Loan Stock

Finance, a la shmoop. What does it mean to buy on margin? Whoa, okay enough of that

yeah. That was buying on margarine but okay yeah that was a stretch, buying on [Guy sliding around with blocks of margarine on his feet]

margin is something totally different. Well margin just means debt or a loan or [Guy in a hospital bed]

credit and this buying on margin usually refers to an investor buying stocks,

pledging their portfolio as collateral in making that purchase. (Illustrative example time).

Grete Greedmonger has a hundred million dollar portfolio filled with very conservative [Greta stood next to a list of her holdings]

stocks comprising ninety percent of it or ninety million bucks and she has 10

million in cash. Well Greta, tired of flying in her measly small jet wants to [Greta's jet in the sky]

be able to afford a really big jet like the kind of the truly wealthy fly like [Warren Buffet and Bill Gates walking up to the bigger jet]

you know those guys. She wants to be in the billionaire's Club and your [Greta sat in the Billionare's club bar]

membership card gets you a great discount on private planes, so you know

like why not. Well anyway she's impatient to just let her stocks compound away and

get there quote naturally unquote at the 8% a year or so compound growth rate [The value of Greta's investment shown after each 5 years]

that they kind of have shown last a few decades. Well she wants to add gasoline

to the relatively slow burning embers of her portfolio and speed up her compound [Pouring gasoline over a fire]

rate to get to billionaire status from her current hundred millionaire status [The value is shown to be almost 2 billion in 10 years]

you know and by a G6 and that plan can't possibly backfire right.. So she bets big [Greta's big jet falls out the sky]

on a few stocks believing that she has a solid understanding of the stock market. [Greta buying amazon stock]

Specifically she wants to invest 40 million dollars in Amazon, currently

trading at 2000 bucks a share well she only has 10 million in cash. Well how can

she buy 40 million dollars when she only has 10. Well she could sell 30 million [Greta holding a big sack of stocks]

dollars worth of her stock unfortunately though those stocks were acquired years [The broker has a big sack of money]

ago at a very low price, so if she sold them she would pay massive tax bills and in [The money the broker pays is taxed]

fact to generate 30 million dollars of net after-tax cash she'd probably have [The tax calculation is shown]

to sell something north of 50 million dollars of stock to pay for

it and that's way too high a price in taxes to pay to be worth making the sale [Greta runs away with her stocks]

at all. So instead she borrows money to invest that 40 million bucks, only she [Greta getting the borrowed money and buying Amazon stock with it]

borrows it on margin, meaning she is borrowing that money from herself she

has 90 million dollars in stocks and 10 million in cash and needs another 30

million beyond the cash she already has to buy that 40 million of Amazon right. Well her

account at Schwab is already set up as a margin account or margin style account, [Definition of a margin account shown on a 100 dollar bill]

meaning that she has already signed a bunch papers stating that she understands the

margin rules the brokerage and the biggest rule is that the maximum margin [The rule is highlighted on the contract]

she's allowed to take in her account is 50 percent, five zero. So with her account

value at 100 million the most she could borrow would be 50 million bucks and [Margin limit calculation is shown]

there's that little dangerous voice whispering in her ear and well there [Devil version of Greta in her ear]

might be another voice telling her to just spend a few bucks on jet skis and [Angel version of Greta in her other ear]

vacations instead of that big jet and she just ignores that one and that's [Greta flicks the angel away]

good because otherwise we wouldn't have this video for you. So if she needs 40

million bucks to invest in Amazon she'll use up her ten millio in cash

and then take out a margin loan of thirty million dollars against herself.

