Buyingonmargin

Topic : Buying on margin

STOCK MARKET

Group 14 : Nguyễn Tường Linh Nguyễn Anh Phương Nguyễn Thu Hường Bùi Thị Thúy Hằng An Đinh Tú Quyên

Definition. Margin requirements. Stock margin trading. Exercises.

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Content:

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Definition: what is buying on margin?

The investor borrows part of the purchase price of the stock from a broker.

Margin: portion of purchase price contributed by the investor.

Investments with borrowing.Borrowing cash: buying on

marginBorrowing shares of stock:

short sales.

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Definition: what is buying on margin?

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Margin requirement

• - Imposed by the Federal Reverse

• - Representing the minimum proportion

of funds that must be covered with cash.

Limiting the proportion of funds that may be borrowed from the brokerage firm to make the investment.

Currently, at least 50% of investor’s invested funds must be paid in cash.

BUYING ON MARGIN PROCESS

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Establishing an account ( called margin account)

Depositing cash ( initial margin: must be at least 50% of

the total investment)

Maintaining the minimum proportion of equity

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

STOCK MARGIN TRADING


Maximum margin is currently 50%;

you can borrow up to 50% of the stock

value. (Set by the Fed)

Minimum margin is:

Minimum level of the equity margin.

Currently 30%, set by the securities

commissions. 8


Maintenance margin: minimum amount

equity in trading can be before additional

funds must be put into the account.

Minimum maintenance margin of New York

Stock Exchange ( NYSE) and Nasdaq : 25 %.

In Viet Nam, minimum maintenance margin

is up to the broker but not less than 40 %

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Margin call: notification from broker you

must put up additional funds.

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MARGIN TRADING – INITIAL CONDITIONSIBM price $100

# of shares purchased 100

Total stock value $10,000

Loan from broker $4,000

Assets Liabilities and owner’s equityStock $10,000 Loan from broker $4,000

Equity $6,000

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Margin = Equity/Stock = 6,000/10,000 = 60%

MARGIN TRADING – MAINTENANCE MARGIN

IBM price $100




Assets Liabilities and owner’s equity

Stock $10,000 $7,000 Loan from broker $4,000

Equity $6,000 $3,000

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Margin = 3,000/7,000 = 43% < 50% = Maintenance Margin

$70

$7,000

Broker issues a Margin Call!

MARGIN TRADING - MARGIN CALLHow far can the stock price fall before a

margin call?

IBM price P


Total stock value 100P


Assets Liabilities and owner’s equity

Stock 100P Loan from broker $4,000

Equity 100P-$4,000

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Margin = (100P-$4,000)/(100P) = 50% P=80

WHY BUY SECURITIES ON MARGIN?

Wish to invest more than what your money would allow.

Greater upside potentialGreater downside risk

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IMPACT ON RETURNS R = (SP- INV – LOAN + D ) / INV

Where: SP = selling price of stock INV = initial investment by investor, not

including borrowed funds LOAN= loan payments on borrowed

funds, including both principal and interest D = dividend payments

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WHY BUY ON MARGIN? EXAMPLEIBM price $100



Loan from broker $4,000 (interest rate: 10%)

Change in stock price

End-of-Year Value of shares

Repayment of Principal and

interest

Rate of return

Rate of return (if not buying

on margin)

30% increase

$13,000 $4,400 43% 30%

No change $10,000 $4,400 -6.7% 0%

30% decrease

$7,000 $4,400 -57% -30%

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LEVERAGING EFFECT OF MARGIN TRADE

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% = (30%x2-9%)

A 30% drop in the price, though, results in -69% ( -30%x2-9%) return.

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EXAMPLE AND EXERCISE 1: MARGIN TRADINGYou bought on margin one share of ABC at $70,

paying $35 of your own money. The minimum margin is set at 30%.A. Initial position.Stock $70 Borrowing = ? $35 Equity = ? $35B. New Position: Stock price=$40Stock $40 Borrowing =? $35 Equity = ? $5Margin= $5/$40 = 12.5%

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Margin call Investor is required to put up $7 to

bring up the margin to $12 ($5+7), or 30% ($12/40) of current value of stock.

How far can the stock price fall before a margin call?

(1xP - $1x35)/1xP = 30% P=$50

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EXAMPLE AND EXERCISE 1: MARGIN TRADING

X Corp $7050% Initial Margin40% Maintenance Margin1000 Shares PurchasedInitial PositionStock $70,000 Borrowed $35,000 Equity 35,000


How far can the stock price fall before amargin call?

(1000P - $35,000)x / 1000P = 40%

P = $58.33


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Buyingonmargin