Buying and Selling Securities

Group – A

Order SizeIt is the number of shares that is placed by the

buyer or seller while buying or selling common stock.

It involves:a) Round lot: It consists of 100 shares or a multiple

of 100 sharesb) Odd lot: It consists of 1 to 99 sharesc) Round lot and odd lot both: it consists of both

round and odd lote.g. placing an order of 325 shares (3 round lots

and an odd lot of 25 shares)But in case of Nepal, the round lot is of 10 shares

instead of 100 shares and odd lot is from 1-9 shares instead of 1-99 shares

Time limit

It is the limit specified by the investor (buyer or seller) while placing ordersIt could be one day, a week or monthIf the order is not filled by the end of the day, one day order gets cancelledSimilarly, weekly and monthly orders gets cancelled at the end of respective week or month

Time limit contd…

Open order (good-till-cancel), it is effective until the order is filled or cancelled by the investor

Fill or kill orders are cancelled if the broker is unable to fully execute them immediately

Discretionary orders is that order that consists of the decision making power to the broker; authority delegated by the investor

The authority consists of price & timing of the order

Types of order

1. Market order: Common type of order The broker is instructed to act (buy/sell)

immediately on a best effort to get the best possible price

Market orders are days order

2. Limit order

Here, the buyer sets a maximum price to purchase the share and the seller sets a minimum price to sell his/her stock

E.g. if the buyer sets a price of Rs. 675, then the broker only purchases the stock Rs. 675

Similarly, if a seller sets a price of Rs. 976 to his/her stock; the broker only sells the stock for rupees Rs. 976

3. Stop order• stop order is an order to buy or sell a stock once the

price of the stock reaches a specified price, known as the stop price. When the specified price is reached, your stop order becomes a market order.

• Buy Stop Order — Investors typically use a stop order when buying stock to limit a loss or protect a profit on short sales. The order is entered at a stop price that is always above the current market price.

• Sell Stop Order — A sell stop order helps investors to avoid further losses or to protect a profit that exists if a stock price continues to drop. A stop order to sell is always placed below the current market price.

4. Stop limit order• A stop-limit order is an order to buy or sell a stock

that combines the features of a stop order and a limit order. Once the stop price is reached, the stop-limit order becomes a limit order to buy or to sell at a specified price.

• The benefit of a stop-limit order is that the investor can control the price at which the trade will get executed. But, as with all limit orders, a stop-limit order may never get filled if the stock's price never reaches the specified limit price. This may happen especially in fast-moving markets where prices fluctuate wildly.

Long position with margin trading

• Long position involves simply buying and holding the assets in order to make profit from any price appreciation, cash dividends, interest or other incomes

• Popular strategy • Expectation of increasing prices of the

securities• Less risky (up to 100%,generally)

Long purchase contd…

• Single period rate of return can be calculated as follows:

Note: here tax, time value of money & brokerage commission are ignored

• It includes some major variables:1. Margin purchase2. Maintenance margin3. Trigger price

BP

DPSBPEPHPR

1. Margin purchase

• Investors purchase the securities by borrowing the portion of purchase price from the brokerage firm

• Range 40%-100%• Actual margin (margin purchase)

eofassetsMarketvalu

loaneofassetsMarketvalu

EPN

IMBPNEPN

)1(

2. Maintenance margin• It is the minimum actual margin that a brokerage firm will

allow investors to keep in their margin account• It is the compulsory proportion of total purchase price that

the investors have to maintain a minimum equity in the account.

• If am>mm, no need for margin call.• If am<mm, need for margin call.• Margin call is performed for (1)deposit cash or securities into

the account,(2)pay off part of the loan,(3)sell some securities currently held in the account.

Trigger Price• Trigger price is the price which must be maintained by the

investors.• If trigger price > ending price, margin call is performed.• If trigger price<ending price, margin call is not performed.• It can be calculated aswhere, = initial margin = maintenance margin = maintenance margin

BP

BPmm

im

1

1

im

mm

SHORT POSITION & MARGIN TRADING:

Short position Short position is that situation for investor on which an

investor borrows security and sells immediately. Later he/ she will purchase the same security and

replace that security to initial security holder. Broker plays a significant role on it. Objective is to earn profit from it. [sell security and later

expect to buy less price than beginning price] It also called as “ sell high, buy low” in past time.

