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In
finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corn ...

finance
, margin is the
collateral Collateral may refer to: Business and finance * Collateral (finance) In loan agreement, lending agreements, collateral is a Borrower, borrower's pledge (law), pledge of specific property to a lender, to Secured loan, secure repayment of a loan. ...
that a holder of a
financial instrument Financial instruments are monetary contracts A contract is a legally binding document between at least two parties that defines and governs the rights and duties of the parties to an agreement. A contract is legally enforceable because it me ...
has to deposit with a
counterparty A counterparty (sometimes contraparty) is a legal entity, unincorporated entity, or collection of entities to which an exposure to financial risk might exist. The word became widely used in the 1980s, particularly at the time of the Basel I in 198 ...

counterparty
(most often their
broker A broker is a person or firm who arranges transactions between a Purchasing, buyer and a sales, seller for a commission (remuneration), commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a :wikt:princip ...
or an
exchange Exchange may refer to: Places United States * Exchange, Indiana Exchange is an Unincorporated area, unincorporated community in Green Township, Morgan County, Indiana, Green Township, Morgan County, Indiana, Morgan County, in the U.S. state of In ...
) to cover some or all of the
credit risk A credit risk is risk of default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they ope ...
the holder poses for the counterparty. This risk can arise if the holder has done any of the following: * Borrowed cash from the counterparty to buy financial instruments, * Borrowed financial instruments to sell them
short
short
, * Entered into a
derivative In mathematics Mathematics (from Greek: ) includes the study of such topics as numbers (arithmetic and number theory), formulas and related structures (algebra), shapes and spaces in which they are contained (geometry), and quantities ...
contract. The collateral for a margin account can be the cash deposited in the account or securities provided, and represents the funds available to the account holder for further
share trading in Dutch). Stock trading in Dutch). Stock trading activity, as we know it today, was originally a 17th-century Dutch investing technique. File:NY stock exchange traders floor LC-U9-10548-6.jpg, Historical photo of stock traders and stockbroker ...
. On United States
futures exchange A futures exchange or futures market is a central financial exchange An exchange, bourse (), trading exchange or trading venue is an organized market where (especially) tradable securities A security is a tradable financial asset. The term ...
s, margins were formerly called
performance bond A performance bond, also known as a contract bond, is a surety bond In finance, a surety , surety bond or guaranty involves a promise by one party to assume responsibility for the debt obligation of a borrower if that borrower defaults. Usually, a ...
s. Most of the exchanges today use SPAN ("Standard Portfolio Analysis of Risk") methodology, which was developed by the
Chicago Mercantile Exchange The Chicago Mercantile Exchange (CME) (often called "the Chicago Merc", or "the Merc") is a global derivatives market The derivatives market is the financial market A financial market is a market Market may refer to: *Market (economics) ...

Chicago Mercantile Exchange
in 1988, for calculating margins for options and
futures Futures may mean: Finance *Futures contract, a tradable financial derivatives contract. *Futures exchange, a financial market where futures contracts are traded. *Futures (magazine), ''Futures'' (magazine), an American finance magazine. Music *Fu ...
.


Margin account

A margin account is a loan account with a broker which can be used for share trading. The funds available under the margin loan are determined by the broker based on the securities owned and provided by the trader, which act as
collateral Collateral may refer to: Business and finance * Collateral (finance) In loan agreement, lending agreements, collateral is a Borrower, borrower's pledge (law), pledge of specific property to a lender, to Secured loan, secure repayment of a loan. ...
for the loan. The broker usually has the right to change the percentage of the value of each security it will allow towards further advances to the trader, and may consequently make a margin call if the balance available falls below the amount actually utilised. In any event, the broker will usually charge
interest In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money availa ...

interest
and other fees on the amount drawn on the margin account. If the cash balance of a margin account is negative, the amount is owed to the broker, and usually attracts interest. If the cash balance is positive, the money is available to the account holder to reinvest, or may be withdrawn by the holder or left in the account and may earn interest. In terms of futures and cleared derivatives, the margin balance would refer to the total value of collateral pledged to the CCP (
central counterparty clearingA central clearing counterparty (CCP), also referred to as a central counterparty, is a financial institution Financial institutions, otherwise known as banking institutions, are corporation A corporation is an organization—usually a grou ...
) and or futures commission merchants.


