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Margin Trading

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Margin Providers Risk Management Strategy

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Margin Trading

  1. 1. Case Study-Assignment<br />Sri Lanka Margin Providers Risk Management Strategy<br />K.M.Waruna Sri Jayanath<br />FM/13/2010<br />
  2. 2. Introductions<br />This presentation presents a case study of Sri Lanka Margin Providers Risk Management Strategy<br />What is Margin Trading?<br />Market Trend <br />Future Opportunities in Equity Market<br />Margin Trading Role of CSE<br />Margin Factor<br />Portfolio Return<br />Risk Management<br />Risk Management Methodology and Strategy<br />
  3. 3. Margin Trading<br />Margin Trading is where an Investor pledges a Quoted Share Portfolio in his/her Central Depository System (CDS) Account to a financial institution and obtains credit up to 50% of the market value of the quoted share portfolio pledged. The 50% upper limit is the limit set by the Colombo Stock Exchange (CSE) and the Securities and Exchange Commission of Sri Lanka (SEC). <br />Tri-partite Agreement between the Lender, Borrower and the Stock Brokering firm. <br />
  4. 4. Market Trend <br />With the end of the 20 years civil war Sri Lanka is stabilizing the economy with the latest government lobbies as well as FDI (foreign Direct Investments). As a part of this Macro factors interest rates, inflation, GDP are moving upward in the line. Inline with these phenomena the openings for investment have becomes so aggressive among the financial institution in the region. This is evidenced by the Colombo Stock Exchange Index movements. Immediately with the end of the war the ASPI (All share price index) of Colombo bourse has doubled.(3000 to 7000).This shows the aggressiveness of the investment market specially investor confident on the Colombo bourse. Evidence will be the arrivals of new IPO as well as operation stock brokers in the region. The upward movement of the ASPI was largely supported by the Margin providers who have pumped billions of funds into the bourse and moved the ASPI toward 7000 levels. Significant increase in volumes of fund cause increased the risk of Margin Providers. Implementing risk management strategies are essential to manage risk.<br />MPI<br />ASPI<br />
  5. 5. Future Opportunities in Equity Market<br /><ul><li>ASPI recorded a growth of over 125% for 2009 and over 96% for 2010
  6. 6. Best performing index for the year on 22nd January 2009 – Bloomberg Newswire Statistics
  7. 7. World’s best performing Stock Market for the year 2009 on 05th October 2009 – Reuters
  8. 8. 2nd best performing Stock Market in the World - 2009 & 2010 – Bloomberg
  9. 9. Political Factors : Most of the companies are expanding to the former war zones and are diversifying into </li></ul> different business areas. <br /><ul><li>Economical : The economy has been growing despite the many challenges in recent years.
  10. 10. Technological : Developments in the technological front such as social networking, smart phones have </li></ul> led to new methods of information dissemination. <br /><ul><li>Legal : Continued relaxations of foreign exchange laws will ensure free flow of capital in the </li></ul> long term. <br />
  11. 11. Margin Trading Role of CSE<br />Margin Trading plays a vital role in Colombo bourse. The recent past after war era was a good example where margin trading played a pivotal role. The all share price index of the Colombo bourse rose from 3000 level to 7500 within a year. This shows more than 100% growth of the bourse.<br />If we analyze this growth we could see most of the dealing was undertaking through margin traders funds. The lenders has contributed and pumped billions of funds to the bourse. The major problem with the Colombo bourse was the liquidity problem and this was eroded by the margin providers fund and levered the index to rise toward 7500 levels. On this pretext if we see the very recent movement of the ASI it is travelling downward due the margin restrictions imposed by the SEC. Hence this scenario stands as a prominent evidence of margin trading as a key factor to Bourse.<br />The other side also could be argued with the same points as margin trading erode the liquidity of the bourse.<br />
  12. 12. Margin Factor<br />In Sri Lanka Stockbrokers can provide a margin up to 50%.<br />After the initial purchase, changes in the market price of the stock will cause changes in the investor’s equity, which is equal to the market value of the collateral stock minus the amount borrowed. Obviously, if the stock price increases, the investor’s equity as a proportion of the total market value of the stock increases; that is, the investor’s margin will exceed the initial margin requirement<br />You acquired 200 shares of a $50 stock for a total cost of $10,000.<br />A 50 percent initial margin requirement allowed you to borrow $5,000, making your initial equity $5,000<br />If the stock price increases by 20 percent to $60 a share, the total market value of your position is $12,000 and your equity is now $7,000 or 58 percent ($7,000/$12,000)<br />Increasing the percentage of gain or loss on your investment when the stock price increases or decreases<br />200*$50=$10,000<br />200*$60=$12,000<br />$5,000<br />41.67%<br />50.00%<br />
  13. 13. Margin Factor cont..<br />You acquired 200 shares of a $50 stock for a total cost of $10,000.<br />A 50 percent initial margin requirement allowed you to borrow $5,000, making your initial equity $5,000<br />If the stock price declines by 20 percent to $40 a share, the total market value would be $8,000 and your investor’s equity would be $3,000 or 37.5 percent ($3,000/$8,000)<br />Increasing the percentage of gain or loss on your investment when the stock price increases or decreases<br />200*$50=$10,000<br />200*$40=$8,000<br />$5,000<br />62.50%<br />50.00%<br />
