Transcript Margin call
How Securities are Traded • • 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: 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)