May 5, 2003	Monday	Rabi-ul-Awwal 2, 1424

How many times over the past have we heard glowing reports about a new economy—hundreds, maybe, thousands of times, right? With policies changing, political instability intervening and unexpected news booming from every where, mind you, this is not only the case with Pakistan. It is all across the world. Economists celebrate the broadening “service economy” and proclaim that in this economic growth, a new information age has been unprecedented in its vibrancy and scope. Rhetoric is cheap. Evidence is some thing else.

Imagine you’re sitting at the club table and then the dealer throws you an ace. You’d love to increase your bet, except that you are a little short on cash. Luckily, your buddy offers to spot you 500 and says you can pay him back later. Sounds tempting, doesn’t it? If the cards are dealt right you can win big and pay your buddy back his 500 with profits to spare. But what about the downside? If you lose then not only are you down with your original bet, but you still owe your friend 500. Borrowing money at the casino is like gambling-on-steroids. The stakes are high and your potential for profit is dramatically increased, consequently your risk is also increased.

Now, investing on margin isn’t gambling. However, you can draw some parallells between margin trading and the casino. Margin is a high risk strategy used by banks and its treasury departments all over the world, which can yield a huge profit if executed correctly. The dark side of margin is that you can lose your shirt and any other assets you’re wearing.

Every day is filled with new investment opportunities. You can’t always predict or expect them, but you can make the most of them. You have to be able to seize the moment. But what if the timing is not right because you don’t have cash readily available?

Flexibility: It’s what you need to make the most of your investment strategy. And it’s why many investors choose margin credit, which offers access to funds for your immediate needs. Your purchasing power is the amount of credit available based on the value of your eligible investments, which you can access at any time.

Most investors use investment financing, or “margin,” to diversify their portfolios, meet business liquidity needs or take advantage of timely investment opportunities. But you can also use it, like an emergency loan, for unexpected or short-term personal, family or business needs, such as major purchases or consolidating expensive credit.

With margin, you capitalize on and are in control of your own resources, which gives you opportunities to boost your investment returns. Of course, pledging securities as collateral involves special risks of which you need to be aware.

On the 24th of April 2003, Mr. Moin Fuda, Managing Director, Karachi Stock Exchange Ltd, told a Karachi daily that a committee was being formed to introduce new financial products in order to encourage investments at the KSE. He emphasized that a foreign bank (without mentioning any name) would start margin financing. According to him, by September this year, each brokerage company would be facilitated by internet trading, index trading, margin trading and financing.

Buying on margin: Buying on margin is borrowing money from a broker to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you’d be able to normally.

To trade on margin, you need a margin account. This is different from a regular cash account in which you trade using the money in the account. By law, to open a margin account your broker is required to obtain your signature. The margin account may be part of your standard account opening agreement or may be a completely separate agreement. An initial investment of at least Rs2000 is required for a margin account, though some brokerages require more.

This deposit is known as the minimum margin. Once the account is opened and made operational, you can borrow up to 50 per cent of the purchase price of a stock. This portion of the purchase price that you deposit is known as the initial margin. It’s essential to note that you don’t have to margin all the way up to 50 per cent, you can borrow less, say 10 or 25 per cent. Be aware that some brokerages require you to deposit more than 50 per cent of the purchase price.

You can keep your loan as long as you want, provided you fulfil your obligations. First, when you sell the stock in a margin account, the proceeds go to your broker against the repayment of the loan, until it is fully paid. Second, there is also a restriction called the maintenance margin, which is the minimum account balance you must maintain before your broker will force you to deposit more funds or sell stock to pay down your loan. When this happens, it’s known as a “margin call.”

Borrowing money isn’t without its costs. Regrettably, marginable securities in the account are collateral, in addition to this you’ll have to pay the interest on your loan. The interest charges are applied to your account unless you decide to make payments. Over time, your debt level increases as interest charges accrue against you. As debt increases, the interest charges increase, and so on.

Therefore, buying on margin is mainly used for short-term investments. The longer you hold an investment, the greater a return you need to break even. So you see that by holding an investment on margin for a long period of time, you stack the odds (the probability that you will make a profit) against you.

