6.25.2005

Q&A: At what price will an investor get a margin call?

...suppose the investor pays $6,000 toward the purchase of 100 shares at $100 per share), borrowing the remaining from the broker. The maintenance margin is set to be 30%.

  • The initial percentage margin = 60%.
  • If the price of the stock falls to $57.14: the percentage margin becomes = (100 *57.14-4,000) / (100*57.14) = 29.9%. The investor will get a margin call.
  • Leverage factor = 1/margin% = (100%/60%) = 1.7

Bonus Points

  • Investors who purchases stocks on margin borrow from their brokers, and leave purchased stocks with the brokerage firm as collateral
    • The interest rate charged by the broker is typically 1.5% above the rate charged by the bank making the loan. aka. the call money rate.
    • The Federal Reserve sets the margin requirement (ie. the minimum proportion of total transactions value that must be paid in cash).
  • The Leverage effect: margin transactions enable investors to earn returns higher than those possible with a cash purchase. Also expose to larger possible gains and losses
  • Return on margin transaction = (change in investor's equity - interest - commission) / initial investor's equity.
  • Percentage margin: the ratio of the net worth, or "equity value" of the account to the market value of the securities.
  • Maintenance margin: the required proportion of your equity to the total value of the stock. The minimum maintenance margin specified by the Federal Reserve is 25 percent.
  • If the percentage margin falls below the maintenance margin, the broker issues a margin call requiring the investor to add new cash or securities to the margin account. If the investor fails to provide the required funds in time, the broker will sell the collateral stock to pay off the loan.

Category: C++ Quant > Financial Markets

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