An example of short selling

Scenario A

• The investment manager decides to short sell Company A's shares in September 2010. As the manager does not own any of Company A's shares they borrow the shares from a Company A shareholder who lends them for a 1% p.a fee (in the same way banks charge borrowers).
• The manager then sells the shares at $22.00 per share and the proceeds are placed on deposit at 5% p.a. Interest income accrues to the manager, the short seller.
• Any dividends accrue to the lender. Over the year to September 2011, the dividends declared are 48c and 29c per share.
• The manager buys back the shares in September 2011 at $15.00 per share, and returns them to the stock lender to close the transaction.
• In summary the manager makes $7.11 profit per share:
  • $7.00 on the trade
  • receives $1.10 in interest (5% of $22.00)
  • pays $0.77 in dividends to the lender
  • pays $0.22 in borrowing fees to the lender (1% of $22.00)

Scenario B

• The investment manager decides to short sell Company A's shares in September 2010. As the manager does not own any of Company A's shares they borrow the shares from a Company A shareholder who lends them for a 1% p.a fee (in the same way banks charge borrowers).
• In September 2011 Company A announces a dramatic improvement in sales and a positive outlook for 2012. The share price rises to $25.00.
• The manager, believing the share price will continue to rise, buys back the shares and loses $3.00 on the trade.
• In summary the manager makes a loss of $3.11 per share:
  • Loss of ($3.00) on the trade
  • receives $1.10 in interest (5% of $22.00)
  • pays $0.77 in dividends to the lender
  • pays $0.22 in borrowing fees to the lender (1% of $22.00)