Waria-it doesn't have to be the broker who freezes the cash in Kizee's account.

Infact,for the NSE,CDSC would probably do the freezing of the cash. It did something similar for Equity & other banks that were doing marginal lending during the Safcom IPO.


www.mjengakenya.blogspot.com

Waria- please stop eating bariis (sp) with porridge.

Anyway,if you are the long-term holder of Equity,yer you still get your fee income.

However,if you are short-sell,you my friend will have made (13.45-20-0.40)*50,000 = (347,500) loss.

Short-selling is just a investment like buying except you are betting on shareprice fall not a rise. Therefore,if share rises,you make a loss.


www.mjengakenya.blogspot.com

Ecstasy-you explained it better than me. Except original shareholder in effect gets a bonus during the drop in his share's value

www.mjengakenya.blogspot.com

How does a short sale work: two examples below

Simple analogies from the book Web of Debt by Ellen Brown:

'Pretend that you borrowed your neighbor's lawn mower,which your neighbor generously says you may keep for a couple of weeks while he's on vacation. You're thinking of buying a lawn mower anyway so you've been researching the latest sales and have seen your neighbor's lawn mower on sale for $300,marked down from $500. While you're mowing your lawn,a passerby stops and offers to buy the lawn mower you're using for $450. You sell him the lawn mower,then go out and buy the same one on sale for $300 and return it to your neighbor when he returns. Only now you've made $150 on the deal.'

Another analogy: 'You believe Amazon is overvalued and its price is going to fall. So as a short seller,you borrow Amazon stock which,like the lawn mower,you don't own,from a broker and sell it into the market...You borrow and sell 100 shares of Amazon at $50 per share,yielding a gain,exclusive of commissions,of $5,000. Your research proves correct and a few weeks later Amazon is selling for $35 per share. You then buy 100 shares of Amazon for $3,500 and return the 100 shares to the broker. You then have closed your position,and in the meantime you've made $1,500'.

According to Web of Debt,'It sounds harmless enough when you are borrowing your neighbor's lawn mower with his 'generous permission.'...The price is not responding to 'free market forces'. It is responding to speculators with the collisive battering power to overwhelm the market with sell orders - orders that are actually phoney,because the 'sellers' don't own the stock.'

Many experts will tell you that today speculators only have to drop the price low enough to trigger the automatic stop losses and margin calls of big mutual funds and hedge funds in the US. As a strategy for trading through a recession,some people in the US believe that short selling sustained the great depression in the 1930s. Short selling is not a solution to anything and is more likely a tool in spreading panic like wild fire.

SCUBI

I sense some fears. Fears of the unknown which are completely understandable and I’ll try and address some of them.

Solloh-it’s just an example,but in practice,short-selling has exactly the same consequences as going long on the share. Profits and losses are only limited by one person. You the investor selling or buying the share to close your position.

Scubidu- by your copying and pasting some googled article,I assume you believe that story. I won’t dissuade you otherwise.
Drake- I appreciate your logical approach so I’ll respond in kind:
· You understanding of opportunity cost is interesting. Kizee never had the cash from sale of Equity so there is zero OC. That is MainaT’s cash which is being protected.
· Notice the deposit for the margin call is again to secure the broker in a situation where the trade goes against Kizee and Kizee absconds (and I apologise for using you as an example Kizee). Re the dividend cover,Kizee would have been well aware of the dividend so no issue. Infact,the cash flow issue that you are alluding to from Kizee’s pt of view is much much smaller than if Kizee had to wait for Equity to get to Ksh12,buy the full 12*50,000 shares and wait or it to up to Ksh13.45 while he waits to realise some profits.
· In practice,if the market was opened up to short-selling,MainaT could still wake up one morning and decide to get his shares back without affecting Kizee. In the same way that if you want to buy 50,000 Equity shares today,you can easily get them because there is liquidity in the market for the share.
· With the exception of the small margin call cash,that Kizee will be required to put aside at the outset,the cashflow impact here is very positive for everybody concerned. MainaT gets to have some cash during a period that would otherwise be depressing (i.e. watching his portfolio go down in value). Kizee gets to trade on Equity on its way down and may even be able to raise cash such that he can go long on equity at Ksh12.
· Returns are risk-adjusted because we are assuming that in the same way you buy a share knowing it can go up or down in value,you will short-sell it knowing that it may go up.
· In the absence of the momentum to change the underlying causes of the current bearish stance in the NSE (economy),short-selling will reduce the flight of liquidity that happens far too often. Without a certain amount of liquidity staying here,the NSE won’t grow to be the vibrant capital market that it can be. EFT like current bonds,will merely take away that liquidity.
· I do agree we need a commodities exchange,but I’m sure that it’ll also cause some to have fears of the unknown.

www.mjengakenya.blogspot.com

yes I've been thinking about this for long.its the best way to go now that the index is still heading south,but what about delays in order excecutions...

hold tight to your chutes we are about to dive

I believe the liquidity situation will improve through more listings,NSE demutualisation,greater regional participation (merger of market exchange) and better research (& analysis). Taking into account the limitations of our economy (its size) and the fact that foreigners dominate trading of major counters then liquidity will always be an issue. I think key to taking a short position should be to put more emphasis on market research,as the only sure way of ensuring a legitimate trade (and not an abuse one). Given how poorly regulated our market is I wonder just how well short-selling will be regulated efficiently. There is no incentive for the real owners (company owners) to approve short selling. It is pegged on identifying impairments on their books and results in shareholder wealth being eroded. Why would listed Kenyan firms endorse short selling?

