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How does the Mechanism of Margin Call Works?

Updated on December 2, 2021 , 335 views

Not being tempted to trade with a margin account could be more stringent. However, what you must keep in mind is that things not going well can result in the occurrence of a feared margin Call. Let’s admit it; you cannot trade in the stock market without experience risks and volatility.

But, when you start losing more than gaining, it becomes dreading. After all, you cannot have risk-free trading. Margin serves as the faith deposit, helping the clearinghouse of an exchange run smoothly and without any hindrances.

Margin Call

With a margin call mechanism, you can stay in business for long. This post will help you understand more about its aspects.

What is a Margin Call?

Understanding the margin call meaning is quite simple. A margin call transpires when the value of a margin account (the one comprising securities purchased with borrowed money) of an investor goes below the required amount of a broker. Thus, a margin call turns out to be the demand of a broker that an investor deposit additional securities or money so that the account can be brought up to its minimum value, which is called the maintenance margin.

Usually, a margin call defines that securities kept in the margin account have gone below a specific point in terms of their value. Therefore, the investor should either deposit more money in the margin account or sell off a few assets.

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Margin Call Explained: The Working Method

Whenever an investor borrows money from a broker for investment purposes, a margin call occurs. Also, when the investor utilizes the margin to sell or purchase securities, he could pay by using the amalgamation of borrowed money and funds that he held.

The equity of an investor in the investment turns equal to the securities’ market value while subtracting the borrowed amount from the broker. In case the margin call isn’t met, the broker gets the obligation to liquidate securities available in the account.

Sure, the prices and figures related to the margin calls can be based upon the percentage of equities and margin maintenance involved. However, in terms of an individual, the specific stock price below the point that triggers a margin call can easily be calculated.

Generally, it arises when the account equity or value is equal to the maintenance margin requirement (MMR). Thus, the formula used in this instance is:

Account Value = (Margin Loan) / (1-MMR)

Example of Margin Call

Let’s say you have a margin account of INR 3,68,128. You decide to borrow INR 3,68,128 from a brokerage firm to invest in the securities worth INR 7,36,256. Suppose the broker has set the minimum margin maintenance requirements of 30%. You have equity worth INR 7,36,256 in your margin account.

Now, the minimum margin maintenance requirements for this account will be approx INR 5,25,834. If your account value goes below this maintenance level, then the margin call will be triggered. If your margin account is worth INR 5,15,379, the investor will initiate the margin call of INR 7,362.

What is the Minimum Maintenance Level?

A margin account enables the investor to purchase securities using their own funds and borrowed money. They can request the brokerage firm to lend them the margin funds for the investment. The broker charges a fixed interest on the margin funds as long as the investor does not repay the loan. The broker can make a margin call only when the margin account of the investor falls below the maintenance requirements. If the investor is not in a financial position to fulfill the margin call, then the brokerage firm has the right to sell the securities held in the margin account to offset the loss.

In other words, the broker can liquidate these stocks. FINRA and NYSE have made it mandatory for the investors to deposit at least 25% of their total investment. That means the investor must have 25% of the investment amount in their margin account. However, the brokerage firm can demand a high maintenance requirement. They might ask the investor to keep 30-40 percent of the equity’s value in the margin account. Now, the amount the broker requests you to deposit into your margin account will depend on the current maintenance level and the equities you hold. The margin call is triggered when your equity value matches the margin account value.

Understand Before Making a Move

Before you open a margin call Trading Account, make sure that you comprehend the ins and out of the margin call. Get associated with a broker who can explain margins before commencing the trades. Additionally, to open up the account, you would have to sign a lengthy, bulky document. And, if you sign it without understanding the definition, responsibilities, and risks outlined, know that it would be a grave mistake from your end.

Disclaimer:
All efforts have been made to ensure the information provided here is accurate. However, no guarantees are made regarding correctness of data. Please verify with scheme information document before making any investment.
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