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    The document discusses margin requirements and short selling. It defines initial margin and maintenance margin as the minimum amounts of equity an investor must provide at the time of purchase and maintain in a margin account. For common stock, the initial margin requirement is typically 50%. Maintenance margin is the minimum amount that must be maintained in the account to avoid a margin call. The document also provides an example of how to calculate return on invested capital for a margin transaction and defines pyramiding and short selling.

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    The document discusses margin requirements and short selling. It defines initial margin and maintenance margin as the minimum amounts of equity an investor must provide at the time of purchase and maintain in a margin account. For common stock, the initial margin requirement is typically 50%. Maintenance margin is the minimum amount that must be maintained in the account to avoid a margin call. The document also provides an example of how to calculate return on invested capital for a margin transaction and defines pyramiding and short selling.

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    The document discusses margin requirements and short selling. It defines initial margin and maintenance margin as the minimum amounts of equity an investor must provide at the time of purchase and maintain in a margin account. For common stock, the initial margin requirement is typically 50%. Maintenance margin is the minimum amount that must be maintained in the account to avoid a margin call. The document also provides an example of how to calculate return on invested capital for a margin transaction and defines pyramiding and short selling.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    23 views18 pages

    Market

    Uploaded by

    yunisis
    The document discusses margin requirements and short selling. It defines initial margin and maintenance margin as the minimum amounts of equity an investor must provide at the time of purchase and maintain in a margin account. For common stock, the initial margin requirement is typically 50%. Maintenance margin is the minimum amount that must be maintained in the account to avoid a margin call. The document also provides an example of how to calculate return on invested capital for a margin transaction and defines pyramiding and short selling.

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    of 18

    CHAPTER 2

    Continuation

    Margin Requirements
    The minimum amount of Equity that must be a margin investors own funds.

    Two types of margin requirements

    Initial Margin

    Maintenance Margin

    Initial Margin
    The minimum amount of equity that must be provided by the investor at the time of purchase.

    Restricted Account
    a margin accounts whose equity is less that the initial margin requirement.

    Initial Margin Requirements for Various types of securities


    Security Listed common and preferred stock OTC stock traded on Nasdaq National Market Convertible Bonds Minimum Initial Margin (Equity) Required 50% 50% 50%

    Corporate Bonds
    U.S government bills, notes, and bonds U.S government agencies Options Futures

    30%
    10% of principal 24% of principal Option premium plus 20% of market value of underlying stock 2% to 10% of the value of the contract

    Maintenance Margin
    The absolute minimum amount of margin (equity) that an investor must maintain in the margin account at all times.

    Margin Call
    Notification of the need to bring the equity of an account whose margin is below the maintenance margin level to have enough margined holdings sold to reach this standard.

    The Basic Margin Formula


    Margin = Value of securities Debit balance Value of securities Debit balance The amount of money being borrowed in a margin loan.

    Example Assume that you want to purchase 100 share of stock at $40 per share at a time when the initial margin requirement is 70%. What happens to the margin as the value of the security changes? If over time the price of the stock moves to $65, the margin will be?

    Margin = V D = $6,500 - $1,200 = 81.5% V $6,500

    Note that the margin (equity) in this investment position has risen from 70% to 81.5%. When the price oh the security goes up, the investors margin also increase.

    Return on Invested Capital


    ROIC is a profitability ratio. It measures the return that an investment generates for those who have provided capital. ROIC tells us how good a company is at turning capital into profits. Formula: Total Market Total Market current interest + value of - value of ROIC from
    income received paid on security margin loan at sale
    Amount of equity at purchase

    margin = _____________________________________________________ transaction

    securities at purchase

    Assume you want to buy 100 shares of stock at $50 per share because you feel it will rise to $75 within 6 mons. The stock pays $2 per share in annual dividends. You are going to buy the stock with 50% margin and will pay 10% interest on the margin loan. To find the expected ROIC from this transaction:
    ROIC from $100 - $125 + $7,500 - $5,000 margin = ________________________ transaction $2,500

    = ________ = 99%
    $2,500

    $2,475

    Pyramiding
    The technique of using paper profits in margin accounts to partly or fully finance the acquisition of additional securities.

    Excess Margin more equity is required than in a margin account.

    Short Selling
    The sale of borrowed securities, their

    eventual repurchase by the short seller, and their return to lender. Making money when prices fall is what short selling is all about.

    Margin Requirements and Short Selling


    to make a short sale, the investor must make a deposit with the broker that is equal to the initial margin requirement (50%) applied to the short sale proceeds.

    To demonstrate, assume that you sell short 100 shares of Smart Inc., at $50 per share at a time when the initial margin requirement is 50% and the maintenance margin on short sales in 30%.

    Items

    Initial Short Sale Price $50 5,000 $30

    Subsequent Share Price $70

    Price per share Proceeds from initial short sale

    Initial margin deposit


    Total deposit with broker Current cost of buying back stock Account equity Actual margin Maintenance margin position

    2,500
    7,500 5,000 $2,500 50% OK 7,500 3,000 $4,500 150% OK 7,500 7,000 $500 7.14% Margin Call

    Advantages and Disadvantages


    The major advantage of selling short is the

    change to profit from a price decline. The key disadvantage is that investor faces limited return opportunities, along with high risk exposure. A less serious disadvantage is that short sellers never earn dividend income

    Uses of Short Selling


    Investors short sell primarily to seek speculative profits when they expect the price of the securities to drop.

    END :D

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