FINM7008 Applied Investments Workshop 5
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FINM7008 Applied Investments
Workshop 5
(Practice questions drawn from a prior examination)
a) You have been researching Megalo Ltd for some time and are feeling bullish about its future returns. In fact, you believe that the stock price, which is currently $5.52, may achieve one of five possible price outcomes in one year, with the probabilities of occurrence as follows:
Scenario Pricet+1 Probability
|
1 |
7.05 |
0.20 |
|
2 |
6.55 |
0.25 |
|
3 |
5.52 |
0.25 |
|
4 |
4.50 |
0.15 |
|
5 |
4.05 |
0.15 |
You would like to purchase 10,000 shares of Megalo Ltd, but unfortunately have only managed to raise $30,000 following the sale of some of your underperforming assets. You choose to take out a margin loan to finance the difference. The facility carries a maintenance margin of 40%, and a rate of interest of 7.5% p.a. (with interest payable at the end of each year). Assume there are no tax implications, and that your investment takes place at the beginning of the year.
Required:
i. Calculate your return over the next year, for each of the scenarios provided in the table, and the resulting margins. Assume that the only possible source of returns is through stock price changes.
ii. Recalculate the returns in i), assuming now that Megalo Ltd will pay a cash dividend of 30c per share, across all scenarios, at the end of the year.
iii. What is your overall expected return? Assume in this part that the company pays a 30c cash dividend at the end of the year, across all scenarios.
b) In words, describe how a margin facility would be used to short sell stocks.
2023-05-24