Trading of securities Long position: (buy low and sell high) If price of securities is expected to increase in future that

is if you expect the bull market it is beneficial to buy them to gain from price appreciation (capital gain) and any other cash flow generated by it. Under this position investors buy the security at low, hold it until price appreciation and sell them at higher after collecting respective cash flow. So it is also known as buy low and sell high strategy or bullish strategy. Example: You expect that price of security is expected to increase in future. So you are going to buy 100 share of ABC Company which is currently trading at Rs. 500 each. You also expect company will pay Rs. 20 as dividend. A. Under cash trading find the HPR if, i. P1 = Rs. 600 ii. P1 = Rs. 400 (Note: Cash trading trading of securities by depositing 100% of transaction) Solution, Here, Expectation bull market Position long Nos. = 100 P0 = Rs. 500 D1 = Rs.20 1 + 1 0 1 0 + 1 = = = = 0 0 i) If P1 = Rs. 600 = If, P1 = Rs. 400 = 400 500 + 20 = 0.16 = 16 500 600 500 + 20 = 0.24 = 24% 500

B. Assume that it is margin trading with initial margin requirement of 60%. If so find the MVA equity and loan and prepare the balance sheet. (Note: margin trading trading of securities by depositing less than 100% for which you should open a margin a/c in brokerage house by depositing certain % of transaction amount (here 60%) i.e. called margin money paid, or down payment or initial equity deposit. Remaining part will be funded by broker as loan on which you should pay interest for that period.)

Here, N = 100 Po = 500 IM = 60%

MVA= 50,000 0.6 30,000 0.4 20,000

Balance sheet Assets MVA=50,000

Liabilities/capital Loan= 20,000 Equity= 30,000

C. Find the new MVA equity and loan a. if P1 = Rs.600 b. P1 =Rs. 400 Initially: MVA=50,000 0.6 0.4 MVA= 60,000 0.6 0.4 MVA=40,000 0.6 0.4

30,000 (equity)

20,000 (loan)

40,000 (equity)

20,000 (loan)

20,000 (equity)

20,000 (loan)

(Loan is constant in long position)

D. Find out the actual margin, i. In initial stage ii. If, P1= Rs. 600 iii. If P1 = Rs. 400 Actual margin (AM) = % of equity on new value of securities = % of equity in MVA = equity/ MVA (=

Solution, i. initially IM=AM=60% ii. If, P1 = Rs. 600, = iii. If, P1 = Rs. 400, =
40000 60000 20000 40000

= 66.66% = 50%

E. By assuming 10% interest on loan find the HPR if, i) P1 Rs. 600 and ii) P1= Rs. 400 Solution, = i) If, P1= Rs. 600 ii) If, P1= Rs. 400

1 0 +1 0 600 500+20 20 500 0.6 400 500+20 20 500 0.6

= =

= 33.33% = 33.33%

= 0 = 500 0.4 0.1 = . 20 F. What conclusion did you get about cash trading and margin trading? Trading Cash Margin P1 = Rs. 600 return 24% 33.33% P1 =Rs. 400 loss -16% -33.33%

Both return and loss are higher in margin trading than that of cash trading. So, margin trading is seems to be riskier than cash trading due to the use of loss (leverage) and payment of fixed cost (interest). G. If maintenance margin is 30% find out the triggering price that will trigger margin call. Maintenance margin it is the minimum additional margin to save the broker's loan. Triggering price equilibrium price to save the broker's loan after adjusting maintenance margin (MM). Margin call call or request or demand by broker for additional deposit to maintain MM. = = = % 1 1 1 0

200 = 285.71 1 0.3

H. Find out the minimum collateral for this transaction. Min = 20000 = = 28571 1 1 0.3

OR, = = 285.71 100 = 28571 . Find the actual collateral, 1. If, P1= Rs. 600 2. If P1 = Rs. 400 Actual collateral = new MVA= P1 * N 1. if P1 = Rs.600 then AC = 60000 2. if P1 = 400, AC = 40000 Solution,

1. more about margin call Will investor receive margin call if P1 = Rs. 250 On the basis of P1 and P*. Since P1 face below P* s/he will receive margin call. On the basis of actual and minimum collateral. If P1 = Rs. 250 = 1 = 250 100 = 25000 = 20000 = = 28571 1 1 0.3

Since actual collateral is less than minimum collateral, so s/he will receive margin call. On the basis of actual margin and minimum margin. If P1 = Rs. 250 = 5000 = = 20% 25000

