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Day loans are short-term loans extended by banks to brokers. Sometimes referred to as a morning loan, the proceeds from the loan are used to purchase securities that are intended for delivery later in the day. Once the securities are received, they can then be pledged as collateral for the balance of the day loan, and the bank loan is converted into a standard call loan.
The process for requested and obtaining a day loan is fairly straightforward. A broker will identify specific securities he or she wishes to purchase. Rather than tying up existing assets in the purchase, the broker will approach the bank to finance the acquisition of the securities. The bank will quickly review the securities in question and approve the loan. This action usually takes place in the morning, providing the nickname for the day loan.
Upon the purchase of the securities with the proceeds from the day loan, the securities are marked for transfer to the broker. This is a process that normally does not take more than a few hours to accomplish. If the securities are purchased in the morning, they are normally delivered in the afternoon. After receiving the securities, the broker notifies the bank that the securities have been delivered.
The acquired securities are then pledged as collateral and the day loan is converted into what is known as a call loan. The call loan is a common tool used by brokers to finance the purchase of securities over a longer term. Often, the broker is able to pay off the call loan using a portion of the increase generated by the acquired securities. Once the conversion to the call loan is complete, the day loan is considered settled.
Utilizing a day loan to secure new securities allows brokers to move quickly when a good deal becomes available. Banks are normally open to issuing a day loan, especially if the securities in question show a great deal of promise for growth in the short term. By going with a day loan, the broker does not have to deal with a lot of red tape or wait very long for approval to be granted. This makes it possible to pay for the securities and begin the process of delivery sooner rather than later.
For the bank, the extension of a day loan is also beneficial. The process allows the bank to collect fees for extending the original day loan, as well as apply fees to the conversion process that takes place later in the day. As a result, the bank enjoys the generation of a profit from the effort, and also has access to a desirable security in the unlikely event that the broker defaults on the call loan.