• Using only a portion of the proceeds for an investment

• Borrow remaining component• Margin arrangements differ for stocks and

futures

Margin TradingExample

with Trade12

• 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 $7050% Initial Margin30% Minimum Margin1000 Shares PurchasedInitial PositionStock $70,000 Borrowed $35,000 Equity $35,000

Margin Trading - Initial Conditions

Margin Trading - Minimum Margin

Stock price falls to $60 per share

New PositionStock $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

%30P000,1000,35$P000,1

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 ConditionsZ Corp 100 Shares50% Initial Margin30% Minimum Margin$100 Initial Price

Sale Proceeds $10,000Margin & Equity $ 5,000Stock Owed $10,000

Short Sale - Minimum Margin

Stock Price Rises to $110

Sale Proceeds $10,000Initial Margin $ 5,000Stock Owed $11,000Net Equity $ 4,000Margin % (4,000/11,000) = 36%

Short Sale - Margin Call

• How much can the stock price rise before a margin call?

So, P = $115.38

Note: $15,000 = Initial margin + sale proceeds

$15,000 $100 30%100

PP