The stock is transferred to the lender which has
full title, but the borrower retains all beneficial interests in the securities.
The borrower will receive any dividends, interest or any other benefits that
flow from the stock during the term of the loan.
The ownership of the shares is temporarily transferred to the Lender. The shares
will be held in a custodial account at a major bank or major brokerage firm.
Upon payment of the loan at maturity, ownership is transferred back to the
borrower. This is a non taxable event and the borrower’s cost basis of the
collateral does not change.
This is a NON-RECOURSE loan. This means NO personal liability. The
borrower can walk away from the loan and NOT make the 1st payment.
Because of this, there is a huge risk for the lender.
The lender may utilize the pledged collateral as a part of hedging transactions.
Hedging
Hedging is a way of reducing some of the risk involved in holding an investment.
There are many different risks against which one can hedge and many different
methods of hedging. When someone mentions hedging, think of insurance. A hedge
is just a way of insuring an investment against risk.
Risk management strategy used in limiting or offsetting probability of loss from
fluctuations in the prices of securities. An investment made in order to reduce
the risk of adverse price movements in a security, by taking an offsetting
position in a related security, such as an option or a short sale. In effect,
hedging is a transfer of risk without buying insurance policies. It employs
various techniques but, basically, involves taking equal and opposite positions
in two different markets (such as cash and futures markets). Hedging is used
also in protecting one's capital against effects of inflation through investing
in high-yield financial instruments (bonds, notes, shares), real estate, or
precious metals.
