Страница 42 из 50
If you’re a stock or other securities trader, it’s important to understand how the different trading platforms and markets work. If you’re not an active trader, it’s still good to be familiar with the forces behind today’s markets, and to be aware of how fast things can change, and why.
85. INSIDER TRADING
Suppose you wanted to buy into the corner ice cream store. It looks like a great investment, and the “fringe benefits” of being an owner seem appealing too. So the founder and majority owner offers to let you buy shares. You’re happy about your investment, and ready to cash in (and eat) the proceeds. Everything goes well; your investment rises in value, and you get a nice discount on two-scoop helpings of chocolate peanut butter ice cream besides. Eventually you need the money for something else, and sell for a reasonable profit.
Shortly afterward, you find out that a major operator of ice cream parlors wants to add that store to its chain, and is willing to pay a handsome price for it. Then, in a casual conversation with your neighbor across the fence, you find out that she bought a boatload of stock at a ridiculously low price because the founder/owner gave her a tip that this might happen. She got a tip; you didn’t. She bought; you sold. Is that fair? Should you, also an owner—and other owners—have been privy to the same news before you sold?
Although we’re dealing with a small business, not a big, publicly traded corporation, you’ve been a victim of insider trading. An insider got information you weren’t privy to, and made money on it. What happened here isn’t technically illegal because the ice cream parlor wasn’t “public,” but it gives you an idea of what could happen when owners, directors, key managers, or employees disclose certain private information to privileged investors and not to everyone.
What You Should Know
Insider trading is the illegal trading of a public company’s stock or other securities based on “insider information”—information acquired as, by, or from someone who creates or has access to privileged information about a company not available to the general public. “Insiders” include company officers, directors, or beneficial owners (more than 10 percent) of a company’s stock. The general rule is that employees, by virtue of employment, put shareholder interests ahead of their own—all shareholders’ interests—so disclosing inside information to certain shareholders violates this principle.
That said, especially in today’s teleco
Several high-profile insider-trading cases have come up in recent years, and recent rulings have strengthened the hand of regulators to go after the perpetrators. Former hedge fund manager Raj Rajaratnam was sentenced to eleven years for his role in an insider-trading ring, where he set up at least four different insiders, three of whom were Harvard classmates, to pass information his way. This high-profile case has led to a greater crackdown on the activity, but it remains difficult to enforce, and especially to gain convictions. Still, the prospects of greater enforcement and jail terms have sent a powerful signal to corporate executives about disclosing anything that might be considered sensitive information.
Why You Should Care
First, if you’re an investor, know that you’re putting a lot of pressure on your friends and colleagues if you ask them to tell you what’s going on in the companies they work for. And if you work for a public company, be careful about what you tell others around you. Aside from that, insider trading has led to untold millions in profits for the perpetrators, at least indirectly at your expense. On the flip side, many feel that the recent crackdown has led to faster disclosure of information to the general public (once available to everyone, it isn’t “insider” any more), a good thing for all investors.
86. MARGIN AND BUYING ON MARGIN
Buying on margin refers to borrowing from your broker to buy a security, usually a stock, a bond, or a futures contract. The security, or other securities in your portfolio, is used as collateral. When you borrow to buy on margin, you pay margin interest rates set by the broker, usually a fairly high rate, but not as high as a credit card. Margin buyers are trying to buy larger positions than they can afford out of pocket in order to get more exposure—leverage—from their investments.
What You Should Know
To buy on margin, you must set up a margin account with your broker. Typically that means depositing a certain amount and signing several forms indicating you understand the terms and conditions. This can be done online with online brokers. And not all securities are marginable; some low-price or risky stocks, for instance, do not qualify for margin buying.
When you buy a security on margin, you must have enough collateral to make the purchase. This test comes in the form of a margin requirement, 50 percent for stocks, set by the Federal Reserve in the wake of the 1929 stock market crash. That means you must have at least 50 percent of the entire purchase available in your account as cash or equity. This is, of course, to prohibit you from borrowing too much, as many did in 1929 and before, when they borrowed up to 90 percent of their securities purchases.
That 50 percent requirement only applies to the initial purchase. After that, rules set by your broker apply. There is a minimum maintenance requirement below which your equity portion will trigger a sale or a request for more equity (cash) to be whole—this is a margin call. A typical minimum maintenance requirement is 35 percent, meaning that once your equity falls below 35 percent of the entire stock position, you get the call. So if you buy 100 shares of a $10 stock for $1,000, you can borrow $500 of the $1,000. If the stock drops below the point where the equity portion of the investment is 35 percent, you’ll trigger the call.
What is that price? The formula is: Borrowed Amount/(1−Maintenance Requirement). Got that? So if the maintenance requirement is 0.35 and you borrowed $500, the formula would give you the total securities value to match 35 percent, in this case $500/(0.65), or $769.23. That means that if your $10 stock goes down to $7.69, you will get a margin call.
Margin positions are evaluated each night for sufficient equity. The calculation of margin sufficiency is more complex with multiple securities in an account. Also, this example applies to stocks; the initial and maintenance margin requirements are different for commodities.
Why You Should Care
Margin can add power to your investment portfolio, but like any other borrowing, it can be dangerous, and should be treated accordingly. Margin interest rates, while moderately high, can be lower than some other forms of short-term borrowing, so it might make sense to use margin to get some cash from your investment account for certain purposes. On a larger scale, when stock margin borrowing levels increase in aggregate, it’s a sign that too many people are speculating on stocks and that a bubble might be forming, leading to a bust later on.