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# Thread: need help........FM sample exam question...

1. ## need help........FM sample exam question...

This is a question from sample exam FM. This should be a easy question but I am confused--in the solution provided, what is value of contributions and value of returns? I am not sure how to approach this type of questions. why is the dividend 32 not negative on the left-handside of equation?

Any help is greatly appreciated!!~

Jose and Chris each sell a different stock short for the same price. For each investor,the margin requirement is 50% and interest on the margin debt is paid at an annual effective rate of 6%.Each investor buys back his stock one year later at a price of 760. Jose’s stock paid a dividend of 32 at the end of the year while Chris’s stock paid no dividends. During the 1-year period, Chris’s return on the short sale is i, which is twice the return earned by Jose. Calculate i

Soln:
Chris’ equation of value at end of year:
(Value of contributions) .5 P(1+i) + 760 = P* + .5 P (1.06) (Value of returns), where P = price stock sold for
(*Proceeds received for stock sale at beginning of year are in non-interest bearing account per
government regulations (Kellison top of page 281))
Thus, Chris’ yield i = ((1.03) P – 760)/(.5 P).
Jose’s equation of value at end of year:
(Value of contributions) .5 P(1+j) + 760 + 32 = P* + .5 P (1.06) (Value of returns),
Thus, Jose’s yield j = ((1.03) P - 792)/(.5 P).
It is given that Chris’ yield i = twice Jose’s yield j. So ((1.03) P – 760)/(.5 P) = 2 ((1.03) P - 792)/(.5 P)
or P = 824/(1.03) = 800. Thus, Chris’ yield i = ((1.03) 800 – 760)/400 = 64/400 = .16 or 16%.

2. Value of contributions is what he pays, value of returns is what he receives.

He has to pay the \$32 dividend that incurs before he buys the stock back. So it goes on the contribution side, and is therefore positive.

Tim

Try to work through that problem and this one will make sense. Let me know if you have more questions.

- junk

4. Thanks very much for replies and help!

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