Equities Dividends, Margin, & Short Positions

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Orders  A trade order is an instruction conveyed to a broker who then executes or fills the order.  A broker needs clear instructions on how and when to trade

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Orders: Market  Buy 100 DVC  Buy 100 DVC at the lowest market price  Sell 100 DVC  Sell 100 DVC at the highest market price

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Orders: Limit  Buy 100 DVC limit $52  Buy 100 DVC at the lowest market price but do not pay more than $52  Sell 100 DVC limit $48  Sell 100 DVC at the highest market price but do not take less than $48

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Orders: Stop  A stop order becomes a market order as soon as the market price of a board lot reaches a specified level.

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Orders: Stop  Sell 100 DVC stop $40  I bought Discovery Café and now the price is going down. If it decreases to $40 sell me out before I lose even more money.  Buy 100 DVC stop $60  I short sold Discovery Cafe and now the price is going up. If it increases to $60, cover my short position before I lose even more money.

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Orders: Stop Limit  A stop order becomes a limit order as soon as the market price of a board lot reaches a specified level.

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Orders: Stop Limit  Sell 100 DVC stop $40 limit $35  I bought Discovery Café and now the price is going down. If it decreases to $40 sell me out but don’t take less than $35.  Buy 100 DVC stop $60 limit $65  I short sold Discovery Cafe and now the price is going up. If it increases to $60, cover my short position but don’t pay more than $65

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Equities  Dividends & Splits  Margin  Short Positions

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Dividends  Company Board of Directors  Declaration Date  Record Date  Pay Date  Primary Exchange  Ex-date

Chapter 8: Buying and Selling Equities Dividends Declaration Date Pay Date Record Date Ex Date The dividend is attached to the share. The dividend is detached from the share. T + 3 © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities Dividends: DVC Declaration Date $1/share Pay Date Record Date Ex Date John buys DVC at $51 Mary buys DVC from John at $50. John receives a dividend of $1. © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities Dividends © Oltheten & Waspi 2012  Must buy by 8/14 to get the dividend of record 8/17

Chapter 8: Buying and Selling Equities Splits Declaration DatePay Date Ex Date The shares trades at the pre-split price. The shares trade at the post-split price T-1 Number of shares adjusted for split after all trades are executed. © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities DVC splits 2:1 Declaration DatePay Date Ex Date John buys 1000 $100 for a total value of $100,000 The shares trade at the post-split price so John now has 2000 $50 for a total value of $100,000 UISES credits John’s portfolio with 1000 $0 © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Equities  Dividends & Splits  Buying on Margin  Short Positions

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Buying on Margin  Buying Stock with borrowed money  Margin: percentage you pay for yourself.  Leverage: amplification of return and risk. Leverage = 1. Margin

Chapter 8: Buying and Selling Equities $50 © Oltheten & Waspi 2012  1000 on 50% margin $50,000 Brokers Loan $25,000 50% Margin $25,000

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Leverage  DVC  $70 © Oltheten & Waspi 2012 $25,000 $70,000 $50,000 1.= 2 50%

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Not a partnership Similar to the CAPM exercise with β = 2 © Oltheten & Waspi 2012 $25,000 $35,000 $70,000 $50,000 $25,000 Equity: 50% +40%

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Leverage  DVC  $70 © Oltheten & Waspi 2012 $25,000 50% $25, % $70,000 $50, = 2 50%

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Leverage  DVC  $40 © Oltheten & Waspi 2012 $25,000 $40,000 $50, = 2 50%

Chapter 8: Buying and Selling Equities Margin Call  Margin Call of $5,000 $20,000 $25,000 $40,000 © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities © Oltheten & Waspi  Margin requirements of 10%  Leverage = 1/.10 =10  Small decrease in price triggered a cascade $1,000 $9,000 $10,000

Chapter 8: Buying and Selling Equities 1929 © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities % © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Regulation T  The account must have at least $2000 in cash or securities.  Initial margin of 50%  maintenance margin of 25%.  Most brokers have margin requirements stricter than Regulation T

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Equities  Dividends & Splits  Buying on Margin  Short Positions

Chapter 8: Buying and Selling Equities Long Position Buy Low Sell High © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities Short Position Buy Low Sell High © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Short Sell May 12Project a price decline on Discovery Cafe Borrow 100 DVC: Borrowing fee Sell 100 $ % Margin (regulation T) June 12Borrowing fee June 30Cover: Buy 100 $80 Margin returned Net

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Short Sell May 12Project a price decline on Discovery Cafe Borrow 100 DVC: Borrowing fee Sell 100 $ % Margin (regulation T) June 12Borrowing fee July 1DVC declares $3 dividend July 12Borrowing Fee July 30DVC dividend equivalent July 31Cover: Buy 100 $90 Margin returned Net

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Short Sell May 12Project a price decline on Discovery Cafe Borrow 100 DVC: Borrowing fee Sell 100 $ % Margin (regulation T) June 12Borrowing fee July 1DVC declares $3 dividend July 12Borrowing Fee July 30DVC dividend equivalent July 31Cover: Buy 100 $110 Margin returned Net

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Short Sales  Regulation T  initial margin of 150%  Maintenance margin of 130%  Tick Rules  To prevent destabilization in down markets  Eliminated July 6, 2007  Numerous calls for restoration of the tick rules

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Short Position  By the end of the first month  The portfolio must be 50% invested.  This means that the value of purchases and sales must be at least 50% of the initial cash balance  The portfolio must have at least one short position.  All transactions must be in US Dollars.

Chapter 8: Buying and Selling Equities © Oltheten & Waspi 2012 Short Interest  Short Interest: 900,000 short. = 0.10 = 10% 9,000,000 shares outstanding  Days to Cover: 900,000 short. = 9 days to cover 100,000 shares/day

Chapter 8: Buying and Selling Equities Graphical Representation © Oltheten & Waspi 2012

Chapter 8: Buying and Selling Equities Graphical Representation © Oltheten & Waspi 2012

Equities