Reply #56: Wikipedia: Securities Lending

[DemReadingDU]

In finance, securities lending or stock lending refers to the lending of securities by one party to another. The terms of the loan will be governed by a "Securities Lending Agreement", which, under U.S. law, requires that the borrower provides the lender with collateral, in the form of cash, government securities, or a Letter of Credit of value equal to or greater than the loaned securities. As payment for the loan, the parties negotiate a fee, quoted as an annualized percentage of the value of the loaned securities. If the agreed form of collateral is cash, then the fee may be quoted as a "rebate", meaning that the lender will earn all of the interest which accrues on the cash collateral, and will "rebate" an agreed rate of interest to the borrower.

Securities Lending is an over-the-counter market, so the size of this industry is difficult to estimate accurately. According to the industry group ISLA, in the year 2007, the balance of securities on loan exceeds $2 trillion globally.

Example
In an example transaction, a large institutional money manager with a position in a particular stock would allow those securities to be borrowed by a securities lender. The securities lender (investment bank) would then allow a short seller to borrow the stock and sell it. The short seller would like to buy the stock back at a lower price (which would create a profit). Once the shares are borrowed and sold, it generates cash from selling the stock. That cash would become collateral for the borrow. The cash value of the collateral would be marked-to-market on a daily basis to maintain 105%. The institutional manager would have access to the cash for overnight investment and maintains a long position in the stock.

more...
http://en.wikipedia.org/wiki/Securities_lending