Dominic Coyleanswers your personal finance questions
Short-selling? It's a long story
Q YOUR COLLEAGUE Fiona Reddan wrote in an article last month that the investor who wishes to short "borrows" the share from a broker by means of putting down a deposit.
Why would the broker allow a share that he owns to be shorted? The return to him will be outweighed by the capital loss to him if the share falls.
I read on a bulletin board that the shares the broker lends are the shares they hold as nominees on the Crest system.
Do you know if this is true? In this case, the broker is being paid to lend my shares and is not at financial risk himself.
If the broker can only lend his own shares then perhaps his mind would be a bit more concentrated on the likely consequences.
Mr T.G., Cork
AYour question raises a number of interesting points. Why would a broker lend a share they own to be shorted?
The simplest reason is that the institution lending the share tends to believe that the share will rise in price. If, on top of that gain, they can get a fee from someone with a contrary view, it can make perfect sense to lend shares for shorting.
You are right that, if the share price goes against them, the fee charged for lending the share is unlikely to cover the loss in capital value, but they are betting precisely that this will not happen, which is why they bought the share in the first place.
Shorting is a perfectly legitimate stock-market activity. There is no real logic to the premise that the only bet a person can make on the future direction of a share price is that it will rise (justifying their decision to buy) and shorting is one of the most popular approaches for those who believe the contrary.
Of course, there is a difference between straightforward shorting - where you take a position that a stock will fall - and aggressive shorting, where you actively seek to chase the market down by sheer weight of numbers.
A feature of the latter approach is naked shorting, where the short-seller does not even bother borrowing the shares.
Aggressive short-selling can, in in theory, be disruptive of the market and various initiatives have been put in place to curb it - including restricting naked short-selling.
However, it is worth noting that there is precious little evidence of aggressive short-selling seriously distorting the market.
People may point to the way bank shares have been chased down in the past few months but, if anything, the emerging evidence from the sector is that it was hopelessly overvalued in the first place.
And, interestingly, the decision to ban short-selling in financial stocks in several markets worldwide did little to halt the slide of the shares.
There is nothing to force an institution to lend stock for short-selling and a significant number do not permit it.
I understand that stockbrokers are allowed to lend stock from customers' Crest or Nominee accounts and it is true that, in such cases, the broker is lending stock that is not theirs and they will not be adversely affected by any movement.
However, talking to people connected with the Irish Stock Exchange, I gather that it is not something that happens here.
Their view was that it was not normal practice and would only happen where the terms of the agreement between the broker and the client allowed it.
What to do with a 50,000 windfall
Q I have won €50,000 and am so happy and so nervous that I can't decide what to do with it.
I have a €180,000 mortgage jointly with my husband with 16 years left on it, a car loan for €11,000 and a credit union personal loan for €9,000, both of which have three years to go.
What I'm wondering is: should I pay off the small loans or put it towards the mortgage or blow it on a holiday of a lifetime or a new car?
I find it very hard to actually "save" money and the only advantage to loans for me is that I have to meet the repayment every month.
However, I really want to make the most of this windfall and would greatly appreciate your advice.
Ms B.O'F., e-mail
ACongratulations on your good fortune. As you say, for most of us, €50,000 is a once-in-a-lifetime windfall and it can be quite confusing choosing between the competing urges to spend or save it.
It is impossible to be prescriptive - what you do will depend on all sorts of things, such as your age, general income, foreseeable financial commitments beyond existing borrowings, etc.
However, there are two general pieces of advice that are always worth considering.
First, as a general rule, it is advisable to pay off your debts before you invest in savings or opt to spend.
The fairly sensible thinking goes that you are paying more in interest on your borrowings than you are likely to receive from any savings.
I would suggest that the interest on your car loan and credit union loan will be higher than you will achieve on any savings account.
As to the mortgage, I have no idea what the interest rate is there. It is possible that, in today's extraordinary financial environment, you could get more in a savings account than you are paying on the mortgage.
Given that you say you find it hard to save money, you would benefit strongly by immediately diverting the monthly sums you would have spent on those two loans to accelerate payments on your mortgage.
If you do this immediately, you'll never notice the difference and it will have a marked impact on the length of time outstanding on the mortgage.
The second general principle is that, when confronted with a windfall, you should never act in haste.
Deposit the money in the short term - safe in the comfort of the Government's guarantees - and see how you feel about your options as the excitement dies down.
You could invest your money in the stock market - and there are plenty of people who will tell you the only possible way for stocks to go is up after the carnage of the past 18 months. They could be right. However, there were plenty of people saying the same thing a year ago and markets are down 25 per cent since then.
Spending the money is tempting but, if you have a recent car loan, you hardly need one of those. You might want to set aside a portion of the money for a special holiday or to purchase something you have sought for some time. The sum you have is probably enough to allow for that and for paying off some of those loans, while possibly still leaving something to sit in a longer-term investment or savings account.
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Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street, Dublin 2, or by e-mail to dcoyle@irish-times.ie.
This column is a reader service and is not intended to replace professional advice. Due to the volume of mail, there may be a delay in answering questions.
All suitable queries will be answered through the columns of the newspaper. No personal correspondence will be entered into.
