Question

What is a short sale?) Describe buying on margin.Why is it illegal to trade on insider information?

Answer 1

1. Short Sale

When investor sale a stock or assets without holding or owning the stock. Normally, Investor short sale a stock when he is expecting fall in stock price.

Process of Short sale -

Investor who wants to short sale the stock, firstly, he borrow the stock from his dealer or broker firm at some margin and sale it to the market and when price of stock fallen then he buy back the stock from market and return the stock to his dealer or broker firm.

2. Buying on margin

When investor buy a stock by borrowing money from his broker firm and pays some margin says 10% or 20% of stock Price is called buying on margin.

Suppose a stock is currently trading at $ 100 and your broker firm allow you to buy this stock by paying only 10% of the current stock price, here 10% of current stock price is margin amount i.e $ 10. Buying stock using this facility of broker is known as Buying on margin.

3. Insider Information

Insider information is a price sensitive information which is currently not published in the market. For example, Boards of Director in a meeting decided to declare 20% dividend and this information is yet not published in the market then this is a insider information. Trading on the basis of Insider Information is called Insider Trading.

Insider Trading is an Illegal activity because insider information is available to only few privileged person and using this they make excess profit in the market but at the same time when they are making money the other counter party loosing his money as he does not aware of such insider information.

Insider information reduces the fair practice of trading in financial market. Thus, Insider information is Illegal.