Trading on Margin Concepts and illustrations

Objective Understand how margin accounts operate

Outline Glossary On short selling Purchasing securities on margin Selling short securities on margin Aggregate margin trading

Glossary Margin Account Account opened with a broker for the purpose of trading securities. The broker usually lends part of the funds. Street Name Securities are held in the name of the street (that is, the broker) although they really belong to the investor. Margin purchase Purchase in which part of the funds are provided through a loan by the broker. Margin Requirement The minimum percentage of equity investors have to maintain (another measure of leverage). MR = Account’s equity / Market value of securities Short Sale A sell transaction in which the seller does not own the security yet.

Margin Purchase The margin requirement for a long position MRL = Value of account's equity / Market value of long position

Case1 Buy 500 shares of Air Canada (AC) on margin Stock price per share =$14 MRL = 40% E = (0.4)$7,000 = $2,800 Need to borrow $ 4,200 from the broker September 1 P(AC) = $ AC shares $7,000 Debit Balance $4,200 Equity $2,800 P(AC) = $ 15 September 3 P(AC) = $ AC shares $7,500 Debit Balance $4,200Equity$3,300 MRL = 3,300/7,500 = 0.44 Can take out cash or buy more shares

Case1: cont’d P(AC) = $10 September 15 P(AC) = $ AC shares $5,000 Debit Balance $4,200Equity$800 Margin call $1,200 or sell 300 shares Assume paying $1,200 to reduce loan P(AC) = $9 September 21 P(AC) = $9 500 AC shares $4,500 Debit Balance $3,000Equity$1,500 Margin call $300 or sell 84 shares Assume selling 84 shares

Case1: cont’d September 21 P(AC) = $9 Assume selling 84 shares 416 AC shares $3,744 Debit Balance $2,244 Equity $1,500 MRL =40%

Margin Purchase: Comments When market prices go up, the degree of leverage decreases Change in market value of stock Change in the value of equity

Short Sale on Margin The margin requirement for a short position MRS = Value of account's equity / Market value of shorted securities

Case 2 Sell short 400 shares of Thunder Bay Casino Inc. P(TBC) = $ 20 MRS = 60% 0.6 = E/$8,000 Need to deposit $4,800 September 1 P(TBC) = $ shares $8,000 Equity $4,800 P(TBC) = $ 15 September 3 P(TBC) = $ 15 Cash $12, shares $6,000Equity$6,800 MRS = 6,800 / 6,000 = 113% Can take out up to $3,200 Assume we take out only $2,400 Initial cash $4,800 Proceeds $8,000

Case 2 Case 2 cont’d P(TBC) = $25 September 11 P(TBC) = $ shares $10,000Equity$400 Margin call $5,600 or buy back 374 shares Assume depositing $5,600 P(TBC) = $27 September 13 P(TBC) = $27 Cash $16, shares $10,800Equity$5,200 Margin call $1,280 or buy back 80 shares Assume buying back 80 shares Cash $10,400

Case 2 Case 2 cont’d September 13 P(TBC) = $27 Cash $13, shares $8,640 Equity $5,200 MRS $5,200/8,640 = 60%

Margin short sale: Comments When market prices go up, the degree of leverage rises Change in market value of shorted stock Change in the value of equity

Aggregate Trading on Margin May 4 Buy 100 shares of ABC at $30 (MRL = 40%)‏ Sell short 200 shares of XYZ at $10 (MRS =70%) 100 ABC shares $ 3,000 Initial cash $1,400 Proceeds $ 2,000 Debit balance $ 1,800 Stock owed 200 XYZ $2,000 Equity $2,600 ($1,200 + $1,400)‏

Aggregate Trading on Margin May 5 P(ABC) = $35 P (XYZ) = $ ABC shares $ 3,500 $ 3,500 Cash $3,400 Debit balance $ 1,800 Stock owed 200 XYZ $2,400Equity $2,700 ($1,700 + $1,000)‏ MRL = 48.6% Can take out $300 MRS = 41.6% Must add $680

What to do? Add cash, or Buy back XYZ shares, or Sell ABC shares

Aggregate Trading on Margin May 5 P(ABC) = $35 P (XYZ) = $ ABC shares $ 3,500 Cash + $380 $3,400 + $380 Debit balance $ 1,800 Stock owed 200 XYZ $2,400Equity $3,080 ($1,400 + $1,680)‏ MRL = 40% MRS = 70% Assume adding $380

Aggregate Trading on Margin May 5 P(ABC) = $35 P (XYZ) = $12 72 ABC shares $ 2,520 Cash $980 $3,400 + $980 Debit balance $ 1,800 Stock owed 200 XYZ $2,400Equity $2,700 ($1,008 + $1,692)‏ MRL = 40% MRS = 70.5% Assume selling 28 ABC shares

Aggregate Trading on Margin May 5 P(ABC) = $35 P (XYZ) = $ ABC shares $ 3,500Cash$2,848 Debit balance $ 1,800 Stock owed 154 XYZ $1,848Equity $2,700 ($1,400 + $1,300)‏ MRL = 40% MRS = 70.3% Assume buying back 46 XYZ shares