Stock Research – Margin debt has always been for the SUICIDAL???
Submitted by richardstoyeck
Millions of people use margin debt on a daily basis. Traditionally
what this means is the following. You buy 1000 shares of IBM and let’s
say you pay a $100 per share. You owe the brokerage firm $100,000.
This is the market value of your account if it is the only item in
your account. If you are a cash customer, you write a check for $100,000
by settlement date, and you own the 1000 shares of IBM free and clear
of any encumbrances.
There is another way to go however. You can buy the $100,000 worth
of IBM, and decide not to pay the full cost of the investment. Instead,
you open a margin account with the brokerage firm, sign the appropriate
documents and bingo, you can now buy that IBM by putting just 50%
down, and the brokerage firm lends you the balance. They don’t
do it for free however. They charge you a fee on the borrowed funds.
Depending upon how good a customer you are (frequency and size of
trades), the interest rate charged will vary.
In a sense margin debt is somewhat similar to how you bought your
house. When you bought your house, you probably did not fully pay
for it. Instead, you put more than likely, 20% down, and borrowed
the rest in the form of a mortgage from the bank. The difference is
that in financial world, you must put 50% down to purchase a stock.
The Other Big Difference
If you buy stocks on margin, and the stocks decline in value, you
could get called on the debt. Brokerage firms feel very comfortable
lending money for margin accounts because they hold the securities
as collateral. Brokerage firms begin to feel very uncomfortable when
those stocks begin to go down in value. If the stocks should go down
in value to the extent where the underlying securities are no longer
supporting the value of the account, the account is deemed to be negative
equity. This then becomes the brokerage firm’s worst nightmare.
It’s gets even better. Hedge funds are called hedge funds because
when they go long certain positions, they are supposed to be short
other positions to OFFSET the long positions. Hedge funds therefore
make their money on VOLATILITY. The laws allow hedge funds to borrow
(leverage) their capital base. This means instead of putting down
50% on an investment’s market value, they will use as much as
six times leverage. We have seen hedge funds go to ten times leverage.
Recently, we have also seen hedge funds crash and burn.
This is what you need to know. Years ago, when I was with the largest
investment firm in the world, we did an internal study. The study
showed that the average life expectancy of a margin account before
getting a margin call (the need to deposit more cash into an account)
was 19 months. This means in our opinion that if you are a margin
player, you will at some point get called on the account.
Are we in trouble with the amount of margin debt in this country?
Go to our website for a continuation of this article, and find out
for yourself, you are going to be SHOCKED at the answer.
About the Author
Richard Stoyeck’s background includes being a limited partner
at Bear Stearns, Senior VP at Lehman Brothers, Kuhn Loeb, Arthur Andersen,
and KPMG. Educated at NYU, and Harvard University, today he runs Rockefeller
Capital Partners and StocksAtBottom.com
http://www.stocksatbottom.com/
