Securities Transactions:

Margin Trading

And

Settlement of Contracts

Margin Trading

An-Overview

• Margin trading means we borrow from broker to invest in stocks.

• It increase borrowing power of the investor.

• It allow the investor to buy more than normal stock which he can actually purchase.

What do we mean by margin??

Investor need to open a separate margin account apart from the cash account.

Investor need to enter into separate derivative agreement.

A minimum amount is needed to open a separate margin account 2000$. This deposit is known as minimum margin.

there is another restriction which is known as maintenance margin, it is the minimum amount that the investor need to maintain.

Requirement for margin trading

Margin trading is just like a collateral.Investor need to pay the interest on the

amount they borrow.The longer they hold margin stocks they

need a high return to break even Thus margin trading is generally preferred

for short term investment.

Cost of margin trading

Only a portion of the investment proceed comes from your own money

• • Remaining portion is borrowed from a broker

• Bet on a rise in the price of the security

• Higher leverage, magnifying upside and downside risks

• Stocks purchased on margin must bemaintained with the broker as collateral for the loan

• Increased buying power with less money.• More profit with less investment.• A trader can burrow up to half of his purchasing price as initial margin.• Greatly suitable for day traders, who need to complete more number of trades with higher volume stocks.• Suitable for experienced traders, having knowledge of stock market trend patterns.

Advantages:

• Add more burdens on traders’ shoulders in losing trades.• Cannot trade all stocks - like OTC stocks, penny stocks, IPOs etc.• Your account balance and buying power changes with changes in stock prices.• The chance of margin call is always prevailing.• You are always obligated to keep a minimum account – the maintenance margin.• With falling stock prices the traders have much less control.

Disadvantages:

• Basic Margin Formula

• Example of Using Margin

Margin Value of securities Debit balance

Value of securities

V DV

Margin V DV

$6,500 $1,200

$6,500 0.815 81.5%

Margin Formulas

Return oninvested capitalfrom a margin

transaction

Totalcurrentincomereceived

Totalinterestpaid on

margin loan

Marketvalue ofsecurities

at sale

Marketvalue ofsecurities

at purchase

Amount of equity at purchase

• Return on Invested Capital

Margin Formulas(cont,d)

X Corp. $70 current price1,000 Shares Purchased50% Initial Margin40% Maintenance Margin

Initial Position:• Stock $70,000• Borrowed $35,000• Equity $ 35,000

Ilustration Initial Margin

If stock price falls to $60 per share,

New PositionStock $60,000 Borrowed $35,000

Equity 25,000 Margin (%) = Equity in account / Value of stock

= $25,000 / $60,000 = 41.67%

Rate of return = (25,000 – 35,000)/35,000 = -28.57% Rate of return if own money of $35,000 is used to buy 500 shares

= (30,000 – 35,000) / 35,000 = –14.28%

Maintenance Margin :

How far can the stock price fall before getting a margin call?

Margin (%) = Equity in account / Value of stock

40% = (1,000P - $35,000) / 1,000P

P = $58.33

If stock price falls below $58.33, one gets a margin call

Margin Call :

Settlement of Financial Contracts-An overview

Settlement of Contracts

Settlement of securities is a business process whereby securities or interests in securities are delivered, usually against (in simultaneous exchange for) payment of money, to fulfill contractual obligations, such as those arising under securities trades

Types of Settlement

1. Account period settlement or weekly settlement: On NSE trading period is fixed i.e., from Wednesday to Tuesday.

2. Rolling settlement: currently T+2 system is followed.

Settlement days and Delivery

In India the settlement days for marketable stocks is usually 2 business days after the trade is executed, and for listed options and government securities it is usually 1 day after the execution.

The settlement cycle in India is T+2 days.T+2 means the transactions done on the Trade day, will be settled by exchange of money and securities on the second business day (excluding Saturday, Sundays, Bank and Exchange Trading Holidays). Pay-in and Pay-out for securities settlement is done on a T+2 basis.

As part of performance on the delivery obligations entailed by the trade, settlement involves the delivery of securities and the corresponding payment.