SCUBI

I hear the use of the system has helped some of the bailed out banks in the US make a profits.

you can achive all things through Him(Jesus Christ)

@ Mainat Good sir,I beg to differ

1 ...there is zero OC

+ When building a pricing or valuation model,it's always prudent to factor in cost of interest earned (mostly continuously compounded) to make sure that no cash lies idle. It's an aggressive stance.... the best trading strategies,always are. Consider that when the shares are sold short,cash flows from new buyer C to broker AA but in your example,Kizee has no access to the cash because it forms part of margin! You can be sure that AA will earn interest on this money (being reflected in Kizee's CDS account) or use it to supplement working capital. The opportunity cost here is that:

1. a return (I) will be earned on the proceeds from the short sale.
2. The return shall not flow to you

Assuming 7.2481 on the 91-Day and that you close out your position on November 27th. Interest 'lost' would be 6427.71/=
Remember,Opportunity Cost is defined as value of the best alternative foregone.

2 ....you can easily get them (shares) because there is liquidity in the market for the share.

If that were so then the short-squeeze would not exist in developed markets where they have market makers,large volumes,high liquidity and bid/asks that are tighter than my girlfriend. Alas,one billionaire threw himself under a train for this very reason (Re: the Porsche - VW debacle) In developed markets,most securities lenders are either pension or mutual funds or large banks and u must remember that they are under no obligation to do so (lend or sell). In fact,they are better served holding out and watching their NAV's climb courtesy the squeeze even if short lived.

3. .... the cashflow impact here is very positive for everybody concerned.

At T1,positivity of 'Cash Flow Impact': AA > Mainat > Kizee
I think the most positive thing is that Kizee gets to employ leverage

For the price to move to 12,It will have to drop by 10.78%. Assuming that additional margin required from Kizee covers a similar rise in price and that broker's charges are 1.9% for the transaction.

at T1
Net Cash Flow AA 685277.5
Cash flow Kizee (105277.5)
Cash flow Mainat 40000

Remember that any adverse changes to the share price will mean that Kizee has to top up his margin (variation margin). If he faces margin calls and cash flow problems at the same time then he may be forced to close out his position at a loss.


4...... Returns are risk-adjusted because we are assuming that in the same way you buy a share knowing it can go up or down in value,you will short-sell it knowing that it may go up.

This is simply not so. The most important risk to any investor is downside risk.

Theoretically,the risk return relationship is such that:

Position Upside risk Downside risk
Short Limited Unlimited
Long Unlimited Limited

Theoretically,the price of EQTY can rise to the stratosphere representing UNLIMITED downside risk for the short seller. It's this risk that should be 'quantified' and used to adjust returns.

1. Risk arises when you don't know what you're doing. 2. People diversify their portfolios to counter unsystematic risk. 3. People who diversify their portfolios don't know what they're doing.

@ Mainat

So short selling operates as it should. But we have to assess the motivation for taking the position in the first place,or else you'll be at the tail end of the herd group [of investors]. So you noticed a share (say Barclays) that traded within a given range. Then decided to implement a strategy based on price trends and an impending corporate action,but you still don't know if those factors have any relationship. Some price adjustments may be natural (i.e.,where Barclays pays it's dividend & the price drop reflects the payment in the books),while others such as earnings projections,debt profile or a/c policies will be subjective to the analyst. Developed African markets do not engage in short selling,because more often than not the required due diligence is not done b4 adopting the strategy.

The Einhorn story is very interesting,but his fact-checking was also thorough. According to Wikipedia,'starting July 2007,Einhorn became a short seller in Lehman stock. He believed that Lehman was under-capitalized,and had massive exposures to CDOs that were not written down properly. He also claimed they used dubious accounting practices in their financial filings'...so he made some allegations backed with research he'd done...'In May 2008,Lehman CFO Callan had a private call with Einhorn and his analysts'...verification...'Ms. Callan is said to have fumbled some of her responses to questions on Lehman's asset valuations'...confirmation...'...price took a further knock'...consensus...'Callan was fired a few weeks later'...unfortunate scapegoat,but successful short position!

On an website that had an article related to Einhorm,http://nymag.com/news/businessfinance/47844/index1.html,the author wrote the following 'There have been,by all accounts,a lot of hedge funds shorting financial stocks. But the only prominent investor putting his name,and his face,to a singular position has been Einhorn...The notion of profiting from a company's misfortune,as vital as it might be to the efficient running of the market,is an anathema to people outside the industry,so much so that precious few investors do it publicly anymore. It's too easy to look like a scoundrel who's out to destory companies and put people out of work. Even Jim Chanos,the short seller who smoked out Enron,is reviled in some circles-because thousands of people lost their jobs and because he made money off it. But Einhorn is remarkably unfazed by the vitriol he stirs up. He sees no conflict between his public moralism and the fact that he stands to profit from it. He has a profound sense of duty,and an almost innocent belief that if you're right,nothing else matters.'

Lastly,again,I'll refer to the E-Book - Web of Debt,that says [as opposed to a normal trade] during a short sale a '...price decline is not a linear function of supply expansion. At some point,if supply continues to expand beyond demand,the 'bottom will fall out of the market,' and prices will plunge.'

I don't want to reinvent the wheel so I refer to books...another good book is 'A Colossal Failure of Common Sense: The Incredible Inside Story of the Collapse of Lehman Brothers' written by Larry McDonald. You can buy it in Nairobi book shops and it details the practice of short selling with regard to corporate bonds. btw Mainat,if you're interested in reading the book Web of Debt,just drop me an email at moneyedkenya@gmail.com. <And I'm not related to (don't even know) the author,so I have nothing to gain from sharing this information with you...harmless disclaimer...>


SCUBI