Margin call: In volatile markets, prices can fall very quickly. If the equity (value of securities minus what you owe the brokerage) in your account falls below the maintenance margin, the brokerage will issue a “margin call”. A margin call forces the investor to either liquidate his/her position in the stock or add more cash to the account.

Here’s how this works. Let’s say you purchase Rs20,000 worth of securities by borrowing 10,000 from your brokerage and paying 10,000 yourself. If the market value of the securities drops to 15,000, the equity in your account falls to 5,000 (15,000 - 10,000 = 5,000).As a result, the brokerage may issue you a margin call.

If you do not meet a margin call for any reason, the brokerage has the right to sell your securities to increase your account equity until you are above the maintenance margin. Even scarier is the fact that your broker may not be required to consult you before selling. Under most margin agreements, a firm can sell your securities without waiting for you to meet the margin call.

You can’t even control which stock is sold to cover the margin call. Because of this, it is imperative that you read your brokerage’s margin agreement very carefully before investing. The agreement explains the terms and conditions of the margin account including how interest is calculated, your responsibilities for repaying the loan, and how the securities you purchase serve as collateral for the loan.

Buying power: Let’s say you deposit 10,000 in your margin account. Because you put up 50 per cent of the purchase price, this means you have 20,000 worth of buying power. Then, if you buy 5,000 worth of stock, you still have 15,000 in buying power remaining. You have enough cash to cover this transaction and so you haven’t tapped into your margin. You start borrowing the money only when you buy securities worth over 10,000.

This brings us to an important point, the buying power of a margin account changes daily depending on the price movement of the marginable securities in the account.

Why use margin? It’s all about leverage. Just as companies borrow money to invest in projects, investors can borrow money and leverage the cash they invest. Every point a stock goes up is amplified with leverage. If you pick the right investment, margin can dramatically increase your profit.

A 50 per cent initial margin allows you to buy up to twice as much stock as cash in your account. It’s not difficult to see how there is the possibility to make significantly more money in a margin account than you can by trading from a pure cash position. It simply depends on whether your stock rises or not. The investing world will always be debating whether it is possible to consistently pick winning stocks. We’re not going to weigh in on that debate here, the point is that margin does give you the opportunity to amplify your returns.

The best way to demonstrate the power of leverage is with an example. Let’s imagine a situation that we’d all love to be in, one that results in hugely exaggerated profits:

We’ll keep with the numbers of 20,000 worth of securities bought using 10,000 of margin and 10,000 of cash. ABC Co. is trading at 100 and you feel that it will rise dramatically. Normally, you’d only be able to buy 100 shares (100 x 100 = 10,000). Since you’re investing on margin you have the ability to buy 200 shares (200 x 100 = 20,000).

ABC Co. then locks in Ali Rajab as a spokesman and the shares rocket up 25 per cent. Your investment is now worth 25,000 (200 shares x 125), and so you cash out. After paying back your broker the 10,000 you originally borrowed, you get 15,000, of which 5000 is profit. That’s a 50 per cent return when the stock went up 25 per cent. To simplify this transaction I didn’t take into account commissions and interest. Otherwise, these costs would be deducted from the profit.

Risks of borrowing: Margin borrowing has many advantages, and used prudently it can be an effective tool to help you achieve your financial goals. However, margin has certain associated risks and is not appropriate for all clients.

Because margin involves borrowing against the value of securities in your account, if the value of those securities rises or falls, the amount that you may borrow may also increase or decrease. You should also be aware of the following:

* By borrowing against the collateral in your account, you increase your risk of loss and you can lose more funds than you deposit in the account if the value declines;

* You may be sent a margin call requiring you to deliver to your brokerage firm additional collateral in the form of cash and/or securities to maintain your outstanding margin loan;

* You may not be given an extension of time in which to meet your margin call;

* Your securities may be sold without giving you the option to decide which securities should be sold from your account;

* You margin maintenance requirements may be increased at any time;

* You will be obligated to pay interest on the amount of money that you borrow;

* Interest charges will be deducted from your account; * Your current margin debit balance will appear on each account statement sent to you;

* You will be charged interest on a monthly basis, and the interest rate and total interest charge will be included on your monthly statement.