Manufactured Payment What it Means How it Works Example

Manufactured Payment What it Means How it Works Example

Manufactured Payment: What it Means, How it Works, Example

What Is a Manufactured Payment?

In finance, "manufactured payment" refers to a payment made in relation to securities lending arrangements. These payments are common in short selling, where borrowers must pay interest and/or dividends to the lenders.

Key Takeaways

– Manufactured payments are payments made by securities borrowers to their lenders.

– They are commonly seen in short-sale transactions, where interest and dividends must be paid to the transacting broker.

– Such payments make it difficult to estimate the risks of short-selling because if shorted companies begin paying dividends after the short sale, the holding costs of that short position will rise accordingly.

How Manufactured Payments Work

Manufactured payments are interest or dividend payments that arise when securities are borrowed. Unlike cash loans, where borrowers make interest and principal payments, borrowers of securities pay back the loaned security along with a series of "manufactured payments" during the loan’s life.

Manufactured payments are mostly associated with short selling. In this transaction, the short-seller borrows shares from a brokerage firm and immediately sells them for cash. The short-seller must later return the same number of shares to the brokerage firm while paying interest. The short-seller must also remit funds equivalent to any dividends paid by the shorted stock. These combined payments are known as the "manufactured payments" of the loan.

An Example of a Manufactured Payment

Suppose you are bearish on XYZ Corporation and borrow 100 shares, selling them for $10,000. You pay monthly interest at a 5% annual rate. If XYZ starts paying dividends, you must include the value of those dividends in the manufactured payments to your brokerage firm, in addition to the interest costs.

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Manufactured payments are treated as investment interest expenses and must be reported on Schedule A of a tax return.

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