What is Margin Call?
Margin Call Definition
Purpose of a Margin Call
As a quick refresher, margin in a type of stock account that contains both private investor and broker loaned money for the purpose of buying securities.
The reason investors open margin accounts, are so that they may be able to purchase more securities than they would have been able to on their own.
Defining Margin Call in Simple Terms
A margin call is ordered whenever the investor’s personal funds within the account falls below the minimum % agreed upon, called the maintenance requirement.
The NYSE mandates that investors place at least 25% of their own money in a margin account, but brokerage firms are known to require much more.
Formula for Determining Margin Call
To determine at what threshold a margin call would be issued, you may use the equation Account Value = Margin Loan / 1- Minimum Maintenance Requirement (MMR)
Minimum Maintenance Requirement
If your personal funds fall below the MMR, and a margin call is ordered you have a few options.
You may either :
1) Pay off the margin call
2) Liquidate some of your stock, and use the capital to reduce the margin loan
3) Ignore the call and see your stock liquidated without your approval by the broker.
Example of a Margin Call
Let’s look at an example. An investor buys $50,000 of Google stock, using $25,000 of his own money and $25,000 of a broker’s.
The broker’s MMR is set at 30% which, is great because at the moment the investor has put up 50% of the cost.
However, a week or two goes by and the stock value drops to $35,000.
Which means that the investor’s equity has fallen to $10,000 or 28% (market value- borrowed funds/market value).
Which is less than the 30% MMR.
As a result, the broker makes a margin call of $500 in order to be once again eligible for margin.
(Market Value x MMR – Investor Equity = Margin Call).