csc3 inv products ch 9

CSI Global Education Inc.

Investment Products

CHAPTER 9: Equity Securities: Equity Transactions

2CSI Global Education Inc.

Chapter Highlights There are a variety of ways in which you can buy and sell

equities. You can buy the security outright through a cash account or go

long or short through a margin account. There are also many types of orders to consider when buying

and selling securities.


Speculative Trading Practices

Buying on Margin Long

Predicting prices will rise

Short Selling on Margin Short

Predicting prices will fall

Advantages & disadvantages of each?

Which position is riskier? Why?


Margin Example – Long Position

An investor believes that a stock will increase from $25 to $30. The investor has $2,500 to invest ($2,500 is usually the minimum required investment for margins, and stock margin accounts are generally based on a 50% margin).

Cash Account

The investor purchases 100 shares and the stock moves as predicted. The investor’s rate of return would be:

$3,000 – $2,500Return = = 20%

$2,500


Margin Example

Margin Account – Advantage of Leverage

The investor opens a margin account and purchases 200 shares. The broker puts up $2,500 and the investor puts up the other $2,500.

The share price goes to $30 per share. The investor’s rate of return would be:

$6,000 – $5,000Return = = 40%

$2,500


Margin – Long PositionOn listed securities selling: Maximum Loan Value:

Securities Eligible for Reduced Margin ____________________

at $2.00 and over ____________________

at $1.75 to $1.99 ____________________

at $1.50 to $1.74 ____________________

under $1.50 ___________________


Margin

On listed selling: Maximum SecuritiesLoan Value:

Securities Eligible for Reduced Margin 70% of market

at $2.00 and over 50% of market value

at $1.75 to $1.99 40% of market

at $1.50 to $1.74 20% of market

under $1.50 No loan value


Margin Exercise

a) Assume an investor goes long 5,000 shares of ABC Co. on margin when it sells for $2.25 per share (not eligible for reduced margin). How much would the investor have toput up as margin?

Total cost to buy ABC shares $11,250

Less: Dealer’s maximum loan(50% of $2.25 x 5,000) $ 5,625

Equals:Margin which is put up by the client $ 5,625

Or 50% x $11,250 = $5,625


Margin Exercise

b) Assume the price of ABC’s shares decline to $1.85. Will the investor get a margin call? If so how much?

Original cost of ABC shares (from above) $11,250

Less: Dealer’s revised maximum loan(40% of $1.85 x 5,000) $ 3,700

Equals: Gross margin requirement $ 7,550

Less: Client’s original margin deposit(2 above) $ 5,625

Equals: Net margin deficiency(for which a margin call is issued to the client) $ 1,925


Margin Exercisec) Assume in this case the price of ABC’s shares – instead of

declining to $1.85 – had increased from $2.25 to $2.75. What amount must be added to, or can be withdrawn from the account?

Original cost of ABC shares (1 above) $11,250

Less: Dealer’s revised maximum loan(50% of $2.75 x 5,000) $ 6,875

Equals: Gross margin requirement $ 4,375

Less: Client’s orig. margin deposit(2 above) $ 5,625

Equals: Excess margin in account $ 1,250

The $1,250 can be used as margin toward the purchase of another security, or withdrawn from the account.


Short Sales on Margin

On listed Minimum Credit securities selling: Balance in the Account:

Securities Eligible for Reduced Margin____________________

at $2.00 and over ____________________

at $1.50 to $1.99 ____________________

at $0.25 to $1.49 ____________________

under $0.25 ____________________


Short Sales

On listed Minimum Credit securities selling: Balance in the Account:

Securities Eligible for Reduced Margin130% of market

at $2.00 and over 150% of market

at $1.50 to $1.99 $3.00 per share

at $0.25 to $1.49 200% of market

under $0.25 100% of marketplus $0.25 per share


Short Selling

a) Assume that an investor sells short 500 shares of FED Company Ltd. (eligible for reduced margin) at its current market price of $15. How much must the investor put up as margin?

Minimum account balance required130% of $15 x 500 shares $9,750

Less: Proceeds from short sale500 x $15 $7,500

Equals: Minimum margin required $2,250


Short Selling

b) Assume that, later on, the price of FED’s shares declines to $12. Will the client have to put up more margin? How much must be added to or could be withdrawn from the account?

Minimum account balance required130% of $12 x 500 shares $7,800

Less: Proceeds from short sale500 x $15 $7,500

Equals: Minimum margin required $ 300


Short Selling

Since the client has already deposited margin of $2,250, the account now has excess margin of $1,950 ($2,250 – $300).

This amount may be withdrawn, or used to purchase more securities, or left in the account to cover possible margin calls should FED’s price begin to rise.


Short Selling

c) If the price of FED’s shares advanced to $18 instead of declining, would the client receive a margin call? If so, for how much?

Minimum account balance required(based on current price)130% of $18 x 500 shares $11,700

Less: Proceeds from short sale(based on original price)(500 x $15.00) $ 7,500

Equals: Minimum margin required $ 4,200

Less: Amount already deposited $ 2,250

Equals: Margin deficiency(for which a margin call is issued to the client) $ 1,950


Types of Orders

• Market Order (“At the Market”)

• Limit Order

• Day Order

• GTC

• AON

• Any Part

• Stop loss/buy

• Pro / N-C


Types of Orders

Market Order (“At the Market”)

An order to buy or sell a specific number of securities at the best price.

Limit Order

An order to buy or sell at a specific price or better.

Day Order

An order to buy or sell that is valid only for the day it is given. All orders are considered day orders unless otherwise stated.


Types of Orders

Good Till Cancelled (GTC) Order

An order that remains outstanding until executed or cancelled.

All or None Order

An order whereby the broker must execute the total number of securities specified before the client will accept a fill.

Any Part Order

An order in which the client will accept all stock in odd, broken or board lots up to the full amount of his order.


Types of Orders

Stop Loss

• An order to sell that becomes effective when the price of a board

lot declines to a specified level.

• Becomes a market order when the stop price is reached.

Stop Buy Order

• An order to protect a short sale. It instructs the broker to purchase shares when they reach a specified price.

• Becomes a market order when the stop price is reached.


Types of Orders

The Pro or N-C Order

Orders from members (partners, directors, IAs etc.) are stamped “Pro” (Professional) N-C (Non-Client) or EMP (employee), to deal with the preferential trading rule.

The Preferential Trading Rule

A trading regulation that means that the client’s order always has priority over a member’s order.

csc3 inv products ch 9

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