A margin call is essentially a broker’s tool where he or she can demand an investor to deposit additional money on invested securities so that a minimum maintenance level of a margin account is accommodated for by the investor.
Margin Calls are usually made by brokers who run margin accounts. These are fundamentally brokerage accounts in which the broker lends cash to a customer so they are able to buy securities from the stock market. The collaterals for the account are the securities value and the cash invested itself.
In a margin account, it is important to know that if the value of the stock drops considerably, then the account holder receives a margin call from the broker to deposit more cash, or sell the portion of the stock in their possession.
On the other hand, a maintenance margin is the bare minimum value of ownership that an investor must maintain in a margin account. Maintenance margins for most securities or stocks in trade are often kept at 25% by brokers. However many brokers can have even higher maintenance margins that can be around 30 to 40%.
Margin Call is made when:
(Market Value of Invested Securities – Broker’s Invested Cash) ÷ (Market Value of Invested Securities) % << Maintenance Margin % specified by the broker.
Jordan wants to invest in a security that has a market value of $50,000. He asks a broker to open a margin account in which his equity or ownership is 50% i.e. $25,000. However the next day the value of the invested security falls down to $30,000. This would result in the broker’s share of the security to become a major portion of the invested capital and the investor’s share falls down to $5,000. Since the bare minimum of 25% margin requirement has been breached, the broker will make a margin call to the investor to deposit more cash to the account or sell off some of the invested security in order to meet the maintenance margin obligation.
On the other hand if we consider the same scenario, but instead of stock price falling, it increases to $70,000 then the situation would not require a margin call from the broker. This is because when the security or stock value is raised, then the invested share of the investor is also raised, leaving the broker much more safe than before.
Financial education is so important, but barely taught at all in our schools. Having resources online is great, but not if they are inaccessible to so many. Thanks 508!