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No one can predict future stock prices, making ‘credit loan’ investments risky.

Is it safe to take out a loan to buy stocks?

July 24,2007
Individual investors at a brokerage house in Seoul watch the fluctuation of stock prices. [JoongAng Ilbo]
Dear Teenteen readers, you might have heard the words “credit loan,” a hot phrase among Korean stockbrokers since early this summer.
Some of you might have seen your parents buy stocks through credit loans, which means purchasing stocks using borrowed funds. Those who borrow to buy stocks usually do so because they think that stock prices will climb in the future and become far more expensive.
But what if the stock prices fall instead of going up? It means those who buy stocks using borrowed funds will be burdened with stocks that fall in value and making interest payments.
However, if the stock price goes up, the stocks can be sold, the debt repaid and anything left over is profit. This is how some people make money by borrowing to buy stocks.
Let me illustrate with an example. Let’s say Johnny’s father borrows money to buy 100 shares of Binggrae, a local ice cream maker, on June 1. His father figured the company’s share price would go up in the summer when everyone wants relief from the heat found in a little bite of ice cream. The share price of Binggrae on June 1 was 41,250 won ($45) per share, meaning it cost 4.12 million won to buy 100 shares.
And there are several conditions to borrowing money for share purchases. You not only have to pay interest but also have to make clear when you will pay back all the debt. And there is one more condition ― you have to chip in a certain amount of cash.
Daewoo Securities Co., Korea’s largest stock broker, requires 40 percent of the stock purchase to be paid by the borrower, meaning the stock broker will borrow only 60 percent of the stock purchase.
So Johnny’s father, in order to buy 100 Binggrae shares worth 4.12 million won, has to cough up 40 percent, worth 1.65 million won, himself, while the remaining 60 percent, or 2.47 million won, is covered by the loan from the stock broker.
The maturity period is 90 days, and the interest is 6.5 percent a year, meaning Johnny’s father has to pay back the 2.47 million won-debt to Daewoo Securities in 90 days, plus the interest payment. The interest rate and the maturity period differ for each broker according to which company the borrower wants to buy shares of and the borrower’s credit.
Anyway, Johnny’s father bought 100 Binggrae shares and waited about 15 days. The Binggrae share price rose to 43,600 won per share, and he immediately sold the shares. He earned a grand total of 4.36 million won, after spending 1.65 million won of his own money to buy the shares two weeks ago. So, even after paying back the 2.47 million won he borrowed from the stock broker and the interest payment of about 7,000 won, Johnny’s father still has 228,000 won.
Well, we wish we could fly into the future, see what’s happening with the stock market, come back to the present, invest in stocks and hit the jackpot. But that’s not the way it works. In fact, a lot of people who borrow from stock brokers to buy stocks lose money big time as share prices fluctuate greatly. If you borrowed money to buy stocks and the stock price remained low until the debt maturity date came, the big loss would be on you.
As Seoul stock markets recently continued rising, a lot of people like Johnny’s father plunged into stock investments, thinking they would be able to make big money. As a result, the investments made by borrowers amounted to a whopping 7.1 trillion won as of June 26, up from a meager 499.9 billion won early this year.
People started raising concerns that the stock market is overheating, partly because of people who invest over their means, saying not only borrowers but also stockbrokers will face serious setbacks once the stock markets take a downturn.
So the Financial Supervisory Service, the mighty financial regulator of Korea, stepped in to solve the problem. The agency in June summoned senior executives of major Seoul stockbrokers and “urged” them to reduce their credit loan lending below 40 percent of each broker’s capital, or below 500 billion won.
Well, the Financial Supervisory Service was practically ordering the stockbrokers to do that, given its status as a mighty organization with unrivaled regulatory power over the financial companies here.
The impact of the “urge” was immediately visible. Most stockbrokers either cut their lending or reduced the percentage of their lending to the total stock purchase.
Thanks to the changes, the total amount of “credit loan” lending, which once hovered over 7 trillion won, has shrunk by 100 billion won each day since then and reached to 6.2 trillion won as of early this month.
Most people believe that stock investors automatically lose money if stock markets go down. But not exactly. A trading scheme called “stock loan” enables people to make money when stock prices fall. How? In a stock loan, an investor borrows shares of a certain company from a stock broker, sells all of the shares to the market immediately, and waits until the company’s stock price tumbles. Once the stock price goes down, he buys back the same exact number of shares that he borrowed and returns them to the stockbroker. The cheaper the stock price becomes, the more profit the investor is bound to reap. The stock loan also has interest rates and a maturity date, just like the credit loan.
Let’s say Peter borrowed 100 shares of Hyundai Marine, worth 40,000 per share, from a stockbroker. He garners 400,000 won by selling all of the shares to the market and waits until the stock price falls to 30,000. Then he buys 100 shares of Hyundai Marine for 300,000 won and returns them to the stockbroker, pocketing 100,000 won for himself.


By Choi Joon-ho JoongAng Ilbo [hawon@joongang.co.kr]


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