FINA 3080

Investment Analysis and

Portfolio Management
Prof. Chao Ying
Lecture 3A
Buying on Margin and Short Sale

FINA 3080 Prof. Chao Ying 1

 Using Margin: price may go up
• Some traders may want to “buy on margin” (leverage)
– Using only a portion of the proceeds for an
investment
– Borrow remaining component from brokers
• Fed requires 50% as initial margin
– At least 50% of the purchase price paid for in cash
– Can achieve greater return but expose to larger risk
• Value of Stock: $10000; loan from broker: $4000
• Margin%=equity/value = (value – debt) / value = 60%

FINA 3080 Prof. Chao Ying 2

 Maintenance Margin
• Value of Stock: $10000; loan from broker: $4000
6000
• The percentage margin is now = 60%.
10000
– What if the stock price fails below $4000?
– The stock can not cover the loan from the broker!!

• Broker sets maintenance margin (e.g., 30%)

• Margin call: if the percentage margin fails below the

maintenance margin, the notification from broker you
must put up additional funds
FINA 3080 Prof. Chao Ying 3
Margin Trading - Initial Conditions Example 3.1

X Corp $100
60% Initial Margin
30% Maintenance Margin
100 Shares Purchased
Initial Position
Stock $10,000 Borrowed(debt) $4,000
Equity $6,000

FINA 3080 Prof. Chao Ying 4

 Margin Trading - Maintenance Margin Ex. 3.1

Stock price falls to $70 per share

New Position
Stock $7,000 Borrowed (debt) $4,000
Equity $3,000
Margin% =equity /value = (value – debt) / value
= $3,000/$7,000 = 43%

FINA 3080 Prof. Chao Ying 5

 Margin Trading - Margin Call Example 3.2
Y
✗
≥ 3- % ✗ = $5714.29

How far can the stock price fall before a margin call?

(value – debt) / value =margin%

(100P - $4,000)* / 100P = 30%

P = $57.14
* 100P - Amt Borrowed = Equity

FINA 3080 Prof. Chao Ying 6

 Short Sales: price may go down
Definition: you sell the stock you do not own and later buy
the stock to pay back.
Purpose: anticipate the stock price will fail; to profit from
a decline in the price of a stock or security.
Mechanics
• Borrow stock from a broker
• Sell it and deposit proceeds and margin in an account
• Closing out the position: buy the stock and return to
the party from which was borrowed

0
• Unlimited risk as price goes up, used with “Stop-buy”

FINA 3080 Prof. Chao Ying 7

 Short Sale - Initial Conditions

Dot Bomb 1,000 Shares

50% Initial Margin
30% Maintenance Margin
$100 Initial Price

Sale Proceeds $100,000

Margin & Equity $50,000
Stock Owed $100,000

FINA 3080 Prof. Chao Ying 8

 Short Sale - Maintenance Margin

Stock Price Rises to $110

Sale Proceeds $100,000 Consider
Initial equity + 50,000 }ASSETS
as

Consideras

Stock Owed 110,000 LIEB

Net Equity 40,000 →

equity
Margin % = (Sale Proceeds + Initial equity
– Stock Owed ) / Stock Owed
=(40000/110000)=36%

FINA 3080 Prof. Chao Ying 9

 Short Sale - Margin Call
How much can the stock price rise before a margin call?
Margin % = (Sale Proceeds + Initial equity
– Stock Owed ) / Stock Owed
($150,000* - 1000P) / (1000P) = 30%
P = $115.38
* Initial equity plus sale proceeds

FINA 3080 Prof. Chao Ying 10

Margin Trading v.s. Short Sale Margin

=
• For margin trading, the initial debt does not
change over time
Margin% =equity /value = (value – debt) / value
• For short sale, the sale proceeds plus initial equity
does not change over time
Margin % = (Sale Proceeds + Initial equity
– Stock Owed ) / Stock Owed

