What is a Margin Call?

//What is a Margin Call?
What is a Margin Call? 2017-10-05T21:21:33+00:00

Definition: A margin call is a situation in which a broker will demand more funds be deposited in a margin account to increase the equity balance to the account minimum. In other words, it is a claim made by a broker in which the investor must increase his account balance to meet the minimum maintenance margin.

What Does Margin Call Mean?

What is the definition of margin call? When an investor sets up a margin account, he is allowed to purchase stocks with his own funds and borrowed funds from his broker. If the investor borrows funds to purchase stock, the stock itself acts as the collateral for the loan. One of the loan conditions to this account is that the investor must have at all times a minimum equity balance on his account. The equity balance is calculated as total balance minus borrowed funds. If this equity balance goes below the minimum set as maintenance margin, a margin call will be triggered and the investor is required to deposit more funds into his account. In this sense, a margin call is a warning that might lead to an action if certain conditions are not met.

Depending on the margin account agreement, the broker might notify the client when a call is issued to give him time to deposit the money or to liquidate some investments to pay off the loan and meet the required minimum. In other cases, the agreement might state that the broker can sell any investment they want without previously consulting the client. In this case, the proceeds from the sale of an investment would first go to pay back the loan. Any proceeds left over would go to the investor’s funds.

Let’s look at an example.

Example

Mr. Houston is an amateur investor. He recently opened a margin account with Gold Financial, LLC to increase his trading activities. He opened the account with $10,000 and borrowed $5,000. The minimum maintenance margin is 25% of the total account balance. After a few days of trading, the account had a balance of $6,500, which means he lost $8,500. At this point, will he receive a call?

According to the concept we previously discussed, a call is triggered when the equity balance of the account goes below the minimum maintenance margin set by the broker, which in this case is 25 percent. Let’s do the math. Mr. Houston’s current equity balance is $1,500 ($6,500 – $5,000) and the minimum required is $1,625. This means he already went below the limit, so a call should’ve already been triggered and he will be required to fund his account an additional $125.

Summary Definition

Define Margin Calls: Margin call means a broker’s demand that the account holder deposit more funds into his account to meet the minimum equity balance required.