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Case Problem 2.2 Ravi Dumar’s High-Flying Margin Account
Ravi Dumar is a stockbroker who lives with his wife, Sasha, and their
five children in Milwaukee, Wisconsin. Ravi firmly believes that the
only way to make money in the market is to follow an aggressive
investment posture—for example, to use margin trading. In fact, Ravi
has built himself a substantial margin account over the years. He
currently holds $75,000 worth of stock in his margin account, though the
debit balance in the account amounts to only $30,000. Recently Ravi
uncovered a stock that, on the basis of extensive analysis, he feels is
about to take off. The stock, Running Shoes (RS), currently trades at $20
per share. Ravi feels it should soar to at least $50 within a year. RS pays
no dividends, the prevailing initial margin requirement is 50%, and
margin loans are now carrying an annual interest charge of 10%.
Because Ravi feels so strongly about RS, he wants to do some
pyramiding by using his margin account to purchase 1,000 shares of the
stock.
Questions
a.
Discuss the concept of pyramiding as it applies to this
investment situation.
b.
What is the present margin position (in percent) of Ravi’s
account?
c.
Ravi buys the 1,000 shares of RS through his margin account
(bear in mind that this is a $20,000 transaction).
1.
What will the margin position of the account be after
the RS transaction if Ravi follows the prevailing initial