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if you have a spare room in your house you could rent that room out to a lodger for a fee for a year now believe it or not you could do similar things with stocks or shares my name is kieran king and today we're going to be talking about stock lending agreements how they are used how they work how people make and lose money from them let's dive in now a stock lending agreement is exactly what it says it is an agreement between two parties where one is a lender of the stock and one is a borrower of the stock the party that borrowed the stock has to give the stock back at a certain point of time however before that time comes the borrower can play with that stock and attempt to make money off of it the typical method used is known as short selling and we're going to get into it a bit later anyways let's look at an example imagine three parties jack alice and a broker that connects the two jack owns one share of apple stock worth three hundred dollars that's the market price at the moment now alice over here believes that apple is going to drop in value next month and she goes to the broker and says look i want to borrow one share of apple stock and i will return you your share in one month on the other side of the broker jack says sure i'm willing to lend my share of apple stock in return for a fee plus interest now alice in order to do in order to borrow this stock we'll need to put up some form of collateral or security in case you can't pay back the borrowed shares anyways jack agrees and they both sign a stock lending agreement with the broker alice becomes the owner of this one share of apple stock along with all the voting and ownership rights associated with it for a period of time that is she then sells that stock on to a third party who buys it for the market price of three hundred dollars over the next few weeks however apple drops in value until one share is now only worth 250 alice then buys back the share from the market for 250 and having bought this share back for a lower price she has essentially made uh fifty dollars fifty dollars of profit minus any other fees associated with what she owes the lender now this whole process here is known as short selling she has effectively made a bet that the price of the share will go down and she's won at the end of the borrowing period alice then gives the borrowed share back to the broker who returns it to jack it all has worked out for alice but what happens if alice's hunch is wrong and apple goes up in value instead of dropping well let's look at the example again alice sells the stock to a third party for three hundred dollars however instead of going down the price of apple goes up to three hundred and fifty dollars per share now at the end of the borrowing period alice will need to fulfill her obligation to pay jack back his share and will need to buy the share back from the market to do this and if she can only buy the share back at 350 dollars she has essentially made a loss of 50 this is because she sold the shares originally for 300 but bought them back for 350. so why would anyone lend stock to others well it can be potentially quite rewarding as i said at the start it's like having a space in your room in your house that you rent out to a lodger you are making your stocks work for you by renting them out to others and the returns can be quite attractive the yield could be as much as five to ten percent a month but what are the downsides to the lender the people who borrow stocks tend to do one thing short sell them if someone is short selling a stock that means that they believe the stock is going to drop in value suppose you have lots of short sellers this exerts downward pressure on a stock that sometimes causes it to slump as a lender do you want to contribute to stocks you ultimately own dropping in value probably not secondly there is a risk that the borrower will default and not be able to give back the shares that they have borrowed and sold on if the stock rallies which means it just goes up rapidly in a short period of time during the time the loan is given the borrower may not have enough funds to buy the stock back from the market to return it to the lender in that case the initial collateral may be given to the lender but it still might not be enough to cover the losses so there's a little bit of risk here too but what are the downsides to the borrower anyone selling stock they have borrowed could potentially face unlimited losses in our same example imagine apple stock goes up to two thousand dollars or three thousand dollars in a short space of time no matter how high the stock goes alice is still obligated to buy back those shares of that price which could have disastrous consequences if she doesn't have the money to do so now i must point out that the example we used here is somewhat theoretical the reality is that the roles are not as simply defined as lender broker and borrower the borrower may not be borrowing shares from the lender instead the borrower may be indirectly borrowing shares from another borrower who has borrowed shares from somewhere else not only that a borrower could be borrowing shares on someone's margin account meaning shares that are not exactly owned outright in the first place as you can see it can get pretty confusing however the good thing is usually you don't have to worry about who is on the other side of the transaction as all your activities will be with one act with one party which is your broker and there you have it i hope you enjoyed this one if you did please smash that like and subscribe button and stay tuned for more feel free to comment below i'd love to hear your thoughts take care everyone see you soon