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KembaraXtra-Islamic Finance-Islamic Capital Market -Short Selling
– Short selling is a trading strategy mainly used in bear markets, where investors expect stock prices to fall.
– It allows investors to make profits from declining stock prices, rather than rising prices.
• Basic Idea of Short Selling
– The investor borrows shares of a stock from a broker.
– The borrowed shares are sold immediately in the secondary market at the current market price.
– The investor receives cash from this sale.
– Later, when the stock price falls, the investor buys the same number of shares at the lower price.
– These newly purchased shares are returned to the broker.
– The difference between the selling price and the buying price becomes the investor’s profit.
• Role of the Broker and Margin
– Shares are borrowed through a broker, not owned by the investor.
– The investor must place a margin deposit with the broker as security.
– This margin protects the broker in case the stock price rises instead of falling.
• How Profit Is Made
– Profit arises because the investor sells the shares at a higher price and buys them back at a lower price.
– If prices fall as expected, short selling is profitable.
– If prices rise instead, the investor incurs losses.
• Numerical Example
– Stock price of Company A = US$20 per share.
– Investor expects the price to fall.
– Investor borrows 100 shares from the broker after placing a margin deposit.
– Investor sells the 100 shares at US$20 per share, receiving US$2,000.
– Later, the stock price falls to US$10 per share.
– Investor buys 100 shares at US$10 per share, paying US$1,000.
– Investor returns the 100 shares to the broker.
– Profit = US$2,000 − US$1,000 = US$1,000.
• Risk Aspect
– Short selling involves high risk.
– If the stock price rises instead of falling, losses can be unlimited, as there is no upper limit to how high a stock price can rise.
One-Line Exam Answer
Short selling is a strategy in which an investor borrows shares, sells them at the current price, and later repurchases them at a lower price to return to the broker, earning profit from the price decline.
– Short selling is a trading strategy mainly used in bear markets, where investors expect stock prices to fall.
– It allows investors to make profits from declining stock prices, rather than rising prices.
• Basic Idea of Short Selling
– The investor borrows shares of a stock from a broker.
– The borrowed shares are sold immediately in the secondary market at the current market price.
– The investor receives cash from this sale.
– Later, when the stock price falls, the investor buys the same number of shares at the lower price.
– These newly purchased shares are returned to the broker.
– The difference between the selling price and the buying price becomes the investor’s profit.
• Role of the Broker and Margin
– Shares are borrowed through a broker, not owned by the investor.
– The investor must place a margin deposit with the broker as security.
– This margin protects the broker in case the stock price rises instead of falling.
• How Profit Is Made
– Profit arises because the investor sells the shares at a higher price and buys them back at a lower price.
– If prices fall as expected, short selling is profitable.
– If prices rise instead, the investor incurs losses.
• Numerical Example
– Stock price of Company A = US$20 per share.
– Investor expects the price to fall.
– Investor borrows 100 shares from the broker after placing a margin deposit.
– Investor sells the 100 shares at US$20 per share, receiving US$2,000.
– Later, the stock price falls to US$10 per share.
– Investor buys 100 shares at US$10 per share, paying US$1,000.
– Investor returns the 100 shares to the broker.
– Profit = US$2,000 − US$1,000 = US$1,000.
• Risk Aspect
– Short selling involves high risk.
– If the stock price rises instead of falling, losses can be unlimited, as there is no upper limit to how high a stock price can rise.
One-Line Exam Answer
Short selling is a strategy in which an investor borrows shares, sells them at the current price, and later repurchases them at a lower price to return to the broker, earning profit from the price decline.
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