Margin buying

Margin buying refers to the buying of securities with cash borrowed from a
broker A broker is a person or firm who arranges transactions between a Purchasing, buyer and a sales, seller for a commission (remuneration), commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a :wikt:princip ...
, using the bought securities as collateral. This has the effect of magnifying any profit or loss made on the securities. The securities serve as collateral for the loan. The net value—the difference between the value of the securities and the loan—is initially equal to the amount of one's own cash used. This difference has to stay above a minimum margin requirement, the purpose of which is to protect the broker against a fall in the value of the securities to the point that the investor can no longer cover the loan. Margin lending became popular in the late 1800s as a means t
finance railroads
In the 1920s, margin requirements were loose. In other words, brokers required investors to put in very little of their own money, whereas today, the
Federal Reserve The Federal Reserve System (also known as the Federal Reserve or simply the Fed) is the central bank A central bank, reserve bank, or monetary authority is an institution that manages the and of a or formal monetary union, and ove ...

Federal Reserve
's margin requirement (under Regulation T) limits debt to 50 percent. During the 1920s leverage rates of up to 90 percent debt were not uncommon. When the
stock market A stock market, equity market, or share market is the aggregation of buyers and sellers of stock In finance, stock (also capital stock) consists of all of the shares In financial markets A financial market is a market in whic ...

stock market
started to contract, many individuals received
margin call #REDIRECT Margin (finance)#Margin call {{redirect category shell, {{R to section{{R printworthy ...
s. They had to deliver more money to their brokers or their shares would be sold. Since many individuals did not have the equity to cover their margin positions, their shares were sold, causing further market declines and further margin calls. This was one of the major contributing factors which led to the
Stock Market Crash of 1929 The Wall Street Crash of 1929, also known as the Great Crash, was a major American stock market crash that occurred in the autumn of 1929. It started in September and ended late in October, when share prices on the New York Stock Exchange T ...
, which in turn contributed to the
Great Depression The Great Depression was a severe worldwide economic depression An economic depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe economic downturn than a economic recession, recess ...
. However, as reported in Peter Rappoport and Eugene N. White's 1994 paper published in ''
The American Economic Review ''The American Economic Review'' is a monthly peer review, peer-reviewed academic journal published by the American Economic Association. First published in 1911, it is considered one of the most prestigious and highly distinguished journals in the ...
'',
Was the Crash of 1929 Expected
, all sources indicate that beginning in either late 1928 or early 1929, "margin requirements began to rise to historic new levels. The typical peak rates on brokers' loans were 40–50 percent. Brokerage houses followed suit and demanded higher margin from investors". For example, Jane buys a share in a company for $100 using $20 of her own money and $80 borrowed from her broker. The net value (the share price minus the amount borrowed) is $20. The broker has a minimum margin requirement of $10. Suppose the share price drops to $85. The net value is now only $5 (the previous net value of $20 minus the share's $15 drop in price), so, to maintain the broker's minimum margin, Jane needs to increase this net value to $10 or more, either by selling the share or repaying part of the loan.


Short selling

Short selling refers to the selling of securities that the trader does not own, borrowing them from a
broker A broker is a person or firm who arranges transactions between a Purchasing, buyer and a sales, seller for a commission (remuneration), commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a :wikt:princip ...
, and using the cash as collateral. This has the effect of reversing any profit or loss made on the securities. The initial cash deposited by the trader, together with the amount obtained from the sale, serve as collateral for the loan. The net value—the difference between the cash amount and the value of loan security—is initially equal to the amount of one's own cash used. This difference has to stay above a minimum margin requirement, the purpose of which is to protect the broker against a rise in the value of the borrowed securities to the point that the investor can no longer cover the loan. For example, Jane sells a share of stock she does not own for $100 and puts $20 of her own money as collateral, resulting $120 cash in the account. The net value (the cash amount minus the share price) is $20. The broker has a minimum margin requirement of $10. Suppose the share price rises to $115. The net value is now only $5 (the previous net value of $20 minus the share's $15 rise in price), so, to maintain the broker's minimum margin, Jane needs to increase this net value to $10 or more, either by buying the share back or depositing additional cash.


