Call Loans

Although not stated, it is usually understood, unless agreed otherwise, that all loans on stocks are call loans, made at the prevailing rate of interest on such loans throughout the period for the bank which carries the stock.

Call loans differ from time loans in that the lender is empowered to demand at his discretion, and without previous notice from the borrower, the payment of his loan. With a time loan, a loan extending over a specified period, the lender must wait for payment until the loan matures.

Large stock exchange operators, whose business is worth having, have an advantage over small traders, since they can privately arrange through their brokers for time loans at reasonable rates of interest as a safeguard against any unusual flurry in interest rates in an excited period of speculative activity.

When there is an accumulation of capital in the vaults of the banks, interest rates on call loans are unusually low. There have been times when such loans could be made by large borrowers at interest rates as low as one per cent. But this condition may quickly change. It is often reversed at the crop-moving period, when interior banks draw on their central bank reserves to provide for the borrowing demand at home. Then it is that loanable capital becomes scarce and commands a premium. Call loans will then sometimes jump to 100 per cent or more.

During the so-called Gates boom in stocks, call loans touched as high as 200 per cent. For one half hour, in October, during the climax of the 1907 panic, call loans were not to be had at any price, although frenzied brokers, whose tense and blanched faces saw disaster staring them in the face, were willing to accept any terms to get money to save them from the ruin that seemed inevitable. A powerful banking syndicate was hurriedly formed to lend $25,000,000 on the stock exchange. The money was obtained, and it saved the day.

In adverting to the variability of interest rates for call money it is my purpose to direct attention to the influence these changes exert on speculation. In fact, observing speculators watch call money interest rates almost as closely as they study prevailing tendencies and conditions in trade, to determine their effect upon security prices.

Take up once more the case of the imaginary buyer of one hundred shares of Union Pacific stock. If he has a profit, he can close his account and draw from his broker his margin, plus the additional amount represented by the advance in his stock, or, if he desires to extend his operation, the increase in his credit balance allows him then to do so.

On the other hand, if Union Pacific, costing $150 a share, declines in price, say in the neighborhood of $140, where the broker fears an impairment of his customer's margin to the point of exhaustion, he will call upon him for an additional margin and unless this deposit is immediately forthcoming it is within the broker's discretion to close the account, sell the stock, and settle with his customer. He does not have to wait until the stock touches $140 a share before doing this. For his own protection he is allowed this privilege, and it is so stated in the agreement the customer signs when placing an order.

The operation varies slightly when a buyer turns a seller of stock. A speculator, believing that Union Pacific at $150 a share is selling too high, will sell the stock through the broker at this price. Suppose he agrees to sell one hundred shares. He deposits with his broker a margin of 10 per cent or $1,500. As he is selling, he does not have to borrow any money. He simply agrees to deliver one hundred shares for $150 a share when he is ready to do it. Should Union Pacific decline to $140 a share, the seller could buy one hundred shares in the open market at this price and by so doing would be making a delivery of his stock on his selling contract. As he has sold it for $150 and bought it for $140 he has made a profit of $10 a share or $1,000 on his sale of one hundred shares. The greater the decline in the price, the larger his profit. But should Union Pacific advance instead of decline in price, every point above $150, the price he agreed to deliver it for, means a loss of one dollar on each share. If the stock should advance to $160 a share, his margin would be exhausted unless he had made an additional deposit to further protect himself.

Stop-Loss Orders

Stop-loss orders are used to limit the amount of possible loss on any transaction. Stop-loss purchases or sales are always made "at market" when a certain price is reached. For instance, if Union Pacific is selling at $135 and an order is placed to sell 100 shares at $130 stop, it means that when the price of Union Pacific on the stock exchange reaches $130 the 100 shares are to be sold at the best price obtainable. If it is impossible to execute the sale exactly at the stop figure it will be executed as soon as a sale can be made under $130. Conversely, if an order is given to buy 100 shares at say $140, it means that 100 shares are to be purchased at the market when the price reaches $140 or higher.

Stop-loss orders are a valuable device for limiting the losses of traders. Purchases may have been made at a certain figure in the belief that the market is to advance but something occurs to cause a break. If a stop-loss order is in, the loss is confined to approximately the difference between this figure and the price at which the stock was purchased, and if it should break ten points further the trader would have saved just that amount. This protection may also be used when a profit is shown on a transaction and the trader believes it will run still further. He may then place a stop-loss order below the market if he is long, or above the market if he is short, but at a figure where a profit is assured. In this way, the transaction may be allowed to run on with all risk of loss eliminated.