FINA 3080 Prof. Chao Ying 11

 Short Sale
Assume you sell short 100 shares of Citibank common
-

stock at $45 per share, with initial margin at 50%. What

would be your rate of return if you repurchase the stock
at $40 per share? The stock paid no dividends during the
period, and you did not remove any money from the
account before making the offsetting transaction.
Initial
A) 25% Equity $2270
0
B) 22% Sales 44+00
proceeds
C) 20%
Pw & $40 "

D) 77%
E) none of the above Rate of tetum =

← 22%
FINA 3080 Prof. Chao Ying
 Short Sale
Assume you sell short 100 shares of Citibank common
stock at $45 per share, with initial margin at 50%. What
would be your rate of return if you repurchase the stock
at $40 per share? The stock paid no dividends during the
period, and you did not remove any money from the
account before making the offsetting transaction.

A) 25% You initial invest the margin worth 100*$45*50％

B) 22% =2250. Your gain is ($45-$40)*100=500. So the
C) 20% return of you investment is r=500/2250=22%
D) 77%
E) none of the above

FINA 3080 Prof. Chao Ying

 Short Sale
Assume you sold short 200 shares of common stock
-

at $60 per share. The initial margin is 50%. What

-

would be the maintenance margin if a margin call

was made at a stock price of $70?
paid $
/ woo

0
.

A) 29% & too

°

initial equity
B) 40%
stock owed at $70 $ 14000
C) 25%
D) 33%
E) none of the above

FINA 3080 Prof. Chao Ying

 Short Sale
Assume you sold short 200 shares of common stock
at $60 per share. The initial margin is 50%. What
would be the maintenance margin if a margin call
was made at a stock price of $70?

A) 29% You initial investment is 200*$60*50%=6000. The

B) 40% current margin is (Sale proceeds – current value +
your investment) / current value= (200*$60 –
C) 25% 200*$70 + 6000) / 200*$70 = 28.5%
D) 33%
E) none of the above

FINA 3080 Prof. Chao Ying

 Buy on Margin
Assume you purchased 100 shares of common stock at
$50 per share using 2,500
-

= of your own money. The initial

margin requirement is 50%. If the maintenance margin is
-

30%, at what prince would you get a margin call?

A) $26.14 debt $2 too

B) $50.00
°
4%7%1=4%11
C) $35.71
D) $77.12

FINA 3080 Prof. Chao Ying

 Buy on Margin
Assume you purchased 100 shares of common stock at
$50 per share using 2,500 of your own money. The initial
margin requirement is 50%. If the maintenance margin is
30%, at what prince would you get a margin call?

A) $26.14
B) $50.00
C) $35.71 the value of all stocks is $5000 and you invest
D) $77.12 $5000*50%=$2500. You owe debt = $2500. The
future margin is (future stock value - debt) /future
stock value = (100*P-$2500)/100*P=30%, then
P=35.71

FINA 3080 Prof. Chao Ying

 FINA 3080
Investment Analysis and
Portfolio Management
Prof. Chao Ying
Lecture 3B
Bond Prices and Yields

FINA 3080 Prof. Chao Ying 18

 Lecture 3B Outline
• Bond characteristics
• Bond pricing
– All no-default bonds are portfolios of Zeros
– Arbitrage enforces this relationship
– Valuing a bond is an application of present value
– A bond’s IRR is called a YTM
• Measuring the returns for a bond investor
• Bond prices over time

FINA 3080 Prof. Chao Ying 19

 Characteristics of Bond
• Face or par value: payment at the maturity
• Coupon rate: annual interest payment per dollar of par
• Callable bonds (firms) ( besides to firm )
– The issuer can call back bonds if interest rate falls and
out of call protection period
– issue new bond at a lower coupon rate to reduce interest
-

