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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 allo...
Investor need to open a separate margin account
apart from the cash account.
Investor need to enter into separate deriva...
Margin trading is just like a collateral.
Investor need to pay the interest on the
amount they borrow.
The longer they ...
 Only a portion of the
investment proceed comes from
your own money
•
• Remaining portion is borrowed from a
broker
• Bet...
• Increased buying power with less money.
• More profit with less investment.
• A trader can burrow up to half of his purc...
• Add more burdens on traders’ shoulders in losing trades.
• Cannot trade all stocks - like OTC stocks, penny stocks,
IPOs...
• Basic Margin Formula
• Example of Using Margin
Margin =
Value of securities − Debit balance
Value of securities
=
V − D
...
Return on
invested capital
from a margin
transaction
=
Total
current
income
received
−
Total
interest
paid on
margin loan
...
 X Corp. $70 current price
1,000 Shares Purchased
50% Initial Margin
40% Maintenance Margin
 Initial Position:
• Stock $...
If stock price falls to $60 per share,
New Position
Stock $60,000 Borrowed $35,000
Equity 25,000
Margin (%) = Equity in ac...
How far can the stock price fall before
getting a margin call?
Margin (%) = Equity in account / Value of stock
40% = (1,00...
Settlement of Financial
Contracts-An overview
Settlement of Contracts
Settlement of securities is a business
process whereby securities or interests
in securities are ...
Types of Settlement
1. Account period settlement or weekly
settlement: On NSE trading period is fixed
i.e., from Wednesday...
Settlement days and Delivery
 In India the settlement days for marketable stocks is usually
2 business days after the tra...
Settlement trade days in India
Instrument Days to Settle in India
Stocks 2 (2 days after trade date or "T + 2")
Money Mark...
Between 2002 –till date rapid progress
in market reforms
 Settlement cycles shortened to T+3
in April 2002, to T+2 in Apr...
The objectives of the reforms
in the securities settlement systems –
 Reduction and mitigation of systemic,
structural an...
Risks Involved in Settlement
 A number of risks arise for the parties during
the settlement interval, which are managed
b...
Nature of Settlement
 Settlement involves the delivery of securities
from one party to another. Delivery usually
takes pl...
Types of Settlement
Traditional (physical) settlement
 Prior to modern financial market technologies
and methods such as...
Types of Settlement (cont,d)
 Physical settlement securities still exist in
modern markets today mostly for private
(rest...
Electronic Settlement
 The electronic settlement system came about largely as a
result of Clearance and Settlement System...
Legal Significance
 After the trade and before settlement, the rights
of the purchaser are contractual and
therefore pers...
Settlement - Auction
Incase there is a shortage in Pay-in of
shares at the time of settlement on T+2,
the Stock Exchange ...
Settlement - Close Out
If the shares could not be bought in the
auction i.e. if shares are not offered for
sale in the au...
Settlement Cycle
 The settlement in the securities market is
done on a T+2 Rolling Settlement Cycle
(where T = Trading Da...
Margin trading and settlement of contracts  an overview
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Margin trading and settlement of contracts an overview

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Margin trading and settlement of contracts an overview

  1. 1. Securities Transactions: Margin Trading And Settlement of Contracts
  2. 2. Margin Trading An-Overview
  3. 3. • 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??
  4. 4. 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
  5. 5. 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
  6. 6.  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 be maintained with the broker as collateral for the
  7. 7. • 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:
  8. 8. • 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. Disadvantage s:
  9. 9. • Basic Margin Formula • Example of Using Margin Margin = Value of securities − Debit balance Value of securities = V − D V Margin = V − D V = $6,500 − $1,200 $6,500 = 0.815 = 81.5% Margin Formulas
  10. 10. Return on invested capital from a margin transaction = Total current income received − Total interest paid on margin loan + Market value of securities at sale − Market value of securities at purchase Amount of equity at purchase • Return on Invested Capital Margin Formulas(cont,d)
  11. 11.  X Corp. $70 current price 1,000 Shares Purchased 50% Initial Margin 40% Maintenance Margin  Initial Position: • Stock $70,000 • Borrowed $35,000 • Equity $ 35,000 Ilustration Initial Margin
  12. 12. If stock price falls to $60 per share, New Position Stock $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 :
  13. 13. 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 :
  14. 14. Settlement of Financial Contracts-An overview
  15. 15. 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
  16. 16. 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.
  17. 17. 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.
  18. 18. 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
  19. 19. 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 ExperienceSharing the Indian Experience The processThe process
  20. 20. 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
  21. 21. 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.
  22. 22. 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.
  23. 23. 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.
  24. 24. 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
  25. 25. 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.
  26. 26. 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.
  27. 27. 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.
  28. 28. 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
  29. 29. 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 SETTLEMENT T + 2 FAILURE TO PAY-IN

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