Margin Trading in Nepal

Margin Trading: Margin Trading refers to the practice by which one can purchase share in the higher amount than the money investor already have and it also helps to sell the security which is not owned by the investor. Margin trading, therefore, is used in both long & short position. Long position refers to buying of security own share in an expectation of drastically or dramatically price increase. But short position refers to selling of own security or short selling of others security, which are not owned by the investor (i. e. short seller).

In order to use margin trading, investor opens margin account in the brokerage house and deposits minimum initial down payment as required by that brokerage house and then purchase or sell the security. Long position and Margin Trading: Long position refers to buying of securities for oneself with the expectation of price increase. Therefore long position holder will have unlimited profit with limited loss (i. e. not more than 100%). Therefore return for long position holder is summation of capital gain and principal repayment (dividend and interest) HPR for long position holder = Ep- Bp +DtP1-P0+Dt Bp P0

Long Position under Margin trading: Long position is held when one expects that price of the security will dramatically increase. For that, investor opens margin account in brokerage house and deposits minimum initial down payment as per the initial margin. For e. g. if brokerage firm has the provision of 50% for initial margin , an investor who wants to purchase the security of Rs. 1 lakh has to deposit 0. 5? 100,000=Rs. 50,000 as initial margin . In case of margin trading change in price or fluctuation in price may change the holding of investor in the brokerage house account that is computed by actual margin.

When investor clears the entire due amount i. e. provided by brokerage house (loan) with its interest, s/he will have all his/her securities. Under margin trading & for Long position holder, the following components play vital roles. 1. Initial Margin (m) 2. Actual Margin (AM) 3. Maintenance Margin (mm) 4. Maintenance Call 5. Triggering Price /striking price for maintenance call (TP) 6. HPR for long position holder 7. Loan for long position Initial Margin: It refers to the minimum down payment percentage of the total value of share one is willing to purchase.

Initial Margin varies from brokerage house to brokerage house as per competition and legal rule. Actual Margin: Market value of assets changes as change in price. This results the change in value of Initial margin. So brokerage house timely check the magnitude of this margin. This new and changed margin is now called Actual margin instead initial margin. In other words, it refers to the degree of holding by the investor as per the price change in the security for the money deposited in the margin account. Therefore actual margin of long position holder increase when the price of the security increased and vice-versa.

Actual Margin is computed with the following equation. Actual Margin = Mkt. value of assets -loan Mkt. value of assets = MVA – loan MVA Maintenance Margin: When the price decreased, long position holder may default to the brokerage house . In order to overcome this risk, if brokerage house sets lower boundary units or limits that is known as Maintenance Margin. Therefore if actual margin is less than or equals to maintenance margin, brokerage house will call for maintenance or in other word investor has to deposit money to maintain maintenance margin all the times. Maintenance Call:

Maintenance Call is happened to be called when Actual Margin becomes less than equals to Maintenance Margin. For e. g. if maintenance margin is 35% and due to the price depreciation if actual margin becomes 35% or less than 35%, brokerage house will call for maintenance to maintain 35% all the time. Triggering Price /striking price for maintenance call: This price is the price of share when the maintenance call is happened to be called. Therefore if price decrease below the triggering price investor will receive maintenance call. In long position triggering price is calculated by following equation. Triggering Price = P0 (1-m) 1-mm) HPR for long position holder: HPR for long position holder includes three factors. For e. g. investor would have capital gain through price appreciation and principal repayment (i. e. dividend or interest) with the obligation of interest for the loan provided by brokerage house based on the equity investment. HPR = P1 – P0 + Dt –I (1- m) P0 Mp0 Where, P1 = Ending price/Selling price P0= Beginning price/ Purchase price Dt= Dividend received at time t I= Interest rate on Loan mp0= equity/initial down payment per share An investor purchase 1,000 shares of SP Co. at Rs. 100 with a brokerage house aving 60% initial margin, 35% maintenance margin with the provision of 10% interest. Find /If a) Statement of assets. b) Initial down payment. c) Actual margin at the time of share purchase. d) Actual margin when the price of the security becomes (i) Rs. 90 (ii) Rs. 110 e) Find, whether investor will receive maintenance call or not if price become Rs. 60. f) HPR for investor i) In part (d) If SP co. announces no dividend. ii) In part (d) If SP co. announces Rs. 4 as dividend. g) Triggering Price for maintenance call h) Money to be deposited in order to maintain maintenance margin all the time when the price fall at Rs. 0. i) By how much price of security should decrease from original price (in pre share basis) in order to get maintenance call. j) HPR as per part (d) assuming cash purchase. k) Why HPR in part (d) & (j) are different. a) Statement of assets. Mkt. value of assets = (100? 1,000) = 100,000 (Variable) Less: equity (initial margin) 60% of 100,000 = 60,000 (Balancing Figure) Loan Rs. 40,000 (constant) b) Initial down payment = Rs. 60,000 Alt. Initial down payment = P0? m? no. of share purchase = (100? 0. 60? 1,000) = Rs. 60,000 c) Actual margin at the time of share purchase.

