margin equals the maintenance margin of .3 is found by solving for P in the equation 100P $4,000 100P .3 which implies that P $57.14. If the price of the stock were to fall below $57.14 per share, the investor would get a margin call.   CONCEPT C H E C K ☞ QUESTION 3 If the maintenance margin in the example we discussed were 40%, how far could the stock price fall before the investor would get a margin call?     Why do investors buy stocks (or bonds) on margin? They do so when they wish to in- vest an amount greater than their own money alone would allow. Thus they can achieve greater upside potential, but they also expose themselves to greater downside risk. To see how, let us suppose that an investor is bullish (optimistic) on IBM stock, which is currently selling at $100 per share. The investor has $10,000 to invest and expects IBM stock to increase in price by 30% during the next year. Ignoring any dividends, the expected rate of return would thus be 30% if the investor spent only $10,000 to buy 100 shares. But now let us assume that the investor also borrows another $10,000 from the broker and invests it in IBM also. The total investment in IBM would thus be $20,000 (for 200 shares). Assuming an interest rate on the margin loan of 9% per year, what will be the in- vestors rate of return now (again ignoring dividends) if IBM stock does go up 30% by years end? The 200 shares will be worth $26,000. Paying off $10,900 of principal and interest on the margin loan leaves $26,000 $10,900 $15,100. The rate of return, therefore, will be $15,100 $10,000 $10,000 51% The investor has parlayed a 30% rise in the stocks price into a 51% rate of return on the $10,000 investment. Doing so, however, magnifies the downside risk. Suppose that instead of going up by 30% the price of IBM stock goes down by 30% to $70 per share. In that case the 200 shares will be worth $14,000, and the investor is left with $3,100 after paying off the $10,900 of principal and interest on the loan. The result is a disastrous rate of return: $3,100 $10,000 $10,000 69% I. Introduction 3. How Securities Are Traded The McGraw−Hill Companies, 2001