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Consider the situation where you are allowed to short sell shares in an asset against...

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Finance

Consider the situation where you are allowed to short sell shares in an asset against depositing money in a broker account that earns zero interest. We shall assume that as a retail investor you must deposit more funds into this account than the value of the shares you have sold short, and assume the initial and maintenance margin is 150% of this value (note that in the textbook this is referred to as a 50% margin). You short 1,000 shares. The initial price of the shares is 100, and the shares pay a dividend at the end of the first year of 5 per share. The price of the shares (ex-dividend) at the end of the first year is 99, and you buy back 500 shares at this point. The dividend at the end of the second year is 5 per share again. The price of the shares (ex-dividend) at the end of the second year is 90, and you clear your position by buying back the remaining 500 shares at the end of the second year. What is the return on your short sale transaction? You should assume you maintain the minimum margin requirements at all time.

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