Q&A with CMMB Securities

Q. With many stores offering up to 12 months interest free credit, does that mean it’s now a better bet to buy a large item on hire purchase rather than get a bank loan to buy it cash?

Koretta, Arima

A: To find out whether it is better to buy an item on hire purchase, the following may help you make your decision:
A consumer should ensure that the rate of borrowing for a hire purchase item is not greater than the cost of a loan from a bank. Often, companies can factor a large rate into the price of the item, which would allow them to recover the interest for the year they are offering it to you “interest free.” Let’s take a simplified example that ignores inflation and interest earned from placing the money in other investments if you were not paying interest for the first year.

A vendor may say “$333.33 per month with interest free credit for the first 12 months” or $8,000 cash. Let’s assume that the term of the hire purchase period is 2 years and that after year one you are required to pay a hypothetical sum of $500 per month. Your total outlay for this item would then be $10,000. Although you did not pay interest for the first 12 months, when you calculate your total installments over the 2 years, you essentially paid interest of 25 per cent. If you went to a bank and your cost of borrowing was 8 percent per year for two years, you would have reduced your cost of borrowing by taking a bank loan. Given the low cost of borrowing at this time, it may be a good idea to take advantage of a loan if you find that the hire purchase option is too costly for the period of the hire purchase plan. However, if you were to borrow from a bank you would need to have either a guarantor or some form of collateral, whereas if you purchased an item on hire purchase, the item purchased would be used as collateral. The collateral supplied to the bank would be tied up until the loan is repaid. This is a consideration to take into account when you are deciding between a loan and a hire purchase option. It’s also a good idea to shop around as banks often have special promotions that make it even easier to access a loan.

Q. Is it possible to use the money I have in shares with a broker as collateral for a line of credit with that broker to buy more stock?

Russell, San Fernando

A: Your question refers to “buying on margin” or “margin trading.” “Buying on margin” is borrowing money from a broker to purchase stock using your current securities as collateral. The first step in purchasing shares on margin would be to open  a margin account with your broker and borrow against shares you currently own. However, in Trinidad and Tobago under the Securities Industry Act of 1995, brokers are not allowed to hold margin accounts and therefore cannot offer this service to you. Alternatively, you could arrange with a licensed financial institution (such as a bank) to provide you with this facility or something similar to it, but you would have to ensure that your cost of borrowing does not outweigh your returns.
Margining  (in countries where it is permitted) allows you to buy more stock to take advantage of returns that you would not have been able to take advantage of given your current resources. The broker would lend you a percentage of the market value of your securities. The securities you put up as collateral would be pledged, meaning that you would not be able to sell them until your loan is paid off.  The licensed financial institution would be authorised to offer you a line of credit and can also act as a trustee for the stocks held as collateral.

Buying stocks on margin however is both risky and costly. You would have to pay the interest on your loan and these charges would be applicable to your account unless you decide to make payments. Thus the longer you borrow, the greater return you would require to break even. Additionally, lets say you borrowed 50 percent of the market value of your securities that were held as collateral by your broker. If the market value of this collateral falls below 50 percent of your borrowed amount, you would be required to increase your collateral either through cash payments or additional securities to return to the 50 percent level.

Q. Is Common Stock different from regular stock?
 
Gilma, Cunupia

A: The two most popular stocks are common stocks and preferred stocks. However, when people talk about stocks they generally refer to Common stocks and these can also be termed regular stocks. The majority  of stocks issued by a corporation normally comprise “Common” form stocks.
A common share would represent ownership in a company and a claim to a portion of profits or dividends and would allow the investor one vote per share. Apart from receiving dividends, investors also benefit from the stock’s capital appreciation, which can increase returns considerably. However, though stocks have the potential to offer higher returns relative to other investments, if a company goes bankrupt and consequently liquidates, the common shareholders will not receive money until the creditors, bondholders, and preferred shareholders are paid. The latter refers to holders of another popular type of stock called Preferred stock, which also represents ownership in a company and does not usually  carry voting rights or has limited voting rights. These shares are paid a fixed dividend for as long as the company is in operation and differs from common stock which are paid variable dividends according to the discretion of management.

Questions can be sent to PO Box 1830, Wrightson Road, Port-of-Spain
e-mail: cmmb@mycmmb.com