A margin call occurs when the value of an investor’s margin account (that is, one that contains securities bought with borrowed money) falls below the broker’s required amount. A margin call is the broker’s demand that an investor deposit additional money or securities so that the account is brought up to the minimum value, known as the maintenance margin.
A margin call usually means that one or more of the securities held in the margin account has decreased in value below a certain point. The investor must either deposit more money in the account or sell some of the assets held in the account.
How Margin Calls Work
A margin call arises when an investor borrows money from a broker to make investments. When an investor uses margin to buy or sell securities, he pays for them using a combination of his own funds and borrowed money from a broker. An investor’s equity in the investment is equal to the market value of securities minus borrowed funds from the broker.
A margin call is triggered when the investor’s equity, as a percentage of the total market value of securities, falls below a certain percentage requirement, which is called the maintenance margin. The New York Stock Exchange (NYSE) and FINRA require investors to keep at least 25% of the total value of their securities as margin. Many brokerage firms may require a higher maintenance requirement—as much as 30% to 40%.
What Is Margin Debt?
Margin debt is debt a brokerage customer takes on by trading on margin. When purchasing securities through a broker, investors have the option of using a cash account and covering the entire cost of the investment themselves, or using a margin account—meaning they borrow part of the initial capital from their broker. The portion the investors borrow is known as margin debt, while the portion they fund themselves is the margin, or equity.
Key Takeaways
Margin debt is the amount of money an investor borrows from the broker via a margin account. Margin debt can be money borrowed to buy securities or sell short a stock. Regulation T sets the initial margin at a minimum of 50%, which means an investor can only take on margin debt of 50% of the account balance.
Meanwhile, the typical margin requirement is 25%, meaning that customers’ equity must be above that ratio in margin accounts to prevent a margin call. Margin debt (a form of leverage) can exacerbate gains, but also exacerbate losses.
How Margin Debt Works
Margin debt can be used when borrowing a security to short sell, rather than borrowing money with which to buy a security. As an example, imagine an investor wants to buy 1,000 shares of Johnson & Johnson (JNJ) for $100 per share. She doesn’t want to put down the entire $100,000 at this time, but the Federal Reserve Board’s Regulation T limits her broker to lending her 50% of the initial investment—also called the initial margin.
Brokerages often have their own rules regarding buying on margin, which may be more strict than regulators. She deposits $50,000 in initial margin while taking on $50,000 in margin debt. The 1,000 shares of Johnson & Johnson she then purchases act as collateral for this loan.
What is a Margin Account?
A margin account is a brokerage account in which the broker lends the customer cash to purchase stocks or other financial products. The loan in the account is collateralized by the securities purchased and cash, and comes with a periodic interest rate. Because the customer is investing with borrowed money, the customer is using leverage which will magnify profits and losses for the customer.
If an investor purchases securities with margin funds, and those securities appreciate in value beyond the interest rate charged on the funds, the investor will earn a better total return than if they had only purchased securities with their own cash. This is the advantage of using margin funds.