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

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 Stock Margin Trading

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

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? 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 Corp100 Shares 50%Initial Margin 30%Minimum Margin $100Initial Price Sale Proceeds$10,000 Margin & Equity$ 5,000 Stock Owed $10,000

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

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