Margin in the Stock Market
A stock brokerage account can be either a cash account or a margin account. A cash account requires the investor to pay in full for every investment security purchased. A margin account allows the investor to borrow a portion of the investment cost from the broker. The margin rules protect both the investor and the broker.
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Initial Margin
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A margin brokerage account allows an investor to borrow up to half of the cost of a stock investment. For example, to buy $10,000 worth of stock, an investor puts up $5,000 and borrows the balance as a margin loan. Using margin allows the investor to buy more stock with the same size brokerage account. The leverage provided multiplies the return earning by the level of margin used. The use of margin when investing will also multiply the losses.
Maintenance Margin
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When an investor has purchased stock using margin, the value of the stock will go up or down, changing the ratio of the margin loan in relation to the value of the shares. If the stock increases, there is no problem. The investor's equity increases and the margin loan is a smaller percentage of the total account value. If the value of the investment falls, the investor is required to maintain a certain level of his own equity in the account. This level is called the maintenance margin and is 25 percent for stock investments.
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Maintenance Margin Example
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An investor with $10,000 in her margin brokerage account buys $20,000 worth of stock, using the maximum level of initial margin. The stocks decline in value to $12,000, leaving the investor with equity of $2,000 and a margin loan of $10,000. The equity in the account is 16.6 percent, below the maintenance margin requirement of 25 percent. The investor will receive a margin call from the broker. Adding $1,000 to the account will bring the equity up to $3,000 and the margin loan down to $9,000, meeting the 25 percent maintenance requirement.
Margin Call
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When a margin account value falls below the maintenance margin level, the broker will issue a margin call for the investor to deposit cash or securities. The investor must respond promptly. The broker has the right to sell any securities in the account to pay down the margin loan if a margin call is issued. A broker will usually give the investor a couple of days to meet the margin call, but can -- in a fast-moving market -- start selling off securities as soon as the margin call has been issued.
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