Lesson 21 of 25 · 6 min

Settlement: the days between a sale and the cash

Collateral leaves on the trade date and the repayment arrives later, so the ratio can worsen in between.

A sale and a repayment are two events on different days, and the gap between them has a shape that surprises people: for its duration, the account can look worse than it did before anything was done.

Shares in most major markets now settle one business day after the trade. Some pooled funds settle on the same schedule and others take longer; a few instruments still settle in two or three days. Until settlement, the proceeds are not cash the lender can apply, so the balance is unchanged.

Watch a $77,105.26 sale, which cures a $29,300 shortfall against a collateral value of $985,000 at a 62 percent threshold, with a balance of $640,000. Before the sale the ratio is $640,000 ÷ $985,000 = 65.0 percent, against a permitted balance of $610,700. On the trade date the shares are gone from the collateral report and the collateral value is $907,894.74, while the balance is still $640,000 — a ratio of 70.5 percent. The account is further from compliance the moment it acts. One business day later the proceeds settle and are applied, giving a balance of $562,894.74 against $907,894.74, which is exactly 62 percent.

Whether that interim worsening is real depends on one operational choice: some lenders credit unsettled proceeds as collateral at full value, in which case nothing changes between the two dates, and others do not. The interest, however, is not a choice. At an illustrative 7.62 percent the balance accrues $640,000 × 0.0762 ÷ 360 = $135.47 a day until the proceeds land, and a sale executed on a Friday settling Monday accrues that for three calendar days, or $406.40, added to a balance the sale was supposed to reduce.

Key terms

Trade date: The day the sale is executed. The collateral is treated as gone from this date, at a price fixed on this date.
Settlement date: The day cash actually changes hands and can be applied to the balance. One business day later for most shares.
Settlement gap: The interval in which the collateral has left and the repayment has not arrived. Interest accrues across all of it.

Worked example

Three dates, three ratios

Collateral value $985,000, threshold 62 percent, balance $640,000. A $77,105.26 sale cures a $29,300 shortfall. Rate 7.62 percent, Act/360.

Before the sale: 65.0%
Trade date, proceeds unsettled: 70.5%
Settlement date, proceeds applied: 62.0%
Interest per day across the gap: $135.47
A Friday sale settling Monday: $406.40

The ratio rose five and a half points on the day the cure was executed, and fell eight and a half on the day it settled.

Check yourself

A $318,000 balance accrues at an illustrative 7.15 percent, Act/360. Pledged shares are sold on a Friday and settle on the following Monday. How much interest accrues before the proceeds are applied?

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Educational only. Nothing in this lesson is investment, legal or tax advice, or a recommendation to enter into any transaction. Figures are illustrative and computed from the inputs stated in the lesson.