Margin Trading
Example
• Using only a portion of the proceeds for an investment
• Borrow remaining component
• Margin arrangements differ for stocks and futures

Stock Margin Trading
• Greatest margin
– Currently 30%
– Set by the securities commissions
• Minimum margin
– Minimum level the equity margin can be
(called “maintenance” in USA)
• Margin call
– Call for more equity funds

Margin Trading - Initial Conditions
X Corp
50%
30%
1000
Initial Position
$70
Initial Margin
Minimum Margin
Shares Purchased
Stock $70,000 Borrowed $35,000
Equity $35,000

Margin Trading - Minimum Margin
Stock price falls to $60 per share
New Position
Stock $60,000 Borrowed $35,000
Equity $25,000
Margin% = $25,000/$60,000 = 41.67%

Margin Trading - Margin Call
• How far can the stock price fall before a margin call?
1 , 000  P 
1 , 000
$ 35 , 000
 P
 30 %
Therefore, P = $50
Note: 1,000xP – Amount Borrowed = Equity

Leveraging effect of margin purchases
• You buy 200 shares of XYZ at $100, expecting a 30% appreciation of the stock in one year:
– Initial margin: 50%
– Financed by a 9% loan for one year
– Expected net return: 51%
• A 30% drop in the price, though, brings a negative rate of return of -69%.

Short Sales
• Purpose: to profit from a decline in the price of a stock or security
Mechanics
• Borrow stock through a dealer
• Sell it and deposit proceeds and margin in an account
• Close out the position: buy the stock and return it to the owner

Short Sale - Initial Conditions
Z Corp
50%
30%
$100
100 Shares
Initial Margin
Minimum Margin
Initial Price
Sale Proceeds $10,000
Margin & Equity $ 5,000
Stock Owed $10,000

Short Sale - Minimum Margin
Stock Price Rises to $110
Sale Proceeds
Initial Margin
$10,000
$ 5,000
Stock Owed
Net Equity
$11,000
$ 4,000
Margin % (4,000/11,000) = 36%

Short Sale - Margin Call
• How much can the stock price rise before a margin call?
P

30%
100 P
So, P = $115.38
Note: $15,000 = Initial margin + sale proceeds