Margin call

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How Securities are Traded
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How firms issue securities
How securities are traded Trading
basics
Trading cost
Order type
Buying on margin
Short sales
Primary vs. Secondary Security
Sales
 Primary
 New issue
 Key factor: issuer receives the proceeds from the
sale
 Secondary
 Existing owner sells to another party
 Issuing firm doesn’t receive proceeds and is not
directly involved
Public Offerings
 Public offerings: registered with the SEC and sale is
made to the investing public
 Initial Public Offerings (IPOs)
Private Placements
Private placement: sale to a limited
number of sophisticated investors not
requiring the protection of registration
 Dominated by institutions
 Very active market for debt securities
 Not active for stock offerings
Costs of Trading
 Commission: fee paid to broker for making the
transaction
 Spread: cost of trading with dealer (NOT an
explicit cost, it is not a fee, but will affect your
return)
 Bid: price dealer will buy from you
 Ask: price dealer will sell to you
 Spread: ask - bid
Types of Orders
Instructions to the brokers on how to
complete the order
 Market order: executed immediately at current
market prices
 Limit order: An order specifying a price at (or better
than) which an investor is willing to buy or sell
 Limit buy: buy at price same or below the stipulated
limit price
 Limit sell: Sell at price same or above the stipulated
limit price
Types of Orders
 Stop order: trade is not executed unless stock hits a
price limit
 Stop-loss orders:


Def: A stock is to be sold if its price falls below a price limit
Idea: sell to stop further loss
 Stop-buy orders:



Def: a stock should be bought when price rises above a
limit
Idea: limit loss from short sales
Idea 2:don’t want to lose opportunity to buy before prices
goes even higher
Margin Trading
 Using only a portion of the proceeds for an investment
 Borrow remaining component
 Margin:
 The net worth (Equity) of the investor’s account
 Margin =Asset-Liability ( borrowed funds or stocks)
 % margin=Equity/Value of stock
 The idea for margin requirement: The % of decline of
your stock value before equity value drops to zero. It
serves as a cushion for the lender.
Stock Margin Trading
 Maintenance margin: minimum percentage of
margin in trading before additional funds must be
put into the account
 Initial margin: maintenance margin when first
purchasing the stock
 Margin call: notification from broker you must put
up additional funds
Margin Trading - Initial Conditions
X Corp
$70
50%
Initial Margin
40%
Maintenance Margin
1000
Shares Purchased
Initial Position
Stock $70,000 Borrowed $35,000
Equity
35,000
Margin Trading - Maintenance
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%
If sock price falls 41.67%, equity will be wiped out
(equity value will be zero).
Margin Trading - Margin Call
How far can the stock price fall before a
margin call?
(1000P - $35,000)* / 1000P = 40%
P = $58.33
* 1000P - Amt Borrowed = Equity
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
 Closing out the position: buy the stock and
return to the party from which is was borrowed
 % Margin=Equity / Values of stocks owned
Short Sale - Initial Conditions
Z Corp
50%
30%
$100
100 Shares
Initial Margin
Maintenance Margin
Initial Price
Sale Proceeds
$10,000
Margin & Equity
5,000
Stock Owed
10,000
Short Sale - Maintenance Margin
Stock Price Rises to $110
Sale Proceeds
$10,000
Initial Margin
5,000
Stock Owed
11,000
Net Equity
4,000
Margin % (4000/11000)
36%
If stock price rises 36%, equity will be zero.
Short Sale - Margin Call
How much can the stock price rise before a margin call?
($15,000* - 100P) / (100P) = 30%
P = $115.38
* Initial margin plus sale proceeds
Warning
 Don’t short!
 Short has unlimited potential loss
 Short is against the long term trend (positive return for
investing)
 Stay away from:
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Small cap, fast growing, high valuation (Netflix)
Potential turning around company (Ford)
Potential taken over target
Short candidates
 Stocks with a broken business model (BBI, DTV, BKS)
 and struggling in competition (Dell, MOT,NOK…)
 and with a high valuation
 and with a large Cap. (small cap stocks can rise very
fast and kill the shorts)
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