A broker (or any one) borrows stock when he has made a contract to deliver, and the stock which he has sold, for any one of various reasons - such as having sold it " short " - cannot be delivered at the time agreed. The usual method of borrowing among stock exchange brokers is as follows:
Sharp & Co. sell 1,000 shares of Western Union Telegraph Co. stock at 90; delivery to be made the following day. The customer for whom they have made the sale cannot deliver it for some little time, possibly he has sold it " short." (See "Selling Short.") Sharp & Co. ascertain that Brown & Co. have 1,000 shares of the same stock, which they are carrying for a customer; they are borrowing upon this stock at a bank at the rate of, say, $70 a share, which is all the bank wishes to loan upon the stock, at the reigning price of $90. In loaning the stock to Sharp & Co., Brown & Co. would receive $90 a share, which would, therefore, be equivalent to borrowing $20 a share more upon the stock than they could in any other way; giving Brown & Co. that much more available cash in their business and for that reason they are willing to loan the stock. The latter must pay Sharp & Co. interest on the money, which usually is a little more favourable to them than the ruling market price. This is called the " loaning rate on stocks." The loaning rate varies greatly for any given stock with the demand to borrow it. Sometimes no interest is paid (the rate is quoted " flat ") on account of a great demand; and again the call to borrow a certain stock may be so great as to cause not only the elimination of the question of interest, but the lender may be able to exact a premium from the borrower. This premium is expressed in percentage as 1-32% (per day). The lender of a stock is entitled to all dividends declared upon it during the time of the loan.
Sharp & Co. would be obliged, each day, if there were any change in the quotations of Western Union stock, to adjust the difference with Brown & Co.; that is, we will suppose that . Western Union stock, on the day after the loan is made to Sharp & Co., advances to 95; Sharp & Co. would be obliged to pay Brown & Co. $5 a share more on the stock; perhaps, however, it declined to 88. In that event Brown & Co. would have to pay $2 per share to Sharp & Co. In other words, the difference between the two firms must always be adjusted in accordance with the price ruling. This protects the original lender of the stock and enables him to buy the stock in, if necessary, at any time, without loss, and does not make him dependent upon Sharp & Co.'s ability to deliver the stock in case called upon so to do by the lender.