Finance: What is Hypothecation?

Hypothecation is the process or rules behind pledging collateral for a loan.

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Transcript

00:28

the Mafia game he wants to take all the dough he made shaking down kwik-e-mart [Jimmy running from police with cash]

00:33

and invest it and he wants his investment account at his stock

00:37

brokerage to be a margin account well he has a hundred grand in the account and

00:41

with a 50% margin limit Jimmy can borrow or margin up to 50 grand worth of his

00:47

stock to you know buy stuff like a new Beemer without all the bullet holes in [BMW car with bullet holes]

00:53

it so he will hypothecate his 100 grand in stocks as that collateral borrowing

00:58

forty seven thousand dollars to buy the car and all is good

01:02

well eventually jimmy plans to pay down his margin account with both cash he [Jimmy carrying cash to woman]

01:06

deposits in there and also through the dividends that the account generates on

01:10

its own which usually exceeds the margin interest that the brokerage is charging

01:15

him so where does hypothecation run into trouble well what if Jimmy wanted to buy

01:20

10 cars like you know he just had a fetish for em and he pledged

01:24

forty-seven thousand for this baby yeah the Beemer but then he also wanted that

01:28

baby for 22 grand and while this one for 35 grand and that one for 70 well he

01:34

can only pledge his collateral once for one setting or one purchase that is he

01:40

can't go to one car seller and promise him the hundred thousand dollars that's

01:44

in his brokerage account as collateral for this used Ferrari and then go to a

01:48

different car seller and pledge him the same hundred thousand dollars that's in

01:51

his brokerage account for that 1973 James Bond Aston Martin and then go to a

01:56

third car seller and do the same thing basically he's promising collateral to a

02:00

whole bunch of people well beyond what that collateral is actually worth and

02:04

basically lying about you know what he's got in his pocket quickly he will have [Man discussing Jimmy's collateral]

02:08

pledged a few hundred thousand dollars worth of collateral in a brokerage

02:12

account that only had value of 100 grand so yeah unless you're

02:15

you know connected we don't recommend going the Jimmy walnuts route [Jimmy appears tied up]