Ike, an investor, is considering opening a margin account and investing $2000 in
ID: 1223981 • Letter: I
Question
Ike, an investor, is considering opening a margin account and investing $2000 in Mike’s mutual fund. The terms of the account require that he pay back the amount he borrowed on the margin by the end of the year with 10 percent interest. Ike is trying to decide what level of margin he wants. For example, if he chooses an account at the level of 50 percent, the bank will let him borrow and invest an additional $1000, or 50 percent of his original $2000.
Complete the table below by filling in Ike’s account value at the end of the year, given varying levels of the margin account and mutual fund performance. Assume that Mike’s mutual fund will return 40 percent per year in a stellar market and 10 percent per year in a fair market, and that in a terrible market, it will lose 30 percent.
Instructions: Round your answers to the nearest dollar.
account level Account value in a
stellar market Account value in a
fair market Account value in a
terrible market No margin $ $ $ 60% $ $ $ 100% $ $ $ 150% $ $ $ 200% $ $ $
Explanation / Answer
For the problem above we are assuming that the date of amount borrowing and investing is at the beggining of the year.
For 0% margin there won't be any interest diducted from the amount of money invested. However, the amount will increase by 40%, as a return from investment.
For example = $2000 * (1+40%)
For X% margin the broker will be charging the 10% interest for the amount of money borrowed and it will be diducted from the total amount plus return.
For example = ($2000 * (1+40%)) - ($2000*X%*10%)
Margin Account value (Steller) Account Value (Fair) Account Value (Terrible) 0 $2800 $2200 $1400 60% $2680 $2080 $1280 100% $2600 $2000 $1200 150% $2500 $1900 $1100 200% $2400 $1800 $1000