There are a number of persons in Wall Street, and some connected with every exchange who make a business of loaning stock to brokers who desire to put thru short sales. In the New York Exchange there is a post on the floor, around which those who wish to loan stock or to borrow it can gather and effect their transactions. It may upon first thought seem strange that any one should desire to loan stock, yet such a transaction is not without its advantages. The bor rower of the stock must deposit with the lender a sum of money equal to the market value of the stock at that time. In other words, he must deposit the equiv alent of its purchase price in the open market. This deposit gives to the lender the full value of the stock, and at the same time entitles him to demand at any time, upon short notice, that the stock be returned. If he had decided to borrow money upon the stock as collateral, instead of loaning it, and had taken it to a bank, he could not have secured its full value, but perhaps would have been given only 80 per cent of the full amount. He, therefore, can raise 20 per cent more money upon his security by loaning it than he can by using it as collateral for loans. It is largely be cause of this fact that there are usually many lenders of securities in the market.
The broker now has in his possession stock which he has borrowed. He takes this and makes delivery in accordance with the rules of the Exchange. The transaction between the selling and the buying broker seems regular in every way, and there is nothing on the face of it to indicate that the sale was at all extraordin ary. The fact is, however, that the broker's cus tomer has sold and delivered stock which he did not own, but which he hopes to be able to buy later at a lower price. If the expectations of the customer come true and the court decision, rendered in accordance with his forecast, causes the value of the stock to de cline, he will be in a position to profit by the per spicacity that led him to take the risk, for he can go into the open market and purchase 300 shares of the railway stock at a lower price than that at which he sold it. As soon as he secures delivery of the se curities, which he now buys, his broker takes them to the firm from which the stock was originally borrowed, returns them and receives a check for the amount of money originally deposited together with interest upon the sum at the prevailing rate for the time dur ing which it was in the hands of the lenders of the se curities.
But the customer, on the other hand, may have inaccurately forecasted the nature of the court's de cision and the stock may advance, upon the strength of the favorable ruling. In this case he would endeavor to cover his "short" sale. He would do this by buying stock in the open market as speedily as possible. He
would, of course, have to pay more for it than the amount for which he sold it. The broker would turn the securities over and get back his original deposit, and the customer would lose the difference between the amount that he was forced to pay for the stock, plus costs and charges and the amount for which he sold it.
5. A short sale briefly stated.—The course of a short sale can be made graphic by an illustration: 1. A sells stock, which he does not own, to B. :'J 2. A borrows stock from C and delivers to B, who never learns that it was borrowed stock, and does not care, since he actually has possession of the stock.
3. A goes into the open market and buys an equal amount of the same stock from any broker, D, and hands it over to C, thus covering and completing the transaction.
6. Loaning rates.—It must be remembered that when C lends stock to A, he receives as security its full market value at the time, in a certified check, which must be kept "market to market," that is, if the stock goes up several points, C receives a check for the dif ference from A, if it goes down, he sends a check for the difference to A. To put it in other words, pay ments are made either way, as prices fluctuate, in order that the lender of the stock may always have the cash equivalent of the present market value of his stock. But C pays A interest on this cash at a trifle more than the prevailing call-loan rate. He is willing to make this arrangement for reasons already men tioned.
If, however, the stock that C lends is very scarce and hard for "shorts" like A to borrow, C may pay a very low rate of interest indeed—far less than the call-loan rate. He may even pay nothing at all, in which case the stock is said to loan "flat." This happens only when that particular stock is very hard to borrow. Finally, the stock may become so scarce that C, in stead of paying interest, may actually receive interest.
Then the stock is said to loan at a "premium." In that case, C, the fortunate possessor of stock, not only gets the full cash market value for the temporary use of his stock, but a commission for its use besides. These interest rates and premiums are expressed in percentages such as %2 per cent (per day) .
7. Broker and customer.—When a customer issues an order to his broker to sell short securities on margin, the understanding is that the broker shall obtain them and deliver them to the buyer. The interesting ques tion is, Where does the broker secure stocks to be de livered? There are four possible sources: ( 1) other brokers ; (2) outsiders; (3) such securities as the broker carries for other customers, if these customers permit him to use them, and (4) whatever securities the broker himself may have.