Conclusion
A margin call simply refers to the situation in which your investments' value has dropped below the level required for equity, causing your broker to demand more funds or sales of your assets. There is use of conservative leverage, monitoring and maintaining a buffer in cash and setting stop-loss orders besides diversification of the portfolio while trying to minimize the risk of margin calls.
8. Required Equity (Maintenance Margin) After Drop:
o The required equity at this point is: Required Equity=12,000×30%=3,600\text{Required Equity} = 12,000 \times 30\% = 3,600Required Equity=12,000×30%=3,600
9. Margin Call Triggered:
o Since your current equity of $2,000 is less than the required equity of $3,600, you would receive a margin call.
6. Stock Price Drops Further:
o The stock price drops by another 20%, bringing its total value to $12,000.
7. Updated Equity:
o The equity in your margin account now is: Equity=12,000−10,000=2,000\text{Equity} = 12,000 – 10,000 = 2,000Equity=12,000−10,000=2,000
5. Required Equity (Maintenance Margin):
o The required equity is: Required Equity=15,000×30%=4,500\text{Required Equity} = 15,000 \times 30\% = 4,500Required Equity=15,000×30%=4,500
o Since your current equity is $5,000, which is greater than the required equity of $4,500, you do not receive a margin call yet.
4. Equity Calculation:
o The equity in your margin account is: Equity=Current Value of Investments−Loan Amount=15,000−10,000=5,000\text{Equity} = \text{Current Value of Investments} – \text{Loan Amount} = 15,000 – 10,000 = 5,000Equity=Current Value of Investments−Loan Amount=15,000−10,000=5,000
2. Maintenance Margin:
o Let’s assume the broker requires a 30% maintenance margin (this is the minimum amount of equity you need to maintain in the account).
3. Stock Price Drops:
o The price of the stock drops by 25%. Now, the value of your stock is $15,000.
Let’s go through an example to illustrate how these formulas work.
1. Initial Investment:
o You invest $10,000 in a stock using a margin account with a 50% initial margin.
o You borrow $10,000 from the broker.
So, your total position is $20,000, with $10,000 of your own money and $10,000 borrowed from the broker.
4. Margin Call Trigger Point:
A margin call will occur when your equity falls below the required equity as per the maintenance margin. You can calculate the point at which a margin call will occur as follows:
Margin Call Point=Loan Amount1−Maintenance Margin Percentage\text{Margin Call Point} = \frac{\text{Loan Amount}}{1 – \text{Maintenance Margin Percentage}}Margin Call Point=1−Maintenance Margin PercentageLoan Amount
3. Maintenance Margin Formula (This tells you the minimum equity required to avoid a margin call):
Required Equity=Current Value of Investments×Maintenance Margin Percentage\text{Required Equity} = \text{Current Value of Investments} \times \text{Maintenance Margin Percentage}Required Equity=Current Value of Investments×Maintenance Margin Percentage
Even in case the value of your account continues to decline following the margin call, your broker would possibly take further steps in closing down more positions without consulting you.
Understanding Margin Calls and How to Avoid Them:-
Explaining the Formula