Margin call

Investors worldwide frequently use margin accounts to purchase bonds, stocks, and other assets. They borrow money to buy securities using these accounts from the broker. Thus, understanding margin calls is necessary for them to successfully manage their leverage and keep an eye on their accounts to avoid margin deficits.

Table of Contents

What is a margin call?
Understanding margin call
Formula of margin call price
Types of margin call
Examples of margin call
Frequently Asked Questions

What is a margin call?

A margin call is an investor’s need to add more securities or funds to their margin account to raise it above the minimum maintenance margin initiated by the broker. This request is made when the account value drops below the necessary threshold, usually as a result of a decrease in the value of the securities held as collateral. If a margin call is not met, assets may be forcibly liquidated to make up the difference, which might increase investment losses.

An investor can buy up to US$ 20,000 worth of securities if they have put US$ 10,000 of their own funds into an account with a 50% margin. The balance of US$ 10,000 can be borrowed from the broker.

Understanding margin call

Brokers use margin calls as a risk-management strategy to ensure investors maintain sufficient funds to cover any losses. Investors need to understand the consequences of margin calls, including the importance of quickly adding more money or securities to the account to fulfill the margin requirements and prevent liquidating assets against their will. A careful understanding of margin call dynamics and effective risk management is necessary for responsible margin trading.

Brokerages must establish margin restrictions for client trading accounts in order to comply with financial authorities like the Financial Industry Regulatory Authority (FINRA).

Suppose the customer’s account drops below the necessary minimum amount. In that case, the brokerage might not always send the consumer a margin call, compelling them to fill up their account with additional funds. Instead, they may sell a portion of the customer’s securities to bring the margin account back to the maintenance margin without informing the consumer.

Formula of margin call price

Mathematically, it may be calculated in the following manner:

(1- initial margin)

Margin call = initial purchase price x ———————————————

(1-maintenance margin)]

Here,

The price paid for purchasing a security is known as the initial purchase price.
The minimal amount required by the investor to acquire the security is known as the initial margin.
The maintenance margin is the equity quantity that must be kept in a margin account.

Types of margin call

Maintenance margin call (house call)

It is issued when the equity in the margin account drops below the minimum maintenance margin needed, necessitating the investor to make additional deposits of funds or securities to meet the minimal margin requirement.

Fed margin calls

Regulation T requires a minimum initial margin of 50%, while many brokerage companies set their requirements higher, at 70%. This means that the investor has to pay 50% of the purchase price of the securities upfront or higher if the brokerage company requires it. This is referred to as a “fed” or federal margin call.

Exchange (NYSE) call

You’ll receive this call when your equity drops below the current 25% threshold set by the New York Stock Exchange (NYSE). Your account was likely in a house call before if, you received an exchange call.

Examples of margin call

For example, an investor has a US$25,000 margin account and wants to use it to buy stocks valued at US$50,000. The broker requires a minimum level of margin of 40%, which implies that the investor must keep at least $20,000 in account equity.

A margin call will be made to the investor if the value of the stocks bought starts to plummet and the margin account’s value drops below the necessary minimum balance.

In this scenario, the investor’s equity in the account would be US$15,000 (US$40,000–US$25,000) if the stock value dropped to US$30,000.

This, however, falls short of the 50% minimum margin requirement as it only represents 30% of the account’s entire stock value. To get the equity back up to the necessary minimum amount of US$20,000, the investor would then receive a margin call from the broker, asking them to make additional deposits into the account. The broker has the right to liquidate all or a portion of the account’s securities to make up the difference if the investor doesn’t fulfill the margin call.

Frequently Asked Questions

Is it risky to trade stocks on margin?

Trading on margin carries a lot of risks since the broker must get repayment of the margin loan whether the investment is profitable or not. Leverage may increase profits when buying on margin, but it can also increase losses.

How can a margin call be met?

A margin call can be addressed in the following manners:

Pay the margin call with cash by making a deposit.
Deposit securities eligible for margins.
Sell any securities that are in your account.

How do you manage the risks associated with margin calls?

Investors can minimise the risks arising from margin calls by keeping sufficient equity to prevent them from triggering and keeping track of account balances and market shifts to anticipate possible margin call scenarios. Along with diversifying their investments and implementing stop-loss orders, investors can also mitigate risk and ensure they have a source of additional funds or assets in case a margin call comes up.

How to avoid margin calls?

Margin calls can be avoided by keeping a close eye on the margin account’s equity and making sure it remains above the limit. To avoid a margin call, investments can be kept in margin accounts with sufficient equity, usually over the broker’s maintenance margin requirement.

Furthermore, you may lower the chance of margin calls by using cautious risk management techniques like diversifying your investments and staying away from high leverage.

How to cover a margin call?

Covering a margin call requires adding more funds or moving securities into the margin account in order to restore the necessary maintenance margin level. When it comes to meeting the margin requirement, investors have two options: sell assets within the account or deposit cash.

As an alternative, they may decide to terminate contracts in order to lower the loan debt. It is essential to respond quickly to a margin call in order to mitigate losses and avoid the broker forcing you to liquidate your shares.