An investor decides to purchase shares of BUFF on margin. The investor has $750,000 cash in their account to use for the purchase (assume this is the only position in the account). The investor may borrow from their broker at 6% per year and must have an initial margin of at least 50%. The maintenance margin is 35%. The current market price of BUFF is $50.00 and BUFF pays quarterly dividends of $0.25 per share (assume the first dividend comes exactly 3 months from today).
a. Assume the investor utilizes their maximum margin potential. How many shares of BUFF can the investor purchase?
b. Below what stock price will the investor receive a margin call?
c. If the investor holds this position for 3 months and then sells the shares and repays the loan, what is the percentage profit (loss) if the market price of BUFF is $40.00 after 3 months?
d. If the investor holds this position for 3 months and then sells the shares and repays the loan, what is the percentage profit (loss) if the market price of BUFF is $60.00 after 3 months?
e. Compare your answers in C. and D. to the profit (loss) if the investor did not use the margin account and instead only purchased $750,000 worth of BUFF shares. Discuss the effect of leverage on returns.