You invest $37.50 of your own money and borrow $12.50 from your broker at an 8% interest rate to buy $50 of stock. Your rate of return is -20% if the stock falls to $40, 0% if it stays at $50, and 20% if it rises to $60. Borrowing half the funds at 8% interest increases risk, as you may need to sell at a loss if the stock drops, but also increases potential returns if the stock price rises above the breakeven point needed to cover interest costs.

1. 1. Suppose you buy 100 shares of stock initially selling for $50, borrowing 25% of the necessary
funds from your broker; that is, the initial margin on your purchase is 25%. You pay an interest
rate of 8% on margin loans.
a. How much of your own money do you invest? How much do you borrow from your broker?
b. What will be your rate of return for the following stock prices at the end of a one-year holding
period? (i) $40; (ii) $50; (iii) $60.
2. Suppose you buy 100 shares of stock initially selling for $50, borrowing 50% of the necessary
funds from your broker; that is, the initial margin on your purchase is 50%. You pay an interest
rate of 8% on margin loans. How does margin affect the risk and return of your position?