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URL:  http://boards.fool.com/jazbo-wrote-personally-i-wouldnt-do-business-11517280.aspx

Subject:  Re: How long to hold a short position? Date:  11/13/1999  10:13 AM
Author:  WeldonM Number:  6013 of 44599

Jazbo wrote
personally i wouldn't do business with one that does.
after all they (you) are holding the money from the sale.
even though none allow you to trade against that equity value.


Just thought I'd pipe in with my two bits. I work for a custodian bank for institutional investors (mutual funds, pension funds, insurance companies). As a result we have a nice collection of securities in custody on behalf of our clients. We lend them out to make some bucks for our clients and ourselves. When a broker comes to us (not me, I don't work in the securities lending department), and borrows securities, we don't do it out of the goodness of our hearts. We take cash or T-Bills as security for the loan, and the interest earned on that cash is ours and we keep it! Ha ha! The bulk goes to the institutional portfolios as "Stock Loan Income", and the rest is ours for providing such a useful service. So no, you don't "have" the cash proceeds of your short sale. We have them and we get the interest! You get your cash back when you return the shares, which is why the cash shows up as it does on your brokerage statement. It is "on deposit" with us as security for the loan you made.

This may seem odd, but the reason for it is made clear when you look at what happened in Malaysia. The government there got scared and banned FOP (free-of-payment) or non-market securities transfers. That basically means you can only trade--buy or sell versus payment in the market. You can't borrow shares to short or return borrowed shares after a buy-to-cover because that is not a for-payment market transfer of securities (buy or sell). It is a free-of-payment non-market transfer of securities. Thus, we never got back the shares we loaned. Oops! Sorry, important institutional client, we lent your shares out to speculators and now we can't get them back. We'll book the sell to your account for the shares we lent versus the cash we held as security for the loan. If, for any reason, you are unsatisfied with this, please forward all complaints to the Government of Malaysia.

This leads to the topic of risk management. When you call up your broker (oops, I mean place an order online) asking to short Bubble.com and you find that no shares are available, it obviously can't mean that no shares are available. It simply means that the brokers and custodians holding these shares won't lend them out. Their potential reward is the interest they'll earn off the cash proceeds of your short sale, which they'll demand of you as security for the loan. Their potential risk is that you'll be insolvent in a week and have to sell a kidney to make your margin call.

Just my two bits,
WeldonM in Toronto

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