  14. 14. Maintenance margin<br />The maintenance margin, which is the required proportion of your equity to the total value of the stock.<br />The maintenance margin protects the broker if the stock price declines. At present, the minimum maintenance margin specified by the SEC is 50 percent, but, again, individual brokerage firms can dictate higher margins for their customers. If the stock price declines to the point where your equity drops below 25 percent of the total value of the position, the account is considered under margined and you will receive a margin call to provide more equity. If you do not respond with the required funds in time, the stock will be sold to pay off the loan. The time allowed to meet a margin call varies between investment firms and is affected by market conditions. Under volatile market conditions, the time allowed to respond to a margin call can be shortened drastically.<br />200*$50=$10,000<br />200*$40=$8,000<br />$5,000<br />62.50%<br />50.00%<br />
  15. 15. Maintenance margin cont..<br />The maintenance margin, which is the required proportion of your equity to the total value of the stock.<br />The maintenance margin protects the broker if the stock price declines. At present, the minimum maintenance margin specified by the SEC is 50 percent, but, again, individual brokerage firms can dictate higher margins for their customers. If the stock price declines to the point where your equity drops below 25 percent of the total value of the position, the account is considered under margined and you will receive a margin call to provide more equity. If you do not respond with the required funds in time, the stock will be sold to pay off the loan. The time allowed to meet a margin call varies between investment firms and is affected by market conditions. Under volatile market conditions, the time allowed to respond to a margin call can be shortened drastically.<br />200*$50=$10,000<br />200*$60=$12,000<br />$5,000<br />41.67%<br />50.00%<br />
  16. 16. Portfolio Return<br />Stock Increased by 20%<br /><ul><li>The market value of the stock is $12,000, which leaves you with $7,000 after you pay off the loan.
  17. 17. The return on your $5,000 investment is:</li></ul>Stock Declined by 20%<br /><ul><li>The market value of the stock is $8,000, which leaves you with $3,000 after you pay off the loan.
  18. 18. The return on your $5,000 investment is:</li></li></ul><li>Risk<br />Buying on margin is to borrow money from a broker to buy stocks so margin-trading is risky<br />the cost of margin-trading could be high as interest is charged on the borrowed proceeds<br />Borrowed money, gains or losses are amplified.<br />Traders buying on margin could receive additional margin call on short notice and be forced to sell part or all the securities as price falling<br />The broker who lends money is able to close the leverage position by selling the securities without consulting the owner of the margin account<br />Risk involve in Margin Trading<br />Liquidity Risk <br />Equity Risk<br />Collateral Risk<br />Credit Risk<br />Legal (compliance) Risk<br />Operational Risk<br />
  19. 19. Strategic risk management process <br />Identification, Assessment, Monitoring, Reporting, Early Warning, Disposal, Evaluation. <br />Risk Management Strategy<br />Market Risk Strategy<br /><ul><li>Quota Management
  20. 20. Portfolio Management
  21. 21. Hedging
  22. 22. Compensation</li></ul>Liquidity Risk Strategy<br /><ul><li>Liquidity Ratio management
  23. 23. Cash Flow Analysis
  24. 24. Stress Testing
  25. 25. Sensitivity Analysis</li></ul>Credit Risk Strategy<br />Collateral Risk<br />Operational Risk Strategy<br />
  26. 26. Risk Management Methodology and Strategy<br />Margin Factor (T+3) <br />Settlement should be done on T+3 ,after T+3 interest charge for the loan($5,000). <br />To minimize the risk, margin factor calculate with considering client future cash flow.<br />200*$10=$2,000<br />T<br />T-3<br />T+3<br />$7,000<br />50.00%<br />200*$50=$10,000<br />200*$60=$12,000<br />$5,000<br />41.67%<br />50.00%<br />
  27. 27. Risk Management Methodology and Strategy<br />Lending Limit<br />Margin provider Impose maximum lending amount for the client. Client margin factor not more than 50% and loan amount should not greater than client maximum Loan amount.<br />200*$10=$2,000<br />T<br />T-3<br />T+3<br />$7,000<br />50.00%<br />200*$50=$10,000<br />200*$60=$12,000<br />$5,000<br />41.67%<br />50.00%<br />
  28. 28. Risk Management Methodology and Strategy<br />Security Value <br />According to share risk ,margin provider impose limits for the securities. <br />
  29. 29. Risk Management Methodology and Strategy<br />Portfolio Restriction <br />client couldn’t buy more than restricted percentage which is imposed by margin provider.<br />
  30. 30. Risk Management Methodology and Strategy<br />Portfolio Limit <br />
  31. 31. Risk Management Methodology and Strategy<br />Portfolio Limit <br />
  32. 32. Conclusion and Recommendations<br />In Sri Lanka Margin Trading system risk measure is in primary level. Risk Management strategies are developing in the county. I learn more margins trading risk management strategic application, combined with the margin providers. This case study explores the strategic risk management is the most urgent implementation a comprehensive risk management in Margin Trading in Sri Lanka.<br />Real Time Monitoring.<br />Client Credit Rating.<br />Implement Strategies Maximizing Profit.<br />Collateral Enhancement.<br />Cash Basis Margin Factor.<br />(t+1) Settlement Option.<br />
  33. 33. References<br /><ul><li>http://www.cse.lk/welcome.htm
  34. 34. http://www.srilankanequity.com
  35. 35. http://www.investopedia.com/
  36. 36. http://www.capitaltrust.lk.com/</li></li></ul><li>Thank you<br />

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