Bulls, Bears, and Pigs
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“Bulls make money, bears make
money, and pigs get slaughtered.”.
. . . Old Wall Street Adage
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The Animals of Wall Street
• Bull – thinks stock prices will go up
• Bear – thinks stock prices will go
down
• Pig – is very greedy so “stays too
long at the trough” or engages in
high risk
• Chicken – is scared to be in the
market and reverts to CD’s and
money market funds
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Chart from June, 2010
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Important Investment Concept:
The risk-return
tradeoff says
that in order to
increase return,
an investor must
increase risk.
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The Ups and Downs of Making
Money in the Market
How do you increase return in a bull market?
Buy on margin
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Questions about Margin:
• What is “buying on margin”?
• How much of the purchase price
must be put up?
• Who determines that percentage?
• Why is the percentage borrowed
limited?
• What is the advantage of buying
stock on margin?
• What are the disadvantages?
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What is buying on margin?
• Buying on margin is buying stock
on credit.
• You actually borrow funds from the
brokerage.
• Why would a brokerage do that?
They earn more in fees from
selling more stock.
• Not all stocks are “marginable.”
• Not all investors can buy on credit.
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How much of the purchase price
must be put up?
• 50% is the margin on stock
• (Margin on bonds, etc. is lower)
• In the Stock Market Game,
students have $100,000 to invest;
however, the game allows players
to margin stocks, so teams can
effectively buy $200,000 of stock
(less broker’s fees and interest
charges.)
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Who determines the margin
percentage?
• The Federal Reserve determines
the percentage.
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Why is the percentage borrowed
limited?
• High borrowing can lead to high
losses.
• When the stock market crashed in
1929, high losses on margin
accounts were a cause.
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What are the advantages of buying
stock on margin?
• A buyer can buy more stock and
make higher returns.
• In other words, returns are
magnified.
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What are the disadvantages of
buying on margin?
• Losses are magnified just like the
gains are.
• Interest must be paid on
borrowing.
• The SMG charges 7% interest.
• In finance, the rate that is charged is
referred to as the “call money” rate,
and the rate is currently 2%.
• In a declining market, you could
get a margin call.
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Sample problem:
Mrs. Jones buys on margin 100 shares of
Coca-Cola at $30 per share.
1. The total market value of the stock Mrs.
Jones buys is $ _______.
2. The amount of money that Mrs. Jones must
pay for this purchase (her initial margin
requirement) is $_______.
3. The maximum amount of money that the
brokerage firm could lend Mrs. Jones (her
debt) is $ _______.
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4. Mrs. Jones’s equity is $ _______.
Sample problem:
Mrs. Jones buys on margin 100 shares of
Coca-Cola at $30 per share.
1. The total market value of the stock Mrs.
Jones buys is $3000.
2. The amount of money that Mrs. Jones must
pay for this purchase (her initial margin
requirement) is $1500.
3. The maximum amount of money that the
brokerage firm could lend Mrs. Jones (her
debt) is $1500.
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4. Mrs. Jones’s equity is $1500.
Mrs. Jones (cont.):
• The value of Mrs. Jones’s 100 shares of
Coca-Cola rises to $40 per share.
Calculate the following:
1. The market value of Coca-Cola in Mrs.
Jones’s account is now $ _______.
2. The amount of money she owes the
brokerage firm (her debt) is $ _______.
3. Mrs. Jones’s equity is $ _______.
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Mrs. Jones (cont.):
• The value of Mrs. Jones’s 100 shares of
Coca-Cola rises to $40 per share.
Calculate the following:
1. The market value of Coca-Cola in Mrs.
Jones’s account is now $4000.
2. The amount of money she owes the
brokerage firm (her debt) is $1500.
3. Mrs. Jones’s equity is $2500.
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Mrs. Jones (cont.):
• The value of Mrs. Jones’s 100 shares of
Coca-Cola falls to $20 per share.
Calculate the following:
1. The market value of Coca-Cola in Mrs.
Jones’s account is now $ _______.
