FIN 402 Week 1 Assignment Case Problem 3.1 The Perezes ’ Good Fortune
trades at $ 20 per share . Ravi feels it should soar to at least $ 50 within a year . RS pays no dividends , the prevailing initial margin requirement is 50 %, and margin loans are now carrying an annual interest charge of 10 %. Because Ravi feels so strongly about RS , he wants to do some pyramiding by using his margin account to purchase 1,000 shares of the stock . Questions a . Discuss the concept of pyramiding as it applies to this investment situation . b . What is the present margin position ( in percent ) of Ravi ’ s account ? c . Ravi buys the 1,000 shares of RS through his margin account ( bear in mind that this is a $ 20,000 transaction ). 1 . What will the margin position of the account be after the RS transaction if Ravi follows the prevailing initial margin ( 50 %) and uses $ 10,000 of his money to buy the stock ? 2 . What if he uses only $ 2,500 equity and obtains a margin loan for the balance ($ 17,500 )? 3 . How do you explain the fact that the stock can be purchased with only 12.5 % margin when the prevailing initial margin requirement is 50 %? d . Assume that Ravi buys 1,000 shares of RS stock at $ 20 per share with a minimum cash investment of $ 2,500 and that the stock does take off and its price rises to $ 40 per share in one year . 1 . What is the return on invested capital for this transaction ? 2 . What return would Ravi have earned if he had bought the stock without margin — that is , if he had used all his own money ? e . What do you think of Ravi ’ s idea to pyramid ? What are the risks and rewards of this strategy ? ============================================
FIN 402 Week 1 Assignment Case Problem 3.1 The Perezes ’ Good Fortune