As an investor, you expect the price of a start-up’s shares to drop in the near future due to an anticipated failure in technology. As a result, you sell 200 shares of this company at $17.50 per share. How much would you earn or lose on this transaction if you repurchased the shares four months later at a price of $14.75 per share?
The correct answer and explanation is :
Correct Answer:
You would earn $550 on this transaction.
Explanation:
To calculate how much you earned or lost on this transaction, let’s break it down step by step:
- Initial Sale of Shares:
- You sold 200 shares at a price of $17.50 per share.
- Total amount from selling:
[
200 \times 17.50 = 3500 \, \text{dollars}
] - So, you received $3500 from selling the 200 shares.
- Repurchase of Shares After Four Months:
- You then repurchased the 200 shares at a price of $14.75 per share.
- Total amount spent on repurchasing:
[
200 \times 14.75 = 2950 \, \text{dollars}
] - So, you spent $2950 to buy back the 200 shares.
- Calculation of Earnings or Losses:
- The difference between what you received from selling the shares and what you paid to repurchase them is your profit (or loss).
- Profit/Loss = Amount from selling – Amount spent on repurchasing
[
3500 – 2950 = 550 \, \text{dollars}
] - You earned $550 in profit from this transaction.
Key Takeaways:
- When you initially sold the shares at $17.50 per share, you received $3500 for the 200 shares.
- After four months, when the price dropped to $14.75 per share, you repurchased the same number of shares (200) for $2950.
- The difference between the amount you received and the amount you spent is your profit, which is $550.
- Essentially, by selling high and repurchasing low, you earned a profit of $550.
This strategy is an example of short selling, where you sell shares you do not currently own with the expectation that the price will fall. Later, you buy the shares back at a lower price to make a profit. In this case, the anticipated price drop worked in your favor, allowing you to earn money on the transaction.