Focus on Heavily Shorted StocksAs a portfolio manager, you commonly take short positions in stocks that have a high short interest margin. What is the advantage of focusing on these types of firms? What is a possible disadvantage?
1. Buying on Margin. Assume that Vogl stock is priced at $50 per share and pays a dividend of $1 per share. An investor purchases the stock on margin, paying $30 per share and borrowing the remainder from the brokerage firm at 10 percent annualized interest. If after one year, the stock is sold at a price of $60 per share, what is the return to the investors?
2. Buying on Margin. Assume that Duever stock is priced at $80 per share and pays a dividend of $2 per share. An investor purchases the stock on margin, paying $50 per share and borrowing the remainder from the brokerage firm at 12 percent annualized interest. If after one year, the stock is sold at a price of $90 per share, what is the return to the investor?
3. Buying on Margin. Suppose that you buy a stock for $48 by paying $25 and borrowing the remaining $23 from a brokerage firm at 8 percent annualized interest. The stock pays an annual dividend of $0.80 per share, and after one year, you are able to sell it for $65. Calculate your return on the stock. Then, calculate the return on the stock if you had used only personal funds to make the purchase. Repeat the problem, assuming that only personal funds are used, and that you sell the stock for $40 at the end of one year.
4. Buying on Margin. How would the return on a stock be affected by a lower initial investment (and higher loan amount)? Explain the relationship between the proportion of funds borrowed and the return.
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