MVA – Loan AM= MVA 100,000 – 40,000 100,000 = 60% From above calculation, actual margin is 60%. So what we can conclude is that, at the time of issue, Actual margin = Initial Margin d) Actual margin when the price is (i) Rs. 90 Before calculating Actual Margin, Lets us first prepare an statement of an assets. Mkt. value of assets (MVA) = 90? 1000 = 90,000 Less loan = 40,000 Equity50,000 Therefore, MVA – LoanEquity AM= =MVA MVA 90,000 – 40,000 90,000 = 55. 55% It means, due to fall in price of stock, initial margin falls to 55. 5% from 60%. This new margin in now termed as Actual Margin. If this margin further drops to 35% or below then investor will receive maintenance call. Actual margin when the price is (ii) Rs110 Mkt. value of assets (MVA) (110? 1,000) = 110,000 Less loan = 40,000 Equity70,000 Therefore, MVA – LoanEquity AM= =MVA MVA 110,000 – 40,000 110,000 = 63. 64% e) In order to find out whether investor gets maintenance call or not we have to first find out actual margin at price of Rs. 60 and compare this with maintenance margin.

If actual margin is less than equals to maintenance margin, then investor will receive call. Statement of an Asset at Price Rs. 60 Mkt. value of assets (MVA) =60,000 Less; loan = 40,000 Equity 20,000 Therefore, AM = 20,000 60,000 = 33. 33% Here, Actual margin (AM) < MM (Maintenance margin) i. e. 33. 33% < 35%, investor will receive maintenance call. Alternatively we can solve this problem by Triggering price method. Triggering Price100(1 – 0. 6)=Rs. 61. 38 1-0. 35 Triggering price Rs61. 38 means that if price of stock falls below Rs 61. 38, then investor will receive call.

Here, market price is Rs 60 which is below the triggering price (i. e. 60 < $ 61. 38 so receive call) so investor will receive call. f) Computation of HPR if dividend not declared. HPR simply refers the average return obtained from the investment during the holding tenure. It is the sum of Capital Gain and Normal gain less any other expenses. TO calculate HPR we use following equation. HPR = P1 – P0 + Dt – I (1- m) P0 M? Po When price is Rs. 90, 90 – 100 + 0 –0. 10 (1 – 0. 6) ? 100 = 0. 60? 100 = -23. 33% It means, by holding this investment, investor have to bear loss of 23. 33% on an average.

When price is Rs. 110, 110 – 100 + 0 –0. 10 (1 – 0. 6) ? 100 HPR == 10% 0. 60? 100 It means if price rises to 110, investor will get 10% avg return by holding this security. When dividend is declared. When price is Rs. 110, 110 – 100 + 4 –0. 10 (1 – 0. 6) ? 100 HPR == 0. 60? 100 g) Triggering PriceP0 (1 – m)100 (1 – 0. 60) == = Rs. 61. 54 (1 – mm) (1 – 0. 35) If price is less than this amount, company makes maintenance call. Justify {Statement (Triggering Price: AM = MM)} MVA(1000 ? 61. 54) = 61,540 Less: Loan= 40,000 Equity 21,540 21540 AM=61540 = 35% proved ) Price or money to deposit to maintain 35% maintenance margin when price becomes Rs. 50. Money to deposited (per share)=TP – MP = 61. 54 – 50 = Rs. 11. 54 Therefore, Total money to be deposited=11. 54 ? 1,000 = Rs. 11,540 i) Price to be decrease from initial price for maintenance call Price decreases = P0 – TP = 100 – 61. 54 = Rs. 38. 46 J) HPR in cash purchase; when Price =90 90 – 100 + 0= – 10% HPR = 100 When Price =110, 110 – 100 + 0= 10% HPR = 100 k) HPR in cash purchase and margin trading are different due to the initial investment. For ex in cash purchase one has to pay whole 100 per share.

In case of margin trading one may have one share having initial investment only Rs. 60. MP0 = 0. 60 ? 100 = Rs. 60 Balance sheet |Assets Liabilities + Capital | |MVA Loan | |Equity | Short Position and Margin Short position can also be used using margin trading . Short Position refers selling of securities which is not owned by investor.

If an investor (short seller) thinks that the price of particular security will drastically decrease, then he opens margin account in brokerage house and sells some share at higher price (today) . Then the proceed from short sale are also kept in brokerage house and it is treated as loan for short seller. When the price decreases, short seller purchases the share to recover the short position at lower price and gets capital gain due to the price depreciation. Therefore profit for, short seller doesn’t exceed 100% but loss might be unlimited because there is no limit for price increment.

