Rachel has $20,000 in cash in her margin account with a broker. The broker charges 4% on borrowed funds and a commission of 2%. The initial margin requirement is 50% and the maintenance margin is 25%. Rachel is interested in purchasing XYZ stock, which is currently quoted at $27.50 bid and $27.78 asked. If Rachel wants to use the maximum margin, the number of shares of XYZ she could purchase is closest to: My question is: Why do we not include for the broker charge in computing for the number of shares here…am confused!! Help plz !!! Answer is : 1384 shares. Tks
I’m not sure that I applied my comission to the proper amount; someone please correct me if I’m wrong. With a 50% margin requirement, she can have a total position worth $40,000, by borrowing $20,000. The fee on the borrowed portion is $20000 * 0.04 = $800. The commission is (40000 - 800) * 0.02 = $784. $40000 - 800 - 784 = $38,416. She purchases the stock at the ask, so 38416 / 27.78 = 1383 shares.
I’ll try… $20,000 in cash Borrow $20,000 from broker. Broker charges 4% on borrowed funds (although I thought for margin accounts, you pay the interest on borrowed funds at end of the month, can someone verify this?) $20,000 * (1-0.04) = $19,200 available from borrowed funds $20,000 + $19,200 = $39,200 is amount you can invest, but you need to reduce by broker commissions $39,200*(1-0.02) = $38,416 Divide by ask price. $38,416/$27.78 = 1382.86 = 1382 shares (I guess I am slightly off)
Haha, nice timing…
brokers charge interest on a daily basis, but I think in this example they assume the broker will set aside the full interest amount up front. I don’t think this is the case with all brokers.
It actually doesn’t (charge interest on borrowed funds). Available funds: 20,000 commission on transaction: 2% To maximize funds, the 20,000 represent the margin required and the commission, 20,000=52% of the total position, so 100% (the total position) would be 20,000/0.52=38,461.5 38,461.5/27.78=1,384.5 shares, that is 1,384 rounded.
hey map1, are you like me hanging aound L1 to ramp up for L2? You got that right. I agree you will not be charged any interest when you first make the position. In this case, the daily interest is like $5 per day, that’s why it does not get factored in. I would think that interest will be used in determining the 25% maintenance margin, it should be.
hey Dreary:) I guess whenever I’m stuck in the L2 material (pretty often), the L1 blues hits me:) And no, interest expense is not considered at margin either. I have not seen an example in the CFAi text though. I guess interest gets deducted at closing because it depends when is the position closed? Or, since you don’t know exactly for how long the borrowing is, you cannot calculate how much is the cost of borrowing? I think I did see an example in Stalla, where the cost of borrowing was deducted, but then again, they were specifying how long would it take for the position to close.
map1, so, how much is the investors equity in the $38,461.5 and how much is loan? Is it 50% of each (ie 0.5*38,461.5)?
Exactly half, 0.5*38,461.5 = 19,230.77 The difference up to 20,000 is the 2% commission , 2%*38,461.5 = 769.23 = 20,000 - 19,230.77
thank you fellas…