What is Margin Call
Margin Call Meaning
A margin call occurs where the percentage of the equity on securities held by an investor falls below the required minimum maintenance margin for a margin account. A margin account contains the investor’s money and money borrowed from the broker/investment firm to purchase securities.
How Do You Calculate a Margin Call?
To calculate a margin call, the investor needs the Debt value owed to the broker firm and the maintenance margin requirement percentage.
Margin Call = Debt Balance / (1- MMR%)
Where;
MMR %= maintenance margin requirement percentage
Examples of a Margin Call
X invests £2000 worth of securities in XR Company bought using £1000 cash and £1000 borrowed from YZ Company at an agreed interest rate, assuming there is a maintenance margin requirement of 40% and the value of the securities held by the investor drops by 20% from £2000 to £1600, the value of equity position of the investor being £600 is below the required minimum maintenance margin value of 40% thus YZ Company would have an affect a margin call.
Another example of a margin call; Investor F buys £100,000 worth of securities in CK company using £50,000 cash and £50,000 borrowed from broker firm FM, with a maintenance margin requirement of 35%, where the value securities drop in value by 25% from £100,000 to £75,000, the equity position of investor F being (£25,000) is less than required maintenance margin thus FM would affect a margin call.
How Does a Margin Call Work?
A margin call is put in place by an investment/broker firm when equity held by the investor on the margin account has fallen below the set maintenance value requirement. When a margin call occurs, the investor may either deposit more funds to meet the minimum margin or the broker/investment firm may liquidate securities held by the investor in a margin account.
For example, AB is required to deposit money to meet an initial margin requirement for a margin account on a £2,000 margin investment. AB must deposit at least £1,000, thus holding 50% equity and 50% Debt at the start of the investment.
After the investor meets the initial margin requirement, a maintenance margin is required, which is usually set by the investment firm. For example, if a maintenance margin of 40% is set and the value of the investment drops to £1600, a margin call would be effected as the equity position of investor AB (£600) is below the required maintenance margin.
AB may either deposit more funds to meet the minimum maintenance margin MMR set by the broker, or the investor may liquidate securities. The investor is free to deposit more money in a margin account at any time to avoid margin calls, subsequent decline in the value of securities held may also allow for further margin calls. Where a margin call is made by the broker/investment firm and no funds are deposited, the investment firm/broker might be forced to liquidate securities. The Initial margin requirement opens the position of the investor, while the maintenance margin maintains the investor’s position on the securities investment.
The minimum maintenance margin (MMR) on margin accounts is set by the broker or investment firm and varies from firm to firm. In the United States (US), the Financial Industry Regulatory Authority (FINRA) recommends this must be at least 25% of the total value of the securities investment. In the UK, the Financial Conduct Authority FCA UK recommends between 25%-50%.
The initial margin requirement is set by Federal Reserve Board in the US; under Regulation T, the investment must be at least 50% of the total value of securities being invested. In the UK, there is no standardised regulation in relation to an initial margin requirement.
How Do You Calculate Initial Margin Requirement Amount?
To calculate the required Initial Margin Requirement [1], an investor needs to consider the total value of securities being purchased amount of cash to be put forward. First, calculate the total value of securities to be purchased, then multiply the value by the margin requirement percentage.
IRM = (P*N) x PP
Where;
P=Purchase price per share of Stock
N=Number of shares
PP= Initial Margin Requirement Percentage
IRM= Initial Margin Requirement Amount
What does it Mean for Retail Investors?
Retail traders/investors must keep an eye out for fluctuations in the market value of securities investments, which consequently affects their required maintenance margin set by investment/broker firms, to ascertain whether a loss or profit is being made on margin account investment.
How/Ways to Avoid a Margin Call ?*
Set money aside separate from initial margin investment to act as a cushion and avoid a Margin Call by a broker firm.
Invests in securities that are less volatile and prone to market fluctuations, thus allowing for a considerably stable equity position by investor.
Key Takeaways
Margin Call - where investor equity position in securities on a margin account falls below the required maintenance margin.
Initial Margin Requirement - minimum value amount required to invest in securities on a margin account.
Maintenance Margin- minimum margin value on securities set by investor/broker firm on a margin account.
Margin Account - an investment account containing money belonging to an investor and borrowed money from an investment firm/broker.
Article Sources
Federal Reserve, “Initial Margin Requirements” Accessed August 10, 2022.
FINRA Rules “Margin Requirements” Accessed August 10, 2022.
FCA UK “Enhancing Conduct of business rules for firms providing contracts for difference products to retail clients” Accessed August 10, 2022.
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