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Hello. I'm Dr. Michael McDonald.
I'm a Professor of Finance at
Fairfield University in
Fairfield, Connecticut.
Today, I want to
talk to you about
a very interesting
case and an aspect of
the financial markets that
most people don't really
understand very well.
That is Hindenburg Research
and the business
of short selling.
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Short selling involves borrowing
a stock that you do not
own and then selling it.
As you would expect though,
if you borrowed
something from someone,
you have to give that back in
the future. How do
you give it back?
We have to buy that
stock back later and
this creates
artificial leverage,
of course, when you do this.
In the United States
and around the world,
there's generally
a requirement that
we have a certain level
of margin or
basically collateral
that's posted when we
take out leverage.
In the U.S., for example,
the Fed's Reg T drives this
margin requirement, and what
we refer to as hypothecation
of securities, that is
securities lending,
hypothecation is just
the fancy name for it.
But securities lending
by the prime broker
can lever up a portfolio
at minimal effective cost.
This is an important source
of financing for hedge funds.
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When we talk about
margin in short selling,
the minimum or initial margin is
generally at least $2,000
in cash or securities.
The Federal Reserve
Board's Regulation T,
or Reg T, mandates
a limit on how much
an investor can
borrow, and that is
up to 50% of the price of the
security that's purchased.
Then, in addition to
that initial margin,
we have a maintenance margin.
The maintenance margin
is the minimum amount of
equity that has to be maintained
in the margin account.
Per FINRA, or the Financial
Industry National
Regulatory Authority,
and the NYSE, after
an investor has bought
securities on margin,
the minimum required
level of margin is
25% of the total value
of the securities in
the margin account.
That level is a minimum though
and most brokerages have
a maintenance requirement of
anywhere from, say, 30-50%.
Failure to meet those
margin requirements
leads to margin calls.
This is all very important
because oftentimes,
the use of margin can
artificially push
stock prices up
or down depending on
whether short sellers
or long investors are buying
or selling that
security on margin.