=
-

payments.
– Priced lower than a non-callable bond: compensate
• Convertible bonds (bondholders)
– Convert bond to stocks when stock price increases
– Conversion ratio is pre-specified bennetts
– Priced higher than a non-convertible bond to bond hollers)
(
more

FINA 3080 Prof. Chao Ying 20

 Zero-Coupon Bonds
• No coupon payment; only a payment of par
value at maturity

• Value is the PV of the par payment

• Zeros are the most fundamental bonds

– Portfolio of zeros can replicate any no-default bond

FINA 3080 Prof. Chao Ying 21

 Building Bonds from Zeros
• Suppose an investor wants to buy 100 T-notes
– A 6% coupon rate; A 2-year maturity; Par = $1,000

0 6 12 18 24

-
/ 000*100 30*100 30*100 30*100 (30+1000)*100

• Replication: the investor could, instead, buy Par = 1000

– 3 of each of the following Zeros
$3m $3000
$3000
• Zero-coupon bonds: 6-month, 12-month and 18-month
– And 103 shares of 2-year Zeros
$103000

FINA 3080 Prof. Chao Ying 22

 Replication and Arbitrage
• T-note and portfolio of Zeros: same cash flows
– Same timing, same amount, and same risk (none)
– Investors should value them similarly
• Arbitrage is getting something for nothing
– Almost never possible in the real world
– So it’s reasonable to assume there’s no arbitrage
• No-arbitrage tells us about relative prices
– E.g., T-note and Zeros must have the same price

FINA 3080 Prof. Chao Ying 23

 Pricing and Valuing Bonds
• Bond value is just a present value calculation
– PV of coupon payments plus PV of par value
– Discount rate is the market interest rate
Mmm

• Bond price is the PV of future cash flows

T = maturity
Coupon Par Value
Bond Price = ∑t =1 (1 + r ) t
+
(1 + r ) T

FINA 3080 Prof. Chao Ying 24

Price: 10-yr, 8% Coupon, Face = $1,000
MKT in -1 .
rate : 6%

T = maturity
Coupon Par Value
Bond Price = ∑
t =1 (1 + r ) t
+
(1 + r ) T

Coupon = 1000*8%/2 = 40 (semiannual)

ordinary
Par Value= 1000 (annuity )
T = 20 periods
r = 3% (semiannual)
=> P=$1148.77

FINA 3080 Prof. Chao Ying 25

 T = maturity
Coupon Par Value
Bond Price = ∑t =1 (1 + r ) t
+
(1 + r )T

yield =
req rule
.
A retina =
mkt.int .
rate

pie par value

=

• 10-yr, 8% Coupon, Face = $1,000; r=8% issue at par.

• Prices and Yields (required rates of return): an inverse relationship
mm
• When yields approach zero, the value of the bond approaches the
sum of the cash flows

FINA 3080 Prof. Chao Ying

 Bond Prius 0 as wkt.int .
rules 0 ,
yield ↳band pret
Bond Prices at Different Interest Rates
(8% Coupon Bond, Coupons Paid Semiannually)

T = maturity
Coupon Par Value
Bond Price = ∑
t =1 (1 + r ) t
+
(1 + r )T

FINA 3080 Prof. Chao Ying

 Yield to Maturity (YTM) =
mkt
int .
rite
• YTM: internal rate of return (IRR) on a bond
– The discount rate that solves the pricing equation

• YTM is quoted as a bond-equivalent yield

T = maturity
Coupon Par Value
Bond Price = ∑ +
t =1 (
1 + YTMBEY
2
) (
t
1+ YTMBEY
2
T
)

FINA 3080 Prof. Chao Ying 28

 Yield to Maturity Example
20
35 1000
950 = ∑ +
(1+ r )
T
t =1 (1+ r )
t

10 yr Maturity Coupon Rate = 7%

Price = $950 ( Mke priest bond )
Solve for r = semiannual rate r = 3.8635%
YTM = 2*r.

