50% and the initial price per share is $60. this means that the total amount costs

400 shares x $60 per share = $24000, where half the shares you acquire through leverage, that is, you only pay out of pocket $12,000 and borrow $12,000 worth of shares.

the maintenance margin is 25%, that is, 1/4 of the total, 

or $24,000 x 0.25 = $6,000

so long as the borrowed shares are worth at least $6,000, there is no margin call.

when the shares fall to $40 per share, the borrowed shares are worth

200 shares x $40 per share = $8000, and since this is greater than the minimum maintenance margin of $6,000, there is no margin call.

thus B - there is no margin call because the investor still meets the minimum maintenance margin required

the critical price for the shares, that is the minimum value for which there is no margin call is then

$6,000 / 200 shares = $30 per share

so if the share price falls below $30, there will be a margin call and the buyer will be asked to top up his margin balance.

suppose the share price drop to $28 per share. the borrowed shares are now worth only 200 shares x $28 per share = $5,600 < $6,000

in this case, there will be a margin call and the investor is asked to deposit enough in their margin account to meet the initial margin requirement.

that is, they must deposit at least $12,000 - $5,600 = $6,400 by the end of the next trading day.

if the investor doesn’t put in the required variation margin, the broker closes the long position by selling the shares, and the investor loses

$12,000 - 400 x $28 = $800

if the price fell to $30 and the broker closed the account, the investor would lose

$12,000 - 400 x $30 = $0 as expected from calculations above, assuming i didn’t make any mistakes.