Manufactured Payment

What Is a Manufactured Payment?

In finance, the term "manufactured payment" alludes to a payment that must be made corresponding to certain securities lending arrangements. Manufactured payments are a common feature of short selling, in which a borrower receives title to shares and must pay interest as well as dividend payments to the lender of those securities.

How Manufactured Payments Work

Manufactured payments are a particular type of interest or dividend payment that arises when securities are borrowed. These contrast from loan arrangements including cash, where borrowers must pay back the balance owed through a series of interest and principal payments. With securities loans, borrowers receive a security that they must pay back sometime not too far off, alongside a series of "manufactured payments" delivered by the borrower during the life of the loan.

Manufactured payments are generally commonly associated with the short sale of stocks. In this type of transaction, the short-seller borrows a certain number of shares from a brokerage firm and afterward quickly sells those shares in exchange for cash. The short-seller is then committed to return similar number of shares to the brokerage firm sometime not too far off, while likewise paying interest to that brokerage firm until the shares have been returned.

As part of this arrangement, short-sellers must furthermore transmit funds to the brokerage firm that are equivalent to any dividends paid by the shorted stock during the life of the loan. Hence, for a dividend-paying stock, the short seller would be required to pay both interest payments and extra payments adequate to match the company's dividends. Taken together, these combined payments are known as the "manufactured payments" of the loan.

An Example of a Manufactured Payment

To illustrate how manufactured payments work, think about the accompanying scenario: Suppose you are bearish on the possibilities of XYZ Corporation. Albeit this company trades at $100 per share, you accept it is overvalued and the fair value is nearer to $25. You choose to borrow 100 shares of XYZ from your brokerage firm, then quickly sell them, understanding proceeds of $10,000. In exchange, you are required to pay month to month interest at an annual rate of 5%. Expecting XYZ doesn't as of now pay dividends, your month to month cost is limited to this interest payment.

Let us presently consider an alternate scenario where XYZ reports earnings that overcome your presumption, at last making its share price climb. The company's sudden profitability empowers it to start paying dividends to investors. In this case, the manufactured payments you make to your executing brokerage firm must thus incorporate the value of any dividends paid by XYZ, notwithstanding your existing interest costs.

Manufactured payments ought to be treated as investment interest expenses that must be reported on Schedule An of a tax return.

Features

• They are commonly found in short-sale transactions, in which interest and dividends must be paid to the executing broker.
• Manufactured payments are the payments that must be made by securities borrowers to their lenders.
• Such payments make it hard to estimate the risks of short-selling since, supposing that shorted companies start paying dividends after the short sale has been made, the holding costs of that short position will rise likewise.