FINA 3080 Prof. Chao Ying 29

 Yield to Call
• YTM: assume the bond will be held until maturity

• Callable bond: may retire prior to the maturity date

– If interest rate falls, the bond price rises

– Callable debt allows the issuer to repurchase the bond

at the call price.

– Yield to Call

FINA 3080 Prof. Chao Ying 30

 Bond Prices: Callable and Straight bond

• Straight (noncallable) bond: 30Y + 8% + $1000 par

• Callable bond: callable at 110% of par value ($1100)
• High r: the risk of call is small since p<<1100; f-slightly
price just
lower
St
than
)
benoit
• Low r: the risk of call is high since p is close to 1100.
.

-
-

FINA 3080 Prof. Chao Ying

 Other Yields lonponpnt face value

• Bond Equivalent Yield: semiannual rate x 2

• Effective Annual Yield: (1+semiannual rate)^2-1

• Current yield: Annual coupon payment/current price

• Realized compound yield (RCY):

– Return on a bond with all coupons reinvested

FINA 3080 Prof. Chao Ying 32

 Realized compound yield vs. YTM
• 2-year bond; par =$1000
• Annual 10% coupon payment
• YTM=10%, P0 =$1000
• Hold till maturity

P0*(1+RCY)2= V2

In A, V2 =$1210, RCY=10%

In B, V2 =$1208, RCY=9.91%

RCY=YTM when reinvestment rate = YTM.

FINA 3080 Prof. Chao Ying
 Holding Period Return
same

a
• HPR: Realized compound yield over holdings
periods greater than one period.

• The forecast of total return depends on both

1. Forecast of YTM when you sell the bond
2. Forecast of reinvestment coupon income

FINA 3080 Prof. Chao Ying 34

 HPR: Reinvestment and Resale
rate

Year 0 Year 20 Year 30

10
(1+6%)20 −1 75 1000
75 ∗ =2,758.92 966.45 = � +
6% (1 + 8%)𝑡𝑡 (1 + 8%)10
𝑡𝑡=1

FINA 3080 Prof. Chao Ying

 →
% ÷ .

FV
coupons
at
year
w FU of bond at yearn
"?T¥÷:-. a)
( selling price )
he investment rate
*
_÷,a¥ +¥÷i
= ×
=

= $2788.92 =
$966.45

=É]÷÷
HPRIRCY
←
at
FV of the year investment
20 ↳
year
6.90%
=
$2758.92T $966.45 :
$ 3725 .
37
=
 Comparison of Yields and Returns
( RC Y )
• YTM equals the realized compound yield when
– Reinvestment rate equals YTMrun

– Bond is held to maturity or YTM at sale is equal to

YTM at purchase
* be have YTM R LY
All rates have to
exactly same to =

• When does holding period return differ from

YTM?
– Change of YTM & sell before maturity
– Reinvestment rate not equal YTM

FINA 3080 Prof. Chao Ying 36

 Bond Prices over Time

• With constant interest rates, present value of

1. Par payment increases exponentially
2. Remaining coupon payments decreases exponentially
• Two effects exactly offset when the market interest rate equals
the coupon rate: issue at par.
• Premium bond: sell above par (r<coupon rate); 2nd dominates
• Discount bond: sell below par (r>coupon rate); 1st dominates

FINA 3080 Prof. Chao Ying

 Lecture 3: Assignments
• Finishing read chapter 1.1-6, 2.1-4, 3.1-5 & 7-9 (if
you haven’t already)
• Read chapter 10.1-4 &6 and skim 10.5
– Practice problems:
• PS: Ch. 10 (1-9, 12-18, 22-24, 28, 32, 36-42)
• CC: Ch. 10 (1-8)
• Work on Problem Set #1
– Due by 11 am on October 12th, 2022 (Wednesday).
– Please submit on BB.
– One group only needs to submit once. Write down group
members’ name & SID.
FINA 3080 Prof. Chao Ying 38