2. The amount of money she owes the
brokerage firm (her debt) is $ _______.
3. Mrs. Jones’s equity is $ _______.
5-18
Mrs. Jones (cont.):
• The value of Mrs. Jones’s 100 shares of
Coca-Cola falls to $20 per share.
Calculate the following:
1. The market value of Coca-Cola in Mrs.
Jones’s account is now $2000.
2. The amount of money she owes the
brokerage firm (her debt) is $1500.
3. Mrs. Jones’s equity is $500.
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How does margin magnify returns?
• Price goes from $30 to $40:
• Return if not margined:
$40 - $30 / $30 = 33.3%
• Profit on margined account:
$4000 - $3000 = $1000
• Return on margined account:
$1000 / $1500* = 66.67%
* $1500 is the investor’s equity
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How does margin magnify returns?
• Price goes from $30 to $20:
• Return if not margined:
$20 - $30 / $30 = (33.3%)
• Profit on margined account:
$2000 - $3000 = ($1000)
• Return on margined account:
($1000) / $1500* = (66.67%)
* $1500 is the investor’s equity
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Margin Summary for SMG:
• Initial margin is 50%
• Maintenance margin is 30%
• Players will receive a margin call if total
equity in the portfolio falls below 30%.
• If the margin call is not met by the end of
the 3rd consecutive week, SMG will
automatically liquidate holdings beginning
with the least expensive stock based on
price per share.
• Interest is charged at the rate of 7%.5-22
The Ups and Downs of Making
Money in the Market
How do you increase return in a bear market?
Sell short
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Questions about Short Selling
• What is a short sale?
• Why is a short sale the reverse of the
usual stock trade?
• What is a “short cover”?
• Why do people sell stock short?
• Why might the price of stock drop?
• Why is selling short so risky?
• What costs are involved in selling short?
• Why is a margin account a must?
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What is a short sale?
• A sale of stock borrowed from a
broker . . .
• . . . borrowed with the intent of
purchasing the same number of
shares later to replace the
borrowed stock
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Why is a short sale the reverse of
the usual stock trade?
• Normal trade
1. Buy stock at lower price
2. Sell stock at a higher price
• Short sale
1. Sell stock at a higher price
2. Buy stock at a lower price
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What is a short cover?
• Buying back stock originally
borrowed from the broker in a
short sale
• Where does the broker get the
stock to loan? Brokers use stock
in their own accounts or stock “in
street name” in other accounts.
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Why do people sell stock short?
• Selling short is a way to make
money when a stock price falls
• Even in a general bull market,
some stocks may decline
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Why might the price of stock drop?
• Bad macroeconomic news
• Bad company-specific news
• Geopolitical events
• What John Maynard Keynes once
called “animal spirits”
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Why is selling short so risky?
• Although the investor is betting
price will go down, if it goes up
instead, the stock must be bought
back at a higher price.
• When prices increase, there is
theoretically no ceiling.
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What costs are involved in selling
short?
• A broker’s fee is paid when the
stock is sold and then again when
it is bought back.
• In the SMG, the brokerage fee is
always 2% of the price.
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Why is a margin account a must?
• For the broker, the risk is that the stock
price will increase and the investor will
not be able to afford to buy back stock
for replacement.
• So, investors must place 50% of the
stock price in a margin account to use for
stock replacement.
• The money originally generated by the sale is
not made available to the investor—it is also
left in that account.
• Dividends that would have been paid by the
borrowed stock must also be replaced.
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Sample problem: Situation 1
• A stock owner sells short 200
shares of a stock at $50 per share.
He buys them back for
replacement (short covers) at $40
per share. Did he make a gain or a
loss? (Include both 2% broker’s
fees.)
• How much?
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Sample problem: Situation 1
• A stock owner sells short 200 shares
of a stock at $50 per share. He buys
them back for replacement (short
covers) at $40 per share. Did he
make a gain or a loss?
(Include
both 2% broker’s fees.) Gain
• How much?
