Lesson 21 of 25 · 7 min

What a prepaid variable forward does to the pledge and to basis

The cash arrives like a loan, the shares stop counting as collateral, and the tax timing is separate again.

The prepayment feels like a loan and the shares feel like they are still yours. The collateral arithmetic follows neither feeling, because the shares committed to the forward are pledged to the counterparty and a lender will not count collateral it cannot reach.

Take a pledged pool of $3,600,000: 30,000 shares of one name at $80, so $2,400,000 at a 40 percent advance rate giving $960,000, plus $1,200,000 of diversified collateral at 75 percent giving $900,000. Lending value is $1,860,000 and the balance is $1,050,000, so loan to value is 56.5 percent.

Now 22,000 of the 30,000 shares, worth $1,760,000, are committed to a forward and cease to count. The remaining 8,000 shares give $640,000 × 0.40 = $256,000, and lending value falls to $1,156,000. The prepayment at 79 percent is $1,390,400. If that cash lands outside the pledged account, loan to value is $1,050,000 ÷ $1,156,000 = 90.8 percent. If it stays as pledged cash at a 95 percent advance rate it adds $1,320,880, taking lending value to $2,476,880 and loan to value to 42.4 percent.

Basis is a separate mechanism again. The shares delivered at settlement carry their original cost basis and holding period, so the disposal and its gain land at settlement rather than at the outset — provided the contract is variable enough that the outset is not itself a disposal. Where that line falls depends on the contract's terms, and this lesson does not resolve it; the point is that the cash and the tax event are not simultaneous by design, and the design is what determines the timing.

The same $1,390,400 of cash produced a 90.8 percent loan to value or a 42.4 percent one. The difference was not the structure. It was which account the cash landed in.

Key terms

Committed shares: Shares promised to a counterparty under a forward. They generally cannot serve as collateral for a separate line at the same time.
Cost basis: The original purchase price used to measure gain on a disposal. It travels with the shares to whoever receives them at settlement.
Timing of the disposal: When a transaction counts as a sale. For a variable forward it is normally at settlement rather than at the prepayment, and the contract's terms decide.

Worked example

Where the prepayment lands decides the ratio

Pool $3,600,000: 30,000 shares at $80 with a 40% advance rate, plus $1,200,000 of diversified collateral at 75%. Balance $1,050,000. A forward commits 22,000 shares and prepays 79% of their value. Illustrative schedule.

Lending value before: $1,860,000
Loan to value before: 56.5%
Lending value after the shares are committed: $1,156,000
Prepayment received: $1,390,400
Loan to value if the cash leaves the pledge: 90.8%
Loan to value if the cash stays, at a 95% advance rate: 42.4%

Committing the shares removed $704,000 of lending value. Whether that mattered depended entirely on the destination of the cash.

Check yourself

A forward commits pledged shares worth $1,760,000 that had carried a 40 percent advance rate, and the $1,390,400 prepayment is transferred out of the pledged account. Lending value was $1,860,000 against a $1,050,000 balance. What is loan to value now?

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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.