A margin call is a demand from a brokerage firm to an investor to deposit additional money or securities into their margin account when the value of the account falls below a certain level, known as the maintenance margin. Margin accounts are brokerage accounts that allow investors to borrow funds from the brokerage to buy securities, using their existing investments as collateral. The process of buying on margin involves using borrowed money to increase the size of a securities position.
How a margin call works:
1. Opening a Margin Account:
- When an investor opens a margin account, they can borrow money from the brokerage to purchase additional securities beyond their available cash.
2. Initial Margin:
- The investor is required to maintain a certain level of equity in the account, known as the initial margin. This is a percentage of the total value of the securities purchased using borrowed funds.
3. Margin Loan and Leverage:
- The investor's own funds, along with the borrowed funds, create leverage, allowing them to control a larger position. While this can amplify returns, it also increases the potential for losses.
4. Maintenance Margin:
- The maintenance margin is a lower threshold set by the brokerage firm. If the value of the securities in the account falls below this level, a margin call is triggered.
5. Margin Call Process:
- When the account value approaches or falls below the maintenance margin, the brokerage issues a margin call to the investor. This is typically done through a notification, either electronically or by phone.
6. Deposit Requirement:
- The margin call specifies the amount of money or additional securities the investor must deposit into the margin account to bring it back to the required maintenance margin level.
7. Timeframe for Compliance:
- Brokers usually give investors a certain timeframe (usually a few days) to meet the margin call by depositing additional funds or selling assets to raise cash.
8. Liquidation:
- If the investor fails to meet the margin call within the specified timeframe, the brokerage has the right to liquidate some or all of the investor's positions to cover the outstanding margin debt.
9. Consequences of Liquidation:
- The brokerage may sell assets at a loss, and any remaining debt after liquidation becomes the responsibility of the investor. This can lead to significant financial losses and may have tax implications.
The investor might need to deposit additional funds or sell some of the stocks to bring the account back to the required maintenance margin level. Failure to do so within the specified timeframe could lead to the brokerage liquidating a portion of the securities to cover the outstanding debt.
