Even though the whole theoretical concept makes sense -the the calculations noted in the examples in the study material are flying past my scalp. here is one ques: 55% margin requirement for a stock selling at $20per share. Broker charges 10% interest, 3% commission on total stock value on both -purchase and sale. 0.50 per share is received as dividend and stock is sold for $27 per share. What is the rate of return on investment. The answer notes 100 shares being purchased -no where does the question mentions the number of shares being purchased -did they just assume? why ? 100 shares x 20 = $2000. out of which 55% is to be equity =$1100, $900 borrowing. interest on borrowing $90 (at 10%) dividend per share =$0.5. For 100 shares =$50. Sold stock for proceeds =$2700. Return on investment is Total Proceeds on sale minus total initial cost - commission -interest + dividend. $2700 -$2000-($60+$81)-$90+50 =$519. Initital investment =$1100 out of total $2000. so $519/$1100 =47% rate of return. But answer notes $1160 as initial investment -includes $60 interest. Where is this interest coming from ? and why ? Regardless of whether you purchase stock or sell stock -you PAY the commission to broker who facilitates each transaction. So where is this commission as ‘contribution’ being sourced from…arggh !!
Sorry -correcting an error *$60 added in initial investment is commission not interest.
Okay -maybe i’ll answer myself. The commission is added back to initial investment because you made that payment to the broker when you purchased the stock -hence it was your cost/investment when you initially purchased stock in addition to the actual value you paid for the shares you bought. I am talking to myself again ! =)
It may be easier if you consider your cash flow at the beginning and end of the investment horizon (when you pay commission, interest, and get dividend, etc.) Since commission is a % of stock value, it doesn’t matter how many shares you purchase. The answer, in % terms, should always be the same. They probably assumed 100 shares to make it simple.