They are cash operations in which credit is offered to the buyer (lending him money) or shares to the salesman (lending him shares) with the finality of liquidating immediately the operations after the contracting. So, for the investor the operation is the same as the typical buying and selling operation done in cash at the exchange rate of the moment. The difference is that initially, the investor only has to cover only a percentage of the operation and being the intermediary the one in charge of granting the necessary shares in case of a sale or to grant the money needed in case of a purchase. This way the investor has the possibility of buying shares with only paying part of its value and lending himself from the intermediary the rest of the money.
The mediator’s function can be realized by: stock exchange associations, official credit institutions, banks, saving banks and cooperative associations.
The common physical or legal person that wishes to operate with credit at the market must fulfill a series of conditions:
- Not all the securities may be contracted at credit, only those securities chosen or admitted by each market can authorize are those securities they register a greater volume of contracting.
- To do credit contracting you have to acquire the minimum number of securities required by the actual regulations at the moment.
- From part of the investor, there has to exist an initial cash guarantee, that is funded at the beginning of the operation, this permits to fulfill the contracted obligations and by so to reduce the associated risk. The medium value of the guarantee required is of between 10% and 50% of the total value of the purchase or sale. So, for example if a person wishes to acquire at credit securities with a value of 50,000 and the guarantee to deposit is of 50%. Then you must deposit 25,000 as guarantee concept.
- In the case of a purchase, the guarantee is part of the price. The level of security obtained is high due that the intermediary disposes of the securities plus the 50% of the price in cash. The investor must pay out the initial 50% of the price in cash. And the remaining 50% to the intermediary. The required guarantee, the securities acquired & the possible dividend to receive are locked up in the depositary institution until the moment of cancellation of the position
At the moment of expiration, the buyer has to realize a sales operation to undo the initial position. At that moment he will receive the total sum of the guarantee initially required, more or less the results from the operations, plus the dividends received for the shares during the period in question, less the accrued interests from the loan.
The buying of securities at credit is usually done when there is a forecast that it is going to rise. The credit investor buys securities today, using loaned money, to sell them in the future at a higher price.
In respect to the sales, it is the intermediary who loans the securities to its client, whom has to deposit an initial guarantee which sum is equal to the selling amount. Now, this deposit is not part of the price, it is exclusively a guarantee, and it must be returned at the end of the operation.
What the investor receives as a loan are the securities he is about to sell. At expiration, the salesman must re-buy the securities, receive the sum of the guarantee he initially deposited, more or less the result of the operation, less the dividends received from the shares during the considered period, which must be delivered to the holder object of the loan.
The credit salesman sells the securities he doesn’t possess because he thinks that in the future he will buy them cheaper.
Besides the initial cash guarantee, they may require from the investor supplementary guarantees that in case of non fulfillment would suppose the automatic cancellation of the contract. The investor must contribute, with money in case of fluctuations either to the rise or to the fall of the value in question.
With respect to the buyer, when the price falls, with respect to the salesman, when the price rises.
So then, the complementary guarantee is required when there are variations in the market rates, normally superior to 10% and in a contrary sense as anticipated by the investor.
- The investor can, voluntarily, cancel beforehand the credit on any working market day, or well to ex tend the agreed period and in this way postpone the operation.
- In the case of the credit buyer, he has to pay the loaned money and keep the securities, or well to order the anticipated sale of them.
- On his part, the credit buyer will cancel its operation by delivering securities from its own portfolio.
The option to operate at credit is used mainly by those short term investors that immediate low/high forecasts of the securities. They usually cancel their operations in a short period of time. With the credit market the profit of the operations increased, due that with only a part of the price (the rest is loaned) you can obtain the same efficiency than with a normal operation.
The profit is greater in case of succeeding, but the risk assumed is pretty high of the predictions results to be wrong.