Types of margin requirements

* The current liquidating margin is the value of a security's position if the position were liquidated now. In other words, if the holder has a , this is the money needed to buy back; if they are
long Long may refer to: Measurement * Long, characteristic of something of great duration Duration may refer to: * The amount of Time#Terminology, time elapsed between two events * Duration (music) – an amount of time or a particular time interval, ...
, it is the money they can raise by selling it. * The variation margin or mark to market is not collateral, but a daily payment of profits and losses. Futures are marked-to-market every day, so the current price is compared to the previous day's price. The profit or loss on the day of a position is then paid to or debited from the holder by the
futures exchange A futures exchange or futures market is a central financial exchange An exchange, bourse (), trading exchange or trading venue is an organized market where (especially) tradable securities A security is a tradable financial asset. The term ...
. This is possible, because the exchange is the central counterparty to all contracts, and the number of long contracts equals the number of short contracts. Certain other exchange traded derivatives, such as options on futures contracts, are marked-to-market in the same way. * The seller of an option has the obligation to deliver the underlying security associated with the option when it is exercised. To ensure they can fulfill this obligation, they have to deposit collateral. This premium margin is equal to the premium that they would need to pay to buy back the option and close out their position. * Additional margin is intended to cover a potential fall in the value of the position on the following trading day. This is calculated as the potential loss in a worst-case scenario. * SMA and portfolio margins offer alternative rules for U.S. and
NYSE The New York Stock Exchange (NYSE, nicknamed "The Big Board") is an American stock exchange in the Financial District, Manhattan, Financial District of Lower Manhattan in New York City. It is by far the List of stock exchanges, world's largest s ...

NYSE
regulatory margin requirements.


Margin strategies

Enhanced leverage is a strategy offered by some brokers that provides 4:1 or 6+:1 leverage. This requires maintaining two sets of accounts, long and short. ;Example 1: An investor sells a
put option In finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in ...

put option
, where the buyer has the right to require the seller to buy his 100 shares in Universal Widgets S.A. at 90¢. He receives an option premium of 14¢. The value of the option is 14¢, so this is the premium margin. The exchange has calculated, using historical prices, that the option value will not exceed 17¢ the next day, with 99% certainty. Therefore, the additional margin requirement is set at 3¢, and the investor has to post ''at least'' 14¢ (obtained from the sale) + 3¢ = 17¢ in his margin account as collateral. ;Example 2: Futures contracts on
sweet crude oil Sweet crude oil is a type of petroleum Petroleum, also known as crude oil and oil, is a naturally occurring, yellowish-black liquid A liquid is a nearly incompressible In fluid mechanics or more generally continuum mechanics, incom ...
closed the day at $65. The exchange sets the additional margin requirement at $2, which the holder of a long position pays as collateral in his margin account. A day later, the futures close at $66. The exchange now pays the profit of $1 in the mark-to-market to the holder. The margin account still holds only the $2. ;Example 3: An investor is long 50 shares in Universal Widgets Ltd, trading at 120 pence (£1.20) each. The broker sets an additional margin requirement of 20 pence per share, so £10 for the total position. The current liquidating margin is currently £60 "in favour of the investor". The minimum margin requirement is now -£60 + £10 = -£50. In other words, the investor can run a deficit of £50 in his margin account and still fulfil his margin obligations. This is the same as saying he can borrow up to £50 from the broker.