Settlement trade days in India

Instrument Days to Settle in India

Stocks 2 (2 days after trade date or "T + 2")

Money Market

Mutual Fund

Typically 1 ("T + 1" or "next day"), though can be 0 ("same day")

Options 1

Regular business days from trade date; dates/terms to settle instruments

Between 2002 –till date rapid progress in market reforms

Settlement cycles shortened to T+3 in April 2002, to T+2 in April 2003 Derivatives products expanded – to include single stock options and futures. The market picked up Margining system in cash and derivatives – VaR based and real time SPAN Risk management refined STP introduced

Sharing the Indian Experience Sharing the Indian Experience The processThe process

The objectives of the reforms in the securities settlement systems –

Reduction and mitigation of systemic, structural and operational risks Increase speed of transaction, execution and settlement of trade and facilitate Quicker settlement of transactions with finality Safety of the settlement process Reduction of transaction costs and thereby Make market more efficient and transparent for investors and participants

Sharing the Indian Experience Current market structure

Risks Involved in Settlement

A number of risks arise for the parties during the settlement interval, which are managed by the process of clearing, which follows trading and precedes settlement.

Clearing and settlement is a  post trade activity therefore market risks in the future.

Clearing involves modifying those contractual obligations so as to facilitate settlement, often by netting and novation.

Nature of Settlement

Settlement involves the delivery of securities from one party to another. Delivery usually takes place against payment, but some deliveries are made without a corresponding payment (sometimes referred to as a free delivery).

Examples of a delivery without payment are the delivery of securities collateral against a loan of securities, and a delivery made pursuant to a margin call.

Types of Settlement

Traditional (physical) settlement Prior to modern financial market technologies

and methods such as depositories and securities held in electronic form, securities settlement had involved the physical movement of paper instruments, or certificates and transfer forms.

Payment was usually made by paper check upon receipt by the registrar or transfer agent of properly negotiated certificates and other requisite documents.

Types of Settlement (cont,d)

Physical settlement securities still exist in modern markets today mostly for private (restricted or unregistered) securities as opposed to those of publicly (exchange) traded securities, however payment of money today is typically made via electronic fund transfers .

Physical/paper settlement involves higher risks, inasmuch as paper instruments, certificates, and transfer forms are subject to risks electronic media are not more or less such as loss, theft, counterfeit, and forgery

Electronic Settlement

The electronic settlement system came about largely as a result of Clearance and Settlement Systems in the World's Securities Markets, a major report in 1989 by the Washington-based think tank, the Group of Thirty.

In an electronic settlement system, electronic settlement takes place between participants. If a non-participant wishes to settle its interests, it must do so through a participant acting as a custodian.

The interests of participants are recorded by credit entries in securities accounts maintained in their names by the operator of the system. It permits both quick and efficient settlement by removing the need for paperwork, and the simultaneous delivery of securities with the payment of a corresponding cash sum (called delivery vs payment, or DVP) in the agreed upon currency.

Legal Significance

After the trade and before settlement, the rights of the purchaser are contractual and therefore personal . Because they are merely personal, their rights are at risk in the event of the insolvency of the vendor. After settlement, the purchaser owns securities and their rights are propritery.

Settlement is the delivery of securities to complete trades. It involves upgrading personal rights into property rights and thus protects market participants from the risk of the default of their counterparties.

Settlement - Auction

Incase there is a shortage in Pay-in of shares at the time of settlement on T+2, the Stock Exchange purchases the requisite quantity in the Auction Market and gives them to the buying trading member.

Settlement - Close Out

If the shares could not be bought in the auction i.e. if shares are not offered for sale in the auction, the transactions are closed out as per SEBI guidelines

Settlement Cycle

The settlement in the securities market is done on a T+2 Rolling Settlement Cycle (where T = Trading Day).

Trading (T)

Option of Early Pay-in

(T1)

Auction (T3)

Close out (T4)

Pay-in and Pay out

(T2)

TRADE SETTLEMENTT + 2

FAILURE TO

PAY-IN