Short position holder in other hand receive some interest for the money deposited (initial margin) in brokerage house. The following components play vital role. a) Initial Margin (M): It is a rate which short seller has to deposit in the brokerage house as per the total value of the short selling. It is initial down payment or known as minimum amount to be deposited. b) Actual Margin: It refers to the degree of holding of a short seller, based on price fluctuation. In case of short position, actual margin increase with the decrease in price and it is equal to initial margin at the time of short selling . It is calculated as follows.

Actual Margin=Total Market value of assets – Loan Loan c) Maintenance Margin (MM): It is the lower boundary of holding of short seller as per the initial margin deposited which changes with the change in actual margin. Therefore if actual margin becomes less than equals to maintenance margin, maintenance call is happen to be called, The price when maintenance call is called is triggering price and it is calculated as under. Triggering Price = P0 (1+M ) (1+MM) d) HPR for short seller: Short seller will receive total profit as the part of capital gain by price depreciation and interest given by brokerage house for the amount deposited.

But he has to meet some obligation by his return ie dividend paid to the share should be paid to actual share holder by short seller if company had announced dividend during the short selling period. HPR for short sellerHPR = P0 – P1 – Dt +I ? m ? P0 M? P0 Where, P0 = Beginning price (assume to be higher) P= =Ending price/Recovering price for short position (Buying back price) Dt = Dividend for the share (paid to the actual share holder) I = Interest rate (gives to Short seller by brokerage house) M = Initial Margin (for which interest is paid by brokerage house) E. g. Mr. C. K. C committed short selling arrangement with XYZ co. or HBL share. At present the price of HBL is Rs 100 and XYZ has provision of 50% initial down payment and 30% has to be maintained all the time If C. K. C. short sold 500 Shares of stock, Find a) Statement of assets b) Actual margin at the time of issue c) Actual margin when the price become (i) Rs 120 (ii) Rs 90 d) HPR as in part © price (i) if co. doesn’t announce dividend (ii) If co. Announce dividend of Rs 4 Remarks XYZ provides 8% interest rate e) What will be the triggering price for C. KC? f) Will C. KC receive maintenance call or not if price of the share increases to Rs 115. 9 or not. g) If price becomes Rs 115. 39 what will be the actual margin. h) How will much C. KC deposit to maintain maintenance margin if price becomes Rs 125 i) What will be the HPR if C. KC does cash trading return than margin trading based on the price explained in part © j) Why do you think HPR in part (d) and HPR in (I) are different Statement a) Mkt. value of assets (MVA/Loan)(100 ? 500) = 50,000 (Variable) Add. Equity initial margin (50% of 50000) = 25,000 (Balancing Figure) Total Mkt. Value (TMVA)75,000 (Constant) b) T MVA – Loan AM = Loan 5,000 – 50,000 == 0. 5 or 50% 50,000 It means at the time of issue, value of equity in total market value ie actual margin is equal with initial margin which is 50% c) I) Price = Rs 120 Statement a) Mkt. value of assets (MVA/Loan)(120 ? 500) = 60,000 (Variable) Add. Equity initial margin = 15,000 (Balancing Figure) Total Mkt. Value (TMVA)75,000 (Constant) T MVA – Loan AM = Loan 75,000 – 60,000 == 25% 60,000 d) 100 – 120 – 0 + 0. 013 ? 0. 50 ? 100 HPR = 0. 50? 100 100 – 100 + 4 + 0. 08 ? 0. 50 ? 100 HPR = 0. 50 ? 100 Comparative Table Long Position |Short Position | |(Margin Trading) |(Margin Trading) | |Actual Margin |Actual Margin | |AM= MVA – Loan |AM = TMVA – Loan | |MVA |Loan | | | | |Triggering Price |Triggering Price |P0(1-m ) |P0(1 + m ) | |(1-mm) |(1 + mm) | |Statement of Assets |Statement of Assets | |Mkt valve of assets (variable) *** |Mkt value of assets (Loan) (Var) *** | |Less: Equity (initial margin) *** | | |(Balancing Fig) |Add: Initial Margin(Equity) *** | |Loan (constant) **** |(Balancing Fig) | | |TMVA (constant) **** | Holding Period Return |Long Position |Short Position | |Without Margin |HPR = P1 – P0 +Div |HPR = P0 – P1 – Div | | |P0 |P0 | |With Margin |HPR = P1 – P0 +Div-P0(1-m)I |HPR=P0 – P1 +Div + P0 ? m? It | | |mP0 |mP0 | | | | | | | | | Where , It =Interest rate m= Initial Margin mm =Maintenance Margin ———————– Example: