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The story of a margin call - example margin gearing

Margin gearing is a method u can use to gain more wealth rapidly if u use it wisely .

I wanted to write a example for margin gearing in simple terms but i just found one on the net .Below is a example in its most simplest form which is refrenced from Ashleighs blog

Time for a worked example: suppose I have no cash but I do have a some assets, and a margin loan with low gearing. Then I see Kick-ass Consolidated shares going for a good price, and giving (say) a dividend yield of about 5%.

If I have to use cash - tough - I lose because I don’t have any.

Bull!But if I buy using debt, I’ll pay about 8% interest on the borrowings. If I get a 5% dividend yield, fully franked, that is an equivalent interest rate of 7%. So the dividends are paying the debt for me, and the cost to me (to prevent the debt from rising) is the difference in interest rates: 1%.

This is a pretty neat deal: If I can buy an asset, and use the cash flow from the asset to pay the debt used to buy it, then I only have to make up the difference. If I can find that 1% of the purchase price, then paying the interest on the loan means you get the capital growth of the asset for 1% down. Potentially this is a very big return. I need to pay that 1% forever, though!

$10,000 purchase of Kick-ass Consolidated - all bought on debt.

Return is $500 per year + franking credits, effectively $700 per year.

Interest on the loan is $800 per year.

So to control $10,000 worth of Kick-ass, I only need to find $100 per year.

Now suppose that I can find (say) 20% of the cost price… lets use some numbers:

I buy $10,000 worth of kick-ass, using debt.

Results as before…

Now I get $2000 from Uncle Freddies inheritence, and pay that straight off the debt.

Return is still $700 per year.

Interest cost is now $8000 * 0.08 = $640 per year.

I can now do nothing and the asset will eventually pay off the debt entirely. Compound interest works in my favour, and the reduction in the loan gets faster each year.

Once the debt is reduced a little, I can go buy something else. The debt goes up, as does the income, and the first asset is helping pay for the second.

And so on, and so on…

Trouble with the above approach is that it is using a very high level of gearing (80%), so I’m at risk of a margin call if the price falls.

If instead you were to reverse the figures, ($2K debt, $8K cash) then the interest charges are well and truly covered, the likelihood of a margin call is dramatically reduced, and when you get the opportunity you have plenty of equity cover already in place to take advantage of opportunities that crop up.

Low to moderate gearing thus forms a low risk, cash-flow positive virtuous circle, where the more you own, the more cash you generate, so the more you can buy.

The kicker is that if you are very patient, and buy quality assets on bad news, you stand a better chance of getting some very nice capital growth thrown in as well.

Comments

  1. Anonymous2:11 AM

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  2. Hi Everyone.

    Your blog is nice and informative. We think your visitors will like this posting. As we all know Indian stock markethas seen correction in recent past rather few days back. ( We have also mentioned on our website that correction is due start booking profit in long positions.)

    Now we are claiming that start buying Nifty or any of your fav. stocks in first half on Monday ie. 21-Jan-08.

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  3. shareinfoline2:49 AM

    Hi
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  4. Anonymous9:20 PM

    Dear Visitors,

    This blog is really nice and informative. We are pleased to know this blog is really helping people. It’s our pleasure to post informative content on this useful blog created by webmaster.

    We require 2-3 days positive closing else nifty can crash. Political issues are also hampering market along with inflation and crude oil price. Major support for Nifty is 3650 and Resistance is 4300. Nifty will remain range bound overall trend will be bit bearish in coming days.

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  5. Anonymous12:45 AM

    Hi,

    Once again after crash Nifty has started going up. Now we suggest all rises should be used as an opportunity to exit old long positions.
    This bull run will continue for few more days. Overall market is in bearish mood as in medium term its just a small rally due to short covering
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    Happy Trading,

    ShareGyan

    ReplyDelete
  6. This blog is novice and informative,it is a pleasure to post a comment on this usefull blog created by a webmaster

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    ReplyDelete
  7. This blog is novice and informative,it is a pleasure to post a comment on this usefull blog created by a webmaster

    Now as such the final stages of the formal completion of nuclear deal has come,so we can expect some positive news effecting the
    movement of the INDIAN STOCK MARKET which means stocks coming in power sector will take new direction

    Companies which will benefited includes mainly

    1.Larsen n Tourbo(LT)
    2.Hindustan Construction Co. Ltd(HCC)

    and the list had few more names..

    Happy Trading

    Have Query

    Feel free to contact us at


    Team
    KnowYourProfit

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    ReplyDelete
  8. Anonymous4:17 AM

    Dear Visitors,
    Now we have seen that Nifty has already cracked down alot due to recession fear. Reality sector was the worst affected in this fall. Stocks like WWIL, Unitech etc has fallen quite drastically. Investors are loosing confidence in the market. Maximum stocks are trading atleast 30% down from there 52 week high in Indian stock market .

    Now one can think of buying stocks for Long term.

    Few best stocks to be picked are:-

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    Just grab these stocks at every dip and stay invested for atleast 3 months and see the appreciation yourself.



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    ReplyDelete
  9. Hi,
    It’s a well know fact that stock market is affected by elections and now Election 2009 are about to begin in some time so for sure they will also have some sort of impact on Indian stock market.
    One can find complete report on Impact of elections on stock market

    Apart from Elections another major concern for Indian stock market is Inflation. There was a time when we were concerned about rising inflation but now we are conscious about this falling inflation.

    So big question is what should day traders and investors do?

    Frankly speaking day traders are least concerned about the market they simply follow trend and make maximum out of it. But yes investors should keep there portfolio light till the elections get over.

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    Play a crucial role in today’s economy; they are the key contributors towards a country’s GDP growth. India in the last decade has established itself as a powerful economy and it is growing at a healthy rate. One of the key constituents of India’s robust economy is its stock market. The stock market tips dates back to the eighteenth century. However, the real journey of the Indian Stock market began in the middle of the nineteenth century with the passing of the “Company’s Act” in 1850. The primary driving forces behind the development of the Indian Stock market were the native shares and the stock broker’s Association.



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  12. Hi, i am from trading tips .Wealth in its most primal form comes from under the ground. Plants come from under the ground. Minerals come from under the ground. Water comes from under the ground. Even petrol comes from under the ground. Little wonder then that Lakshmi, the Hindu goddess of wealth, is called Patala-nivasini, she who resides in the subterranean realm. She is also addressed as Pulomi, the daughter of the Asura-king, Puloman and Bhargavi, daughter of Bhrigus, another name for Shukra, who served as guru to the Asuras. But Asuras are demons who have been shoved under the ground by the gods! What make Lakshmi the daughter of demons? Is this an ancient moral judgment against wealth?
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