Trading on Margin Concepts and illustrations. Objective Understand how margin accounts operate.

Trading on MarginTrading on Margin

Concepts and illustrationsConcepts and illustrations

ObjectiveObjective

Understand how margin accounts operate

OutlineOutline

• Glossary

• On short selling

• Purchasing securities on margin

• Selling short securities on margin

• Aggregate margin trading

GlossaryGlossary

Margin AccountMargin Account

Account opened with a broker for the purpose of trading securities. The broker usually lends part of the funds.

Street NameStreet Name

Securities are held in the name of the street (that is, the broker) although they really belong to the investor .

Margin purchaseMargin purchase

Purchase in which part of the funds are provided through a loan by the broker.

Margin RequirementMargin Requirement

The minimum percentage of equity investors have to maintain (another measure of leverage).

MR = Account’s equity / Market value of securitiesMR = Account’s equity / Market value of securities

Short SaleShort Sale

A sell transaction in which the seller does not own the security yet.

Margin PurchaseMargin Purchase

The margin requirement for a long position

MRL = Value of account's equity / Market value of long position

Case1Case1

Buy 500 shares of Air Canada (AC) on margin

Stock price per share =$14

MRL = 40%

E = (0.4)$7,000 = $2,800

Need to borrow $ 4,200 from the broker

September 1 P(AC) = $ 14

500 AC shares$7,000

Debit Balance$4,200

Equity$2,800

September 3P(AC) = $ 15P(AC) = $ 15

500 AC shares500 AC shares$7,500$7,500

Debit Balance$4,200

EquityEquity$3,300$3,300

MRL = 3,300/7,500 = 0.44

Can take out cash or buy more shares

Case1: cont’dCase1: cont’d

September 15 P(AC) = $10P(AC) = $10


Debit Balance$4,200

EquityEquity$800$800

Margin callMargin call$1,200or

sell 300 sharesAssume paying $1,200 to reduce loan

September 21P(AC) = $9P(AC) = $9


Debit Balance$3,000

EquityEquity$1,500$1,500

Margin callMargin call$300orsell 84 sharesAssume selling 84 shares

Case1: cont’dCase1: cont’dSeptember 21P(AC) = $9

Assume selling 84 shares

416 AC shares

$3,744Debit Balance$2,244

Equity$1,500

MRL =40%MRL =40%

Margin Purchase: CommentsMargin Purchase: Comments

When market prices go up, the degree of leverage decreases

Change in market value of stock

Change in the value of equity

Short Sale on MarginShort Sale on Margin

The margin requirement for a short position

MRS = Value of account's equity / Market value of shorted securities

Case 2Case 2

Sell short 400 shares of Thunder Bay Casino Inc. P(TBC) = $ 20 MRS = 60%0.6 = E/$8,000

Need to deposit $4,800

September 1 P(TBC) = $20

400 shares$8,000

Equity$4,800

September 3P(TBC) = $ 15P(TBC) = $ 15

Cash

$12,800400 shares400 shares$6,000$6,000

EquityEquity

$6,800$6,800

MRS = 6,800 / 6,000 = 113%

Can take out up to $3,200

Assume we take out only $2,400

Initial cash

$4,800

Proceeds

$8,000

Case 2Case 2 cont’d

September 11 P(TBC) = $25P(TBC) = $25

400 shares400 shares$10,000$10,000

EquityEquity$400$400

Margin callMargin call

$5,600$5,600

or buy back

374 sharesAssume depositing $5,600

September 13P(TBC) = $27P(TBC) = $27

Cash

$16,000400 shares400 shares$10,800$10,800

EquityEquity

$5,200$5,200

Margin callMargin call

$1,280$1,280

or buy back

80 sharesAssume buying back 80 shares

Cash

$10,400

Case 2Case 2 cont’d

September 13P(TBC) = $27

Cash

$13,840320 shares$8,640

Equity

$5,200

MRS

$5,200/8,640 = 60%

Margin short sale: CommentsMargin short sale: Comments

When market prices go up, the degree of leverage rises

Change in market value of shorted stock

Change in the value of equity

Aggregate Trading on MarginAggregate Trading on Margin

May 4

Buy 100 shares of ABC at $30 (MRL = 40%)

Sell short 200 shares of XYZ at $10 (MRS =70%)

100 ABC shares$ 3,000

Initial cash$1,400

Proceeds$ 2,000

Debit balance

$ 1,800

Stock owed 200 XYZ

$2,000

Equity

$2,600 ($1,200 + $1,400)


May 5

P(ABC) = $35

P (XYZ) = $12

100 ABC shares100 ABC shares$ 3,500$ 3,500

Cash$3,400

Debit balance

$ 1,800

Stock owed 200 XYZStock owed 200 XYZ

$2,400$2,400

EquityEquity

$2,700 ($1,700 + $1,000)$2,700 ($1,700 + $1,000)

MRL = 48.6%

Can take out $300

MRS = 41.6%

Must add $680

What to do?What to do?

Add cash,

or

Buy back XYZ shares,

or

Sell ABC shares


May 5

P(ABC) = $35

P (XYZ) = $12


Cash$3,400 + $380 + $380

Debit balance

$ 1,800

Stock owed 200 XYZ

$2,400

EquityEquity

$3,080 ($1,400 + $1,680)$3,080 ($1,400 + $1,680)

MRL = 40%

MRS = 70%

Assume adding $380


May 5

P(ABC) = $35

P (XYZ) = $12


Cash$3,400 + $980$980

Debit balance

$ 1,800

Stock owed 200 XYZ

$2,400

EquityEquity

$2,700 ($1,008 + $1,692)$2,700 ($1,008 + $1,692)

MRL = 40%

MRS = 70.5%

Assume selling 28 ABC shares


May 5

P(ABC) = $35

P (XYZ) = $12


CashCash$2,848 $2,848

Debit balance

$ 1,800

Stock owed 154 XYZStock owed 154 XYZ

$1,848$1,848

EquityEquity

$2,700 ($1,400 + $1,300)$2,700 ($1,400 + $1,300)

MRL = 40%

MRS = 70.3%

Assume buying back 46 XYZ shares

Trading on Margin Concepts and illustrations. Objective Understand how margin accounts operate.

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Transcript of Trading on Margin Concepts and illustrations. Objective Understand how margin accounts operate.