Definition§
A margin call is a broker’s demand on an investor using margin to deposit additional cash or securities so that the margin account is brought up to the minimum maintenance margin requirement. This typically occurs when the value of the securities purchased with borrowed funds falls below a certain point, making the account’s equity value too low to cover the borrowed amount.
Examples§
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Stock Purchase on Margin: An investor buys $10,000 worth of stock using $5,000 of their own money and $5,000 borrowed from their brokerage (a margin account). If the stock’s value drops to $8,000, resulting in the equity value falling below the maintenance margin of, say, $4,000, the broker would issue a margin call asking the investor to deposit an additional $1,000 or sell some securities to cover the shortfall.
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Futures Trading: In the futures market, if the value of the futures contract falls, the margin account will also decline. For instance, if an initial margin of $1,000 is required and the account value drops to $600, a margin call will be issued to bring the account back to the initial margin requirement.
Frequently Asked Questions (FAQs)§
What triggers a margin call? A margin call is triggered when the value of the securities in a margin account drops below a certain level, causing the equity in the account to fall below the brokerage’s required minimum.
What happens if you don’t meet a margin call? If you fail to respond to a margin call, your securities in the margin account may be sold by the brokerage to bring the account back to the required level.
Can a margin call be avoided? Yes, investors can avoid margin calls by not leveraging their accounts too highly and maintaining a significant buffer of equity over the maintenance margin requirement.
Is a margin call bad? A margin call can be a sign of financial trouble as it indicates that the value of the investments has dropped significantly. However, it can also serve as a reminder to reassess and manage investment risks.
How quickly must a margin call be met? Brokers typically require margin calls to be met within a few days, though the specific time frame can vary by brokerage.
Related Terms§
- Margin Account: A brokerage account in which the broker lends the customer money to purchase securities, with the securities serving as collateral.
- Maintenance Margin: The minimum amount of equity that must be maintained in a margin account.
- Leverage: Using borrowed capital to increase the potential return of an investment.
- Liquidation: The process of selling an asset or security to cover an obligation, such as a margin call.
Online References§
Suggested Books for Further Studies§
- “The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy” by James Montier
- “The Intelligent Investor” by Benjamin Graham
- “A Random Walk Down Wall Street” by Burton G. Malkiel
- “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor” by Seth A. Klarman
- “Reliability of Margin Call Systems and Margin Coverage” by Christian Hecker
Fundamentals of Margin Call: Finance Basics Quiz§
Thank you for taking the time to understand the intricate details of margin calls with our thorough guide, and for testing your knowledge with our quiz. Keep educating yourself to manage financial risks effectively!