Since AM is not sufficient to cover MM so s/he will receive margin call. Amount of margin call? = 1 = 285.71 250 100 = 3571 OR = 28571 25000 = 3571

Short position (Sell high buy low strategy) If price of securities is expected to decrease in future i.e. if you expect the bear market it is beneficial to sell the securities. If you sell your own securities that are known as just

selling but now our concern is short selling. Short selling means selling of securities (by borrowing from brokerage house) by promising to return back later whatever be the market price. This short selling action for a short period is known as short position. Under this position short seller (an investor) short sell other shares at high price, wait until price decrement and return them to the original owner by purchasing them at low price and they try to make speculative profit. So this is also known as sells high and buys low strategy or bearish strategy or a kind of speculation. Analysis of short position: For example, Price of ABC Company is expected to decrease in future so you are going to short sell 100 shares of ABC. Which are currently trading at Rs. 500 each and you also expect that company will pay Rs. 20 as dividend. If so, A. Under cash trading find HPR. If , i)P1 = Rs. 600 ii) P1 = Rs. 400 Solution, Here, price expectation Market bearish Position short No of shares (N) 100 P0 Rs. 500 D1 Rs. 20 0 1 1 . = = = 0 500 600 20 = = 24% 500 If P1 = Rs.400. 500 400 20 80 = = = 16% 500 500 B. By assuming margin trading with 60% initial margin requirement find MVA, equity, loan and prepare the balance sheet. Margin trading :- trading of securities by depositing less than 100% for which you need to open margin account by depositing certain % of transaction amount (here 60%) but it =

is not necessary to take loan from broker because the value of securities itself is loan (non-interest bearing) so, instead you will get interest in your initial deposit. Here, IM = 60% P0 = Rs. 500 N = 100 shares MVA = 80,000 P0*N (1+IM)

Equity Rs. 30000

Loan Rs. 50000

C. Find out the new MVA loan and equity if, i) P1 = Rs. 600 and ii) P2 = Rs. 400 Solution, Initially i) ii) MVA = 80000 MVA = 80000 MVA = 80000 P0*N (1+IM)

Equity Rs. 30000

Loan Rs. 50000

Equity Rs 20000

Loan Rs 60000

Equity Rs 40000

Loan Rs40000

In short position MVA is constant. D. Find the actual margin if, i) In initial stage ii) if P1 = Rs. 600 iii) if P1 = Rs. 400 Actual margin = % of equity on value of securities. = % of equity on loan =

Solution, i. In initial IM = AM = 60% ii. If P1 = Rs. 600, AM = 20000/60000 = 0.3333 = 33.33%

iii. If P1 = Rs. 400, AM = 40000/40000 = 0.100 = 100%

E. By assuming 10% interest on initial equity. Find out the HPR if, i) P 1 = Rs. 600 ii) P1 = Rs. 400 Solution, = i. If P1 = Rs. 600 . 500 . 600 . 20 + . 30 = 0.30 = 30% . 500 0.60 I = P0 *IM*I = 500*0.6*0.1 = 30 ii. If P1 = Rs. 400 500 400 20 + 30 = = 0.36667 = 36.67% 500 0.6 F. what conclusion did you get about cash trading and margin trading? Self G. If maintenance margin is 30% find out the triggering price that will trigger margin call? 1 + 1 + 0.6 = 0 = 500 = 615.4 1 + 1 + 0.3 OR Let triggering price = x x+30% of x = 800 = x=
800 1.3

0 1 1 + 0

= Rs. 615.4 OR 800 = = = . 615.4 1 + 1.3 H. Find out minimum collateral for this trading? = 1 + = 50000 1 + 0.3 = 65000 I. Find out actual collateral. = = 80000 More about margin call Will investor receive margin call if P1 = Rs. 650? On the basis of P1 and P*. Since 650(P1) 615.34(P*) investor will receive margin call.

 On the basis of actual margin and maintenance margin. MVA = 80000

Equity 15000

Loan 65000 =

15000 = = 23.07 65000 MM AM so s/he will receive margin call. On the basis of Actual collateral and minimum collateral. Actual collateral = old MVA = 80000 Minimum collateral = loan(1+MM) = 65000 (1+0.3) = 84500 Actual collateral is not sufficient to cover minimum collateral so s/he will receive margin call. Amount of margin call = P1 P* = (650-615.4) = 34.60 Or 34.60*100 = 3460