SHORT POSITION WITH MARGIN TRADING:

Investor are allowed to short sell security of other investor. Investor deposits certain percentage market value of security

in form of cash (i.e. im) by opening margin trading account to brokerage firm.

Investor must purchase the same company’s stock and hand over to initial stockholder to meet obligation. (on this, investor have to pay DPS to stockholder, if company has given on that period)

On this period, investor may earn interest on initial deposit to brokerage firm at certain percent if there is an agreement between both, otherwise not.

The stock which are going to short sell process may came from :-

The inventory of stock owned by the brokerage firm itself.

The inventory of another firm.The holding of an institutional investor (such as

pension fund ) that is willing to lend its stock.The inventory of stock managed by investor

own self from friend or relative.

In short position with margin trading, Holding period rate of return for investor:- BP- EP- DPS+ Interest on initial deposit

HPR = BP*IM Where, BP = Beginning price of per share EP = Ending price of per share DPS = Dividend per share IM = Initial margin deposit Interest on deposit = BP* IM* interest

SHORT SELLING PROCESS :- (A). Before short sale

ABC CO.Security

Prime incorp.Brokerage firm

Mr. xStock owner

B. SHORT SELL PROCESS OCCURS:-

Prime incorp. Brokerage firm.

Mr. x owner of stock

Mr. yShort sell investor

ABC CO.

Mr. zBuyer of stock

Allows stock to be lent

1.

Deposit initial margin for short sell

Information flow

4

2

Pays purchase price

3

Receive stock certificate

5

Prime incorp. Brokerage firm.

Mr. x owner of stock

Mr. yShort sell investor

ABC CO.

Mr. zBuyer of stock

Allows stock to be lent

1.

Deposit initial margin for short sell

Information flow

4

2

Pays purchase price

3

Receive stock certificate

5

Prime incorp. Brokerage firm.

Mr. x owner of stock

Mr. yShort sell investor

ABC CO.

Mr. zBuyer of stock

Allows stock to be lent

1.

Deposit initial margin for short sell

Information flow about trans.

4

2

Pays purchase price

3

Receive stock certificate

5

Prime Incorp.

Mr. x

4 Acceptance of stock by

Mr. y

1 Cash flow to make up for dividends obligation if any, allow to purchase stock to name of Mr x. to pay off debt.

ABC CO.

3. Notified that Mr. x , now owns stock.

Mr. R

2. Purchase stock in name of Mr.. x

C. AFTER THE SHORT SALE :-

MARGIN CALL IN SHORT –POSITION:-

• It is the unfavorable situation in which the portion of equity in margin account goes down to the portion maintenance margin (MM), & the broker is in position to call or request to deposit additional cash in margin account to investor to maintain mm.

Margin call can be analyze by either 1. Trigger price 2. Actual margin

1. Trigger price :- it is that ending price , above which margin call will be take place in short position.

i. e. EP should be greater than TP. TP =

[ for decision : if EP> TP , the margin call should be made]

BPmm

im

1

1

2. Actual Margin (MM):- Actual margin shows the percentage of equity on particular ending price of stock.

i. e. AM should be less than < MM AM =

( For decision :- If AM < MM, the margin call should be made)

loan

loanAssets

loan

equityor,

EP

EPimBP )1(

EVALUATION OF RISK IN SHORT POSITION :-

Short position is more risky than long position due to :

price will increase in short position, if unfavorable situation exists

There is no upper limit of price of stockIn comparison to long position as the price

decrease and the loss is limited to 100%Therefore short position is riskier than long

position

Margin Trading : No existence in Nepal

Implications & importance: For investor: the investment gets multiplied For brokerage firm: income source For economic development

Thank-you

Any queries????