Special Security Purchases - Business Finance - ثاني ثانوي

4.3 Special Security Purchases Key Terms Margin Margin requirement Financial leverage Long position Derivatives Futures contract Mutual funds Exchange-traded funds Short position There are a number of different types of market orders that can be made based on an exchange's rules. These include margin purchases, short sales, and derivatives. Link to digital lesson www.den.edu. 4.3a Margin Purchases Investors can purchase securities on margin, which is buying the stock with a combination of the investors' cash and credit supplied by the broker. The phrase "on margin" can be confusing, since it is similar to buying "on credit: Margin is not the amount borrowed but is the investor's equity in the security. This amount is often expressed as a percentage: Мант An investor's equity in a security position Equity Margin Total value of portfolio EXAMPLE If an investor owns stock worth SAR 10,000 and borrows SAR 2,000 from the broker, the investor has SAR 8,000 of equity in the stock. (The amount of equity in any investment is the total amount minus the borrowed amount.) In this example, the equity is SAR 8,000 (SAR 10,000-SAR 2,000) and the margin is: وزارة التعليم SAR 8,000 80% = SAR 10,000 CHAPTER 4 An Introduction to Financial Markets 157

لنصر N Margin repultament The percentage of a purchase price that must be paid up front when buying securities Financial leverage Use of borrowed funds in return for agreeing to pay a fixed return, use of debt financing The margin requirement is the percentage of a purchase price that must be paid up front when buying securities. Individual brokers may require more margin, or a higher level of equity. The minimum payment required of the investor is the value of the securities times the margin requirement. EXAMPLE If the price of 1 share is SAR 100 and 100 are purchased, the investment is SAR 10,000 (SAR 100 x 100 shares). If the margin requirement is 60%, the investor must supply SAR 6,000 (10,000 x 60%) of cash equity to purchase the stock. The other SAR 4,000 (SAR 10,000-SAR 6,000) is borrowed from the broker. The broker will have a fee for allowing the investor to purchase on margin using the broker's funds. Investors use margin purchases to increase the potential return on the Investment. The use of borrowed funds in return for agreeing to pay a fixed return or the use of debt financing is referred to as financial leverage. You Try It Nora wants to purchase a stock on margin. Her broker will allow a 70% margin requirement. Nord wants to invest SAR 15,000 in the stock. How much must Nora provide to make the purchase of the stock? 158 Business Finance LIE How much will the broker loan for the purchase?

4.3b The Short Sale When an investor purchases a stock and profits when its price rises and sustains a loss when its price declines, it is called a long position. However, a long position is not the only way an investor can profit from a stock. An investor can also earn a profit from a decline in the price of a stock by taking a short position. In a short sale, an investor will borrow stock and sell it at a later date. If the price declines, the investor buys back the stock and pays off the loan (that is, pays off the borrowed stock). The investor earns a profit because the stock is bought for less than it was sold (at the borrowed level). Lung position The purchase of securities in ancipation of a price increase Short prition The sale of borrowed secures in anticipation of a price decrease EXAMPLE Assume a stock is selling for SAR 500. Nora believes that the stock is overvalued and that the price will decline. She borrows I share of the stock from a broker and sells this in the market for SAR 500. Several weeks later, the stock price has declined and she is able to purchase the share back for SAR 350. She then returns this to the broker. The proht on this trade is calculated by: Sale price- Purchase price Nora makes a profit of SAR 150 (500-350=150). However, if the stock price rises to SAR 650 before she can repurchase it, she will make a loss of SAR 150 (500-650=-150). You Try It Noro believes a stock will decline in value, she borrows and sells a shore for SAR 200. Two weeks later, she repurchases the share for SAR 140. What profit did she make from the transaction? وزارة التعليم CHAPTER 4 An Introduction to Financial Markets 159

Denvade Contracts between two parties that take their price from the value of an underlying asset such as stock, group of stocks (an index), or other measure An agreement to buy or sell a commodity contractor security at some point in the months or years to come Mutual funds An assortment of securities developed by investment firms and offered to investors Cahange-traded funds Like mutual funds but passive and traded like stocks 4.3c Other Securities There are a number of other securities available on the Tadawul exchange market as well as exchanges around the world. Many of these are created by and used by professional investors and companies. These securities carry higher risk. Derivatives are contracts between two parties that take their price from the value of an underlying asset, such as stock, group of stocks (an index), or other measure. As the price of the underlying asset changes, so does the value of the derivative contract. One type of derivative is a futures contract. A futures contract is an agreement to buy or sell a commodity contract or security at some point in the months or years to come. Most commodities have "futures market contracts, such as the oil and gas market or grain markets. A chemical company may not want to face the market risk of rising oil and gas prices used in their production so they will purchase a futures contract to lock in a price for the commodity to be received in the future. If the price of the commodity rises, the company benefits. If the price drops in the future, the company will pay higher than market rates. Exchange-traded funds and mutual funds Investors will often use exchange-traded funds or mutual funds as investment vehicles. Mutual funds are an assortment of securities developed by investment firms and offered to investors. These mutual funds can hold securities that match an overall market, an industry, or a portfolio of security investments (stocks and bonds). The mutual funds can be actively managed by the investment company, buying and selling securities as the market changes. They can also be passive or locked to a set of securities. Exchange-traded funds, or ETFs, are like mutual funds but are passive and trade like stocks. Like stocks, market makers provide bid and ask quotes to enhance liquidity for ETFs. 160 Business Finance

Exercises Answer the questions. 1. All wants to make two stock investments, one is a long position in stock A and one is a short position in stock B. Stock A is currently priced at SAR 200 and Stock B is priced at SAR 100. Ali takes a long position in 100 shares of Stock A and a short position in 100 shares of Stock B. A month later, Stock A is priced at SAR 220 and Stock B is priced at SAR 80. a. What is Ali's total gain/loss from the long position? b. What is Ali's total gain/loss from the short position? 2. A futures contract is an agreement to buy or sell a commodity or security at some point in the future. True/False وزارة التعليم 2921-19 CHAPTER 4 An Introduction to Financial Markets 161