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9. Equity Securities: Equity Transactions

An introduction to equity transactions, covering the distinctions between cash accounts and margin accounts, long and short positions, margin account transactions, and trading and settlement procedures.

Equity Securities: Equity Transactions

Chapter Overview

In this chapter, you will learn about the characteristics of equity transactions. Otherwise known as the mechanics of buying and selling equities, our journey will traverse the distinctions between cash accounts and margin accounts, long and short positions, the specifics of margin account transactions, and the intricate details of short selling rules, techniques, and risks. Furthermore, we will guide you through the process of how trades are conducted and settled, alongside revealing the diverse types of buy and sell orders through which securities are exchanged.

Learning Objectives

Content Areas:

  1. Define cash and margin accounts: Understand the features and distinctions of these account types.
  2. Establish long and short positions: Grasp the processes and strategies involved in effecting these positions.
  3. Impact of price changes on margin requirements: Analyze how fluctuations in security prices affect margin needs.
  4. Trading and settlement procedures: Gain insights into the entire cycle of trading and settling equity transactions.
  5. Types of buy and sell orders: Distinguish among diverse orders used in the equity markets.

Key Terms

To facilitate better understanding, here are key terms used within this segment. Detailed definitions can be found in the glossary at the end of the chapter.

  • Cash Account: An account in which the transactions are fully paid for by the client.
  • Market Order: An order to buy or sell a security immediately at the best available current price.
  • Confirmation: A document sent to the client, detailing the purchase or sale of a security.
  • Day Order: An order that expires if it is not executed by the end of the trading day.
  • Good Through Order: An order to buy/sell that remains active until a certain date unless it is executed/cancelled earlier.
  • Limit Order: An order to buy/sell a security at a specified price or better.
  • Long Position: The purchase of a security with the expectation that the asset will rise in value.
  • Short Position: The sale of a security not owned by the seller, typically borrowed, hoping to buy it back at a lower price.
  • Margin: The amount deposited by the client with the broker when borrowing to buy securities.
  • Margin Account: An account through which a client can borrow funds from their broker to purchase securities.
  • Margin Call: A broker’s demand for an investor to deposit additional money or securities to bring a margin account up to the minimum maintenance level.
  • Stop Loss Order: An order to sell a security once it reaches a particular price, intended to limit an investor’s loss on a position.
  • Settlement Date: The day by which sold securities and funds must be exchanged.

Key Takeaways

  1. Differences between Cash and Margin Accounts: Cash accounts require full payment for transactions, while margin accounts allow borrowing for purchasing securities.
  2. Long vs. Short Positions: Long positions benefit from an increase in security prices, whereas short positions gain from price declines.
  3. Margin Requirements: Changes in security prices directly impact the margin maintained in brokerage accounts.
  4. Trade and Settlement Workflow: Proper procedures ensure timely and efficient trades, reducing the risk of default.
  5. Variety in Orders: Different buy and sell orders cater to diverse trading strategies and objectives by defining execution terms.
    sequenceDiagram
	    participant Investor
	    participant Broker
	    participant Market
	    Investor->>Broker: Places market order
	    Broker->>Market: Executes order
	    Market-->>Broker: Confirms execution
	    Broker-->>Investor: Sends trade confirmation
	    Broker->>Investor: Issues margin call (if applicable)

Frequently Asked Questions (FAQs)

Q: What is the difference between a cash account and a margin account?

A: A cash account requires the client to pay the full amount for the securities they purchase, essentially prohibiting the use of borrowed funds. In contrast, a margin account allows clients to borrow money from the broker to buy securities, a process subject to margin requirements and maintenance levels.

Q: What are the risks associated with short selling?

A: Short selling carries various risks, including the potential for unlimited losses (since there’s no cap on how high a stock’s price can rise), margin calls if the stock price increases substantially, and the obligation to return the borrowed security, which might necessitate buying it back at a higher price.

Q: How is a settle date different from a trade date?

A: The trade date is the day when a securities transaction is executed, whereas the settlement date is when the actual exchange of funds and securities takes place, typically occurring a few business days post the trade date.

Q: What types of orders can be used to execute transactions?

A: Orders can range from market orders for immediate execution at the best available price, to limit orders that set maximum buying prices or minimum selling prices, as well as stop orders and good-til-canceled orders.


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Good luck!