$50 - $40 = $10 per share excluding
broker’s fees
$10 x 200 = $2000 – broker’s fees
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Sample problem: Situation 1
• How much? Considering broker’s fees
Short sale (200 x $50) =
$10,000
Broker’s fee ($10,000 x .02) - $200
Proceeds
$ 9,800
Short cover (200 x $40) =
Broker’s fee ($8,000 x .02)
Cost
$ 8,000
+ $160
$ 8,160
Proceeds from short sale
- Cost of short cover
Gain
$ 9,800
- 8,160
$1,640
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Sample problem: Situation 2
• A stock owner sells short 100
shares of XYZ Corporation at $20
per share and has to short cover
them at $40. Did she make a gain
or loss? (Include both 2% broker’s
fees.)
• How much?
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Sample problem: Situation 2
• A stock owner sells short 100
shares of XYZ Corporation at $20
per share and has to short cover
them at $40. Did she make a gain
or loss? (Include both 2% broker’s
fees.) Loss
• How much?
$20 - $40 = ($20)
($20) x 100 = ($2000) + broker’s fees
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Sample problem: Situation 2
• How much?
Short sale (100 x $20) =
Broker’s fee ($2,000 x .02)
Proceeds
$2,000
- $40
$ 1,960
Short cover (100 x $40) =
Broker’s fee ($4,000 x .02)
Cost
$4,000
+ $80
$4,080
Proceeds from short sale
- Cost of short cover
Loss
$ 1,960
- 4,080
($2,120)
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Sample problem: Situation 3
• A stock owner sells short 100
shares of Apple Pie Corporation at
$50 per share. The initial margin
requirement is 50%. How much
money must be deposited in the
margin account?
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Sample problem: Situation 3
• A stock owner sells short 100
shares of Apple Pie Corporation at
$50 per share. The initial margin
requirement is 50%. How much
money must be deposited in the
margin account?
100 shares x $50 = $5000
$5000 x .50 = $2500
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Sample problem: Situation 4
• The SMG requires that the equity in
a portfolio must be equal to 30%
of the market value of the short
sale. How much equity is needed
in the portfolio if $5000 worth of
stock is sold short?
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Sample problem: Situation 4
• The SMG requires that the equity in
a portfolio must be equal to 30%
of the market value of the short
sale. How much equity is needed
in the portfolio if $5000 worth of
stock is sold short?
$5000 x .30 = $1,500
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BETA
• Underlying the ability to gain on
margin trading or short selling is
the idea that the market must
move up or down.
• A stock which just sits there and
doesn’t move is counterproductive.
• How do you judge the likelihood
that the stock will move? BETA
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As the market moves,
beta measures stock
movement compared to
the market.
Theoretically, when
beta is 2.0 and the
market moves 5%, the
stock would move
10%.
(2.0 x 5% = 10%)
When beta is 1.0 and
the market moves 5%,
the stock would move
5%.
(1.0 x 5% = 5%)
When beta is .5 and the
market moves 5%, the
stock would move
2.5%.
(.5 x 5% = 2.5%)
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BETA
• Therefore, high beta stocks move more
than low beta stocks.
• Here is a major difference between real
life, and the SMG: when students are
playing a 10-week game, they often
look for high-beta stocks that will
move more than the market.
• It is very important to explain the
difference between “game playing”
versus long-term investing.
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BETA
Examples of beta: (from finance.yahoo.com)
Walmart
Exxonmobil
McDonalds
Gamestop
Aeropostale
Apple
Ebay
Sterlite Industries
.29
.37
.55
.96
1.01
1.44
1.75
2.64
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Stock Selection Ideas
• Students learn about the global
economy through focusing on where
the good investment opportunities are.
• Search out investment ideas in the
BRIC countries:
• Brazil
• Russia
• India
• China
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Stock Selection Ideas
• Avoid investments in the PIIG
countries:
• Portugal
• Ireland
• Italy
• Greece
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Stock Selection Ideas
• Technology stocks to analyze:
• Cloud computing
• Companies that feed the mobile device
market (3G or 4G networks, etc.)
• Cisco
• Broadcom
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