lec03-marginShortSale - Fin406 Fall 2009 Smeal College of...

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Fin406 – Fall 2009 Smeal College of Business Penn State University 1/18/2010 ©2009 JingZhi Huang 1 Lecture 3 Two Leveraged Strategies Fin 406 - Fall 2009 1 Professor Jingzhi Huang Smeal College of Business Penn State University Copyright © 2009 JZH Motivation Two simple and widely used trading strategies Evaluate Performance Trade Security Selection Asset Allocation Define Objectives and Constraints Develop Market Expectations •Return •Risk •Tax •Horizon •Economy •Markets •Risk-Return Model •Benchmark Portfolios •Risk-Return tradeoff •Fixed Income •Equity •Cash •Orders •Leverage •Margin •After-tax Returns •Risk •Risk-Adj. Ret. •Benchmarks 2 Buying on margin (borrowing cash from the broker) Short selling (borrowing securities) Understand the risk and return involved in two strategies At both the individual security and the portfolio levels Important concepts: margin, maintenance margin, margin call I. Buying on Margin Buying on margin means buying securities with borrowed funds from a broker How it works Open a margin (or cash-margin) account with your broker and Transfer/deposit the required minimum ( currently $2000 ) in cash or securities to the account 3 You can then borrow up to 50% of the value of stocks purchased. Namely, at least 50% ( the minimal initial margin ) of the value comes from your own The initial margin is set by Federal Reserve Potential benefits and costs of this strategy (over a simple long strategy) to investors More risky Consider a stock currently selling at $100. In one year it will be worth either $150 or $50. You have $10,000 in equity to invest $10,000 50% Margin Trade All Equity Trade Investment $10,000 Leverage = Asset/E = 1 / Margin A Long Strategy vs. Buying on Margin 4 $5000 $15,000 -50% 50% Loan $0 $10,000 Assets $10,000 $20,000 Assets ROI -100% +100% $10,000 $30,000 -$5000 $5,000 P/L -$10,000 $20,000 Levered Ret = Leverage x Ret 2* (-50%) = -100% 2* 50% = 100% Margin: Definition Definition Margin = Your equity in the account Value of stock in the account Margin measures
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This note was uploaded on 04/06/2010 for the course FIN 100 taught by Professor Staff during the Fall '08 term at Pennsylvania State University, University Park.

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lec03-marginShortSale - Fin406 Fall 2009 Smeal College of...

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