"Regarding the solution to problem 3 (p. A-3), when investors open a short position in a stock, they must post funds in addition to the proceeds from the short sale. Cash is not borrowed and so interest is not charged. The correct rate of return on the investment is thus $550/2,675 = 20.56%." If funds are not borrowed, than the denominator should be the all the sum(5600), not just 2,675. Don’t you agree?
have you gone through this?
Post the full question pls.
When you establish a short position, you borrow shares from the broker and sell those share in the market. The proceeds form the sale are not going to you, these money are kept in the margin account, by the broker. Additionally, you are required to post a margin of 45% of the position, that is, you have to deposit 45%*5600= 2,520. The broker also charges a one time 155 commission, that means your total initial investment would be 2,520+155=2,675. The profit from this position would be: 5,600 (what you got when you sold short the shares) - 4,500 (what you paid to buy back the shares from the market) - 155 (commission at short position initiation) - 145 (commission at short position closing) - 2.5*100 (dividends that you, as the short seller, have to pay to those that bought the 100 shares) = 550 No money are borrowed at any time. The rate of return is therefore, 550/2,675 = 20.56%
Thanx map1. Great explanation as usual!