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In finance , margin is collateral that the holder of a financial instrument has to deposit with a counterparty most often their broker or an exchange to cover some or all of the credit risk the holder poses for the counterparty. This risk can arise if the holder has done any of the following:.
The collateral for a margin account can be the cash deposited in the account or securities provided, and represents the funds available to the account holder for further share trading.
On United States futures exchanges , margins were formerly called performance bonds. A margin account is a loan account by a share trader with a broker which can be used for share trading. The funds available under the margin loan are determined by the broker based on the securities owned and provided by the trader, which act as collateral over the loan.
The broker usually has the right to change the percentage of the value of each security it will allow towards further advances to the trader, and may consequently make a margin call if the balance available falls below the amount actually utilised. In any event, the broker will usually charge interest , and other fees, on the amount drawn on the margin account. If the cash balance of a margin account is negative, the amount is owed to the broker , and usually attracts interest. If the cash balance is positive, the money is available to the account holder to reinvest, or may be withdrawn by the holder or left in the account and may earn interest.
In terms of futures and cleared derivatives, the margin balance would refer to the total value of collateral pledged to the CCP Central Counterparty Clearing and or futures commission merchants. Margin buying refers to the buying of securities with cash borrowed from a broker , using the bought securities as collateral. This has the effect of magnifying any profit or loss made on the securities. The securities serve as collateral for the loan. The net value—the difference between the value of the securities and the loan—is initially equal to the amount of one's own cash used.
This difference has to stay above a minimum margin requirement , the purpose of which is to protect the broker against a fall in the value of the securities to the point that the investor can no longer cover the loan. In the s, margin requirements were loose.
In other words, brokers required investors to put in very little of their own money. During the s leverage rates of up to 90 percent debt were not uncommon. They had to deliver more money to their brokers or their shares would be sold. Since many individuals did not have the equity to cover their margin positions, their shares were sold, causing further market declines and further margin calls. This was one of the major contributing factors which led to the Stock Market Crash of , which in turn contributed to the Great Depression.
White's paper published in The American Economic Review , " Was the Crash of Expected ",  all sources indicate that beginning in either late or early , "margin requirements began to rise to historic new levels. The typical peak rates on brokers' loans were 40—50 percent.
Brokerage houses followed suit and demanded higher margin from investors". Short selling refers to the selling of securities that the trader does not own, borrowing them from a broker , and using the cash as collateral. This has the effect of reversing any profit or loss made on the securities. The initial cash deposited by the trader, together with the amount obtained from the sale, serve as collateral for the loan. The net value—the difference between the cash amount and the value of loan security — is initially equal to the amount of one's own cash used.
This difference has to stay above a minimum margin requirement , the purpose of which is to protect the broker against a rise in the value of the borrowed securities to the point that the investor can no longer cover the loan.
Enhanced leverage is a strategy offered by some brokers that provides 4: This requires maintaining two sets of accounts, long and short. The initial margin requirement is the amount of collateral required to open a position. Thereafter, the collateral required until the position is closed is the maintenance requirement.
The maintenance requirement is the minimum amount of collateral required to keep the position open and is generally lower than the initial requirement. This allows the price to move against the margin without forcing a margin call immediately after the initial transaction.
When the total value of collateral after haircuts dips below the maintenance margin requirement, the position holder must pledge additional collateral to bring their total balance after haircuts back up to or above the initial margin requirement. On instruments determined to be especially risky, however, the regulators, the exchange, or the broker may set the maintenance requirement higher than normal or equal to the initial requirement to reduce their exposure to the risk accepted by the trader.
For speculative futures and derivatives clearing accounts, futures commission merchants may charge a premium or margin multiplier to exchange requirements. The broker may at any time revise the value of the collateral securities margin , based, for example, on market factors. If this results in the market value of the collateral securities for a margin account falling below the revised margin, the broker or exchange immediately issues a "margin call", requiring the investor to bring the margin account back into line.
To do so, the investor must either pay funds the call into the margin account, provide additional collateral or dispose some of the securities. If the investor fails to bring the account back into line, the broker can sell the investor's collateral securities to bring the account back into line. If a margin call occurs unexpectedly, it can cause a domino effect of selling which will lead to other margin calls and so forth, effectively crashing an asset class or group of asset classes.
This situation most frequently happens as a result of an adverse change in the market value of the leveraged asset or contract. It could also happen when the margin requirement is raised, either due to increased volatility or due to legislation. In extreme cases, certain securities may cease to qualify for margin trading; in such a case, the brokerage will require the trader to either fully fund their position, or to liquidate it.
The minimum margin requirement , sometimes called the maintenance margin requirement , is the ratio set for:. So the maintenance margin requirement uses the variables above to form a ratio that investors have to abide by in order to keep the account active. So at what price would the investor be getting a margin call? For stock price P the stock equity will be in this example 1, P. Let's use the same example to demonstrate this:.
Margin requirements are reduced for positions that offset each other. For instance spread traders who have offsetting futures contracts do not have to deposit collateral both for their short position and their long position.
The exchange calculates the loss in a worst-case scenario of the total position. Similarly an investor who creates a collar has reduced risk since any loss on the call is offset by a gain in the stock, and a large loss in the stock is offset by a gain on the put; in general, covered calls have less strict requirements than naked call writing.
The margin-equity ratio is a term used by speculators , representing the amount of their trading capital that is being held as margin at any particular time.
The probability of losing their entire capital at some point would be high. By contrast, if the margin-equity ratio is so low as to make the trader's capital equal to the value of the futures contract itself, then they would not profit from the inherent leverage implicit in futures trading. Return on margin ROM is often used to judge performance because it represents the net gain or net loss compared to the exchange's perceived risk as reflected in required margin.
The annualized ROM is equal to. Sometimes, return on margin will also take into account peripheral charges such as brokerage fees and interest paid on the sum borrowed. The margin interest rate is usually based on the broker's call.
From Wikipedia, the free encyclopedia. This article is about the term as it is used in the jargon of bourses. For the film, see Margin Call film.
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