We have discussed before what a margin account is. In a margin purchase, the portion of the value of an investment that is not borrowed is called the margin. The portion that is borrowed incurs an interest that is based on the broker’s call money rate, which is the rate brokers pay to borrow bank funds for lending to customer margin accounts. Here are a few case scenarios of margin accounts calculations:
Example 1: The Account Balance Sheet
You want to buy 1000 TechnologySage shares at $24 per share. You put up $18,000 and borrow the rest.
Solution
Amount borrowed = $24,000 – $18,000 = $6,000
Margin = $18,000 / $24,000 = 75%
ASSETS LIABILITIES AND ACCOUNT EQUITY
1000 WM shares $24,000 Margin loan $ 6,000
Account equity 18,000
Total $24,000 Total $24,000
In a margin purchase, the minimum margin that must be supplied is called the initial margin. The maintenance margin is the minimum margin that must be present at all times in a margin account. When the margin drops below the maintenance margin, the broker may demand for more funds. This is known as a margin call.
Read also: Choosing A Broker And The Broker Customer Relationships
Example: Margin Requirements
Your account requires an initial margin of 50% and a maintenance margin of 30%. Stock A is selling at $50 per share. You have $20,000, and you want to buy as much of stock A as you possibly can.
Solution:
You may buy up to $20,000 / 0.5 = $40,000 worth of shares.
ASSETS LIABILITIES AND ACCOUNT EQUITY
800 A shares $40,000 Margin loan $20,000
Account equity 20,000
Total $40,000 Total $40,000
Example: Margin Requirements
After your purchase, the share price of stock A falls to $35 per share.
ASSETS LIABILITIES AND ACCOUNT EQUITY
800 A shares $28,000 Margin loan $20,000
Account equity 8,000
Total $28,000 Total $28,000
New margin = $8,000 / $28,000 = 28.6% which is less than maintenance margin of 30% Therefore, you are subject to a margin call.
In conclusion, Margin is a form of financial leverage. It is important to bear in mind that when you borrow money to make an investment, the impact is to magnify both your gains and your losses. You should therefore deal with margin accounts with caution.