Leverage with Margin Transactions

Suppose you have an opportunity to purchase an Internet stock you really like. It is selling for $11 a share. You have about $5,500 to invest. So, you purchase 500 shares. A year later, you sell the stock at $33 per share. You receive about $16,300 after commissions on a $5,500 investment. Not bad.

However, you could use margin instead. Suppose you bought on margin 1,000 shares of an Internet stock for $11 a share. You put up 50 percent of the stock's purchase price ($5,500) and borrowed the rest from the brokerage firm. Next year, the stock is valued at $33 per share. If you sell the stock and repay the broker, you are left with close to $27,000 after commissions and interest charges. That is even better for a $5,500 investment.

However, what if your stock had dropped in price to, say, $8? In the cash transaction, you would receive about $3,900 back from your $5,500, but only $1,700 from the margin transaction after commissions and interest. That is bad and worse.

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