Ian Lance, CFA, is discussing short selling with a client and states, "The short seller must pay any dividend of the issuer to the lender of the stock. In addition, the short seller must provide some collateral to the brokerage house." Is Lance correct about the short seller's obligations?
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A. B. C.A
Lance's statement about the short seller's obligations is partially correct. Let's break down the two parts of his statement:
This statement is incorrect. When a short seller borrows shares to sell them in the market, they are obligated to compensate the lender for any dividends that the lender would have received if they had held the shares. This means that the short seller must pay the lender an amount equal to the dividend per share. In essence, the short seller is responsible for reimbursing the lender for the missed dividend income.
This statement is correct. When engaging in short selling, the short seller is essentially borrowing shares from a brokerage house or another lender. To secure this borrowing arrangement, the short seller is typically required to provide collateral to the lender. The collateral serves as a form of security in case the short seller is unable to fulfill their obligations or the value of the borrowed shares declines significantly. The collateral can be in the form of cash, other securities, or other assets that are acceptable to the lender.
Therefore, the correct answer is C. Lance is incorrect about paying the dividend, and correct about providing collateral.