Her account will have a hundred thirty million dollars in equities in it and 30 [Greta's holdings are shown]

million dollars of debt and no cash and that cash that she's borrowed carries

interest charges that is in return for borrowing money from herself she will [Greta paying Schwab]

pay Schwab a few percent a year in interests. That's nice high margin business for

Schwab because the money to them is almost free so all is good until she

decides she wants to put 20 million into Netflix as well all on margin so now she [Greta is watching Netflix on her TV]

has fifty million dollars in margin in an account with a hundred fifty million

in equities and 50 million in debt so note that her base hundred million

dollars in value and equity has not changed since the beginning of this [The value of the portfolio is shown]

awesome story only now she has a hundred fifty million in investments in that

account and fifty million of debt so if the portfolio goes up 10 percent she'll

show gains of 15 million versus a situation where if she hadn't done any

with margin while that gain of 10% would have given her just 10 million in gains [The with and without margin gain calculations]

right, 10 percent of 100 million invested vs. 10 percent of 150 million invested.

And yes she'll be paying say 4 percent interest now on the 50 million she

borrowed or about 2 million a year to rent that money from herself it's really

Schwab kind of fronting the cash for her using her portfolio as collateral. So all [Schwab demanding that she pay back the loan]

is great she's thinking about the upholstery color in her g5 and then a

bomb goes off in North Korea and well all bets are off the stock market freaks [Explosion]

out printing down 20% in a short period with the high octane names like Amazon

and Netflix trading down even more and all the sudden 150 million dollars in

value in her portfolio is cut 40% such that the 150 million dollars is now [The loss on Greta's holings is shown]

worth only 90 million and that's a really big problem. Why? Because she still

has 50 million bucks in margin loans on the account and the brokerage has a max

50% limit that is, clients cannot borrow more than half of their portfolio.

Because it's just too risky for Schwab to have to potentially bear the burden [Guy holding sacks full of I.O.U.s falls over]

of making the margin whole on that account like if the market then really

tanks like if it went down another 30 or 40 percent you can imagine it would be [Stock chart showing price going even lower]

worth less than 50 million dollars which is the debt that they have [Combined stock value going down]

outstanding and then it's really bad and Schwab could go bankrupt really fast. So [Money disappearing from Schwab vault]

Schwab sends her a kindly loving nasty gram requiring her within 24 hours to [Schwab sending an email telling her to pay or never see you precious portfolio again]

inject 10 million dollars of capital into that margin account to quote true

it up unquote to be at least a hundred million dollars in value like she could

wire in 10 million bucks that says sitting around in her BofA account [Greta using an ATM]

to make it whole and in that case her margin account would go down from 50

million to 40 million on an account that would have just gone from 90 million to [Greta's holdings are shown]

a hundred million dollars and she'd be just fine. So that's 40 million bucks of

margin on a hundred million dollars of an account value and it's ten points

below the red line threshold of that 50% maximum [Greta's margin level is calculated]

margin limit. Only problem, she doesn't have 10 million dollars in her BofA

account just sitting around. So what else can she do well she'll have to sell

stock in her Schwab account to meet her margin requirements and you can see what [Greta at her stock for sale stand]

a vicious spiral this is gonna become and if she won't proactively call in the

orders herself well then Schwab has the right to step in and sell

them for her and Schwab won't care a whole lot about whether they're making [Schwab guy selling Greta's stock at any price]

smart sales or not they just need the margin minimums met right away and oh by

the way she'll pay taxes on those Schwab sales if there were gains on them and [The stock sale being taxed]

then the IRS is coming after her for dough later so it gets really ugly and [IRS taking money from Greta]

yes you can imagine that if a whole lot of people were caught in the margin [The word margin being squeezed by two hands]

squeeze like this in a bad market where they got more greedy than fearful and a [Guy in a suit running around]

whole lot of brokerages put in sell mortimer, sell, at market orders well that [Guy in a suit waving his arms around]

the whole system would cave in on itself with massive supplies of stock for [The broker collapses]

relatively little demand and well that's how stock markets crash and that's why [Big sack of stock and only 1 person left to buy]

brokerages have you know typically 50 ish percent margin kind of limits at

least for retail investors. And the general goal of the G-man here is to you

know, avoid such a slippery set of circumstances and maybe she should just [Guy wants to use a block of margarine as a sled]

get used to flying commercial. [Greta looks unhappy on a commercial flight]