## What is the primary difference between a cash account and a margin account? - [ ] A cash account allows for borrowing funds for trades, while a margin account does not. - [ ] A cash account permits short selling, while a margin account does not. - [x] A margin account allows investors to borrow funds to purchase securities, while a cash account requires full payment for purchases. - [ ] A margin account has no risk, while a cash account does. > **Explanation:** In a cash account, investors must pay for their purchases in full, while a margin account allows investors to borrow funds to buy more securities, increasing their purchasing power. ## What does establishing a long position in a margin account involve? - [ ] Selling securities that are borrowed. - [ ] Only using cash to buy securities. - [ ] Selling securities with the expectation that their price will decrease. - [x] Borrowing funds to purchase more securities, with the expectation that their price will increase. > **Explanation:** Establishing a long position in a margin account involves borrowing additional funds to buy more securities, anticipating an increase in their value. ## What is short selling? - [ ] Selling securities that the investor owns. - [ ] Borrowing funds to buy securities. - [x] Borrowing and selling securities with the intention to buy them back later at a lower price. - [ ] Purchasing securities and holding them for a long-term gain. > **Explanation:** Short selling involves borrowing securities and selling them with the intent to repurchase them at a lower price, hoping to profit from the price difference. ## How does a margin call protect the lender in a margin account? - [ ] By reducing the interest rate on borrowed funds. - [ ] By allowing the investor to borrow more funds. - [ ] By forgiving the debt if the investor faces a loss. - [x] By requiring the investor to deposit more funds or securities if the value of the margin account drops below the required level. > **Explanation:** A margin call requires the investor to add funds or securities to their account to maintain the minimum margin requirement, thus protecting the lender from potential losses. ## What is a market order? - [x] An order to buy or sell a security immediately at the best available current price. - [ ] An order to buy a security only at a specified price or lower. - [ ] An order to sell a security only if its price reaches a certain level. - [ ] An order that remains active until the investor cancels it. > **Explanation:** A market order is an instruction to buy or sell a security immediately at the best available price. ## What is a limit order? - [ ] An order to buy or sell a security immediately. - [x] An order to buy a security only at a specified price or lower, or to sell a security at a specified price or higher. - [ ] An order to execute a trade at the end of the trading day. - [ ] An order to execute a trade regardless of the price. > **Explanation:** A limit order sets a specific price at which a security must be bought or sold, ensuring the trade happens only if that price is met. ## What happens if the price of securities in a long position drops significantly? - [x] The investor may face a margin call and need to deposit more funds or securities. - [ ] The investor's risk reduces. - [ ] The investor will automatically repay borrowed funds. - [ ] The securities are sold automatically at the current market price. > **Explanation:** If the value of securities drops, the investor might receive a margin call requiring them to deposit more collateral to maintain the margin requirements. ## What type of order is executed at the end of the trading day if not already filled? - [x] A day order. - [ ] A limit order. - [ ] A market order. - [ ] A stop order. > **Explanation:** A day order expires at the end of the trading day if it has not already been executed. ## What is the settlement date in equity transactions? - [ ] The actual execution date of the trade. - [ ] The date the investor decides to place the order. - [ ] The date when securities are first listed on an exchange. - [x] The date by which the buyer must pay for the securities and the seller must deliver them. > **Explanation:** The settlement date is the specific date by which the buyer must pay, and the seller must deliver the securities. ## What is a stop-loss order? - [ ] An order to buy a security as soon as its price surpasses a certain level. - [ ] An order to sell a security at the end of the trading day. - [x] An order to sell a security once its price drops to a certain level to limit potential loss. - [ ] An order to hold a security regardless of price changes. > **Explanation:** A stop-loss order triggers a sale of the security when its price hits a predetermined level, helping to limit potential losses.

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In this section

  • 9.1 Introduction
    Understand the mechanical processes involved in acquiring, holding, and selling investments including equity transactions such as margin trading, short selling, and the variety of buy and sell orders investors use to trade stocks.
  • 9.2 Cash Accounts And Margin Accounts
    In this section, we delve into the fundamental differences between cash accounts and margin accounts in securities transactions, clarifying how each operates and the key considerations for investors.
    • 9.2.1 Long Positions And Short Positions
      Explore the fundamental concepts of long and short positions in the stock market, including detailed examples and guidance for Canadian Securities Course exam preparation.
  • 9.3 Margin Account Transactions
    Learn about margin accounts used for long and short margin positions, how to interpret the impact of price changes, and the process involving interest calculations on margin loans.
    • 9.3.1 Long Margin Accounts
      A comprehensive guide to understanding long margin accounts, including regulations, examples, risks, and frequently asked questions as per IIROC guidelines.
    • 9.3.2 Short Margin Accounts
      Comprehensive guide to short margin accounts including definitions, examples, and margin requirements. Learn about short selling, its risks, profit calculations, and industry practices.
    • 9.3.3 Risks Of Short Selling
      Understanding the various risks associated with short selling, including borrowing shares, maintaining adequate margin, liability for dividends, buy-in requirements, volatile price action, and regulatory risk.
  • 9.4 Trading And Settlement Procedures
    Comprehensive overview of trading and settlement procedures for equity transactions, focusing on the roles of investment dealers, trade lifecycle, settlement timelines, and best practices.
    • 9.4.1 Trading Procedures
      Detailed guide covering the trading procedures within the Canadian Securities Market, including the steps involved in retail securities transactions, and settlement procedures. Discover important concepts, detailed steps, and common scenarios in trading stocks, bonds, options, and other securities.
  • 9.5 How Securities Are Bought And Sold
    Understanding how securities are bought and sold is fundamental for acting as a proficient investment advisor. This section provides a comprehensive overview of various types of buy and sell orders, price restrictions, special instructions, and the dynamics of the bid-ask spread.
    • 9.5.1 Types Of Orders
      Comprehensive guide to different types of stock orders including market, limit, day, good-through, on-stop sell, on-stop buy, and professional types.
  • 9.6 Summary
    A comprehensive summary of the key concepts covered in chapter 9.6 of the Canadian Securities Course, focusing on equity transactions, client account types, margin positions, and types of buy and sell orders.
Tuesday, July 23, 2024