Initial and maintenance margin requirements

The initial margin requirement is the amount of collateral required to open a position. Thereafter, the collateral required until the position is closed is the maintenance requirement. The maintenance requirement is the minimum amount of collateral required to keep the position open and is generally lower than the initial requirement. This allows the price to move against the margin without forcing a margin call immediately after the initial transaction. When the total value of the collateral dips below the maintenance margin requirement, the position holder must pledge additional collateral to bring their total balance back up to or above the initial margin requirement. On instruments determined to be especially risky, however, either regulators, the exchange, or the broker may set the maintenance requirement higher than normal or equal to the initial requirement to reduce their exposure to the risk accepted by the trader. For speculative futures and derivatives clearing accounts,
futures commission merchant A commodity broker is a firm or an individual who executes orders to buy or sell Commodity market, commodity contracts on behalf of the clients and charges them a Commission (remuneration), commission. A firm or individual who trades for his own acc ...
s may charge a premium or margin multiplier to exchange requirements. This is typically an additional 10%–25%.


Margin call

The broker may at any time revise the value of the collateral securities (margin) after the estimation of the risk, based, for example, on market factors. If this results in the market value of the collateral securities for a margin account falling below the revised margin, the broker or exchange immediately issues a "margin call", requiring the investor to bring the margin account back into line. To do so, the investor must either pay funds (the call) into the margin account, provide additional collateral, or dispose some of the securities. If the investor fails to bring the account back into line, the broker can sell the investor's collateral securities to bring the account back into line. If a margin call occurs unexpectedly, it can cause a
domino effect A domino effect or chain reaction is the cumulative effect produced when one event sets off a chain of similar events. This term is best known as a mechanical effect and is used as an analogy to a falling row of dominoes Dominoes is a family ...

domino effect
of selling, which will lead to other margin calls and so forth, effectively crashing an asset class or group of asset classes. The "Bunker Hunt Day" crash of the silver market on
Silver Thursday Silver Thursday was an event that occurred in the United States silver commodity markets on Thursday, March 27, 1980, following the attempt by brothers Nelson Bunker Hunt, William Herbert Hunt and Lamar Hunt to Cornering the market, corner the si ...
, March 27, 1980, is one such example. This situation most frequently happens as a result of an adverse change in the market value of the leveraged asset or contract. It could also happen when the margin requirement is raised, either due to increased volatility or due to legislation. In extreme cases, certain securities may cease to qualify for margin trading; in such a case, the brokerage will require the trader to either fully fund their position, or to liquidate it.


Price of stock for margin calls

The minimum margin requirement, sometimes called the maintenance margin requirement, is the ratio of (stock equity − leveraged dollars) to stock equity, where "stock equity" is the stock price multiplied by the number of shares bought and "leveraged dollars" is the amount borrowed in the margin account. For instance, assume that an investor bought 1,000 shares of a company each priced at $50. If the initial margin requirement were 60%, then stock equity = $50 × 1,000 = $50,000 and leveraged dollars (or amount borrowed) = $50,000 × (100% − 60%) = $20,000. If the maintenance margin changed to 25%, then the customer would have to maintain a net value equal to 25% of the total stock equity. That means that he or she would have to maintain net equity of $50,000 × 0.25 = $12,500. At what price would the investor get a margin call? For stock price ''P'' the stock equity would be (in this example) 1,000''P''. *(Current Market Value − Amount Borrowed) / Current Market Value = 25% *(1,000''P'' - 20,000) / 1000''P'' = 0.25 *(1,000''P'' - 20,000) = 250''P'' * 750''P'' = 20,000 * ''P'' = 20,000/750 = 26.67 So if the stock price dropped from $50 to $26.67, then the investor would be called to add additional funds to the account to make up for the loss in stock equity. Alternatively, one can calculate ''P'' using \textstyle P=P_0\frac where ''P0'' is the initial price of the stock. Using the same example to demonstrate this: P=\$50\frac = \$26.66.


Reduced margins

Margin requirements are reduced for positions that offset each other. For instance
spread traderIn finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money available w ...
s who have offsetting futures contracts do not have to deposit collateral both for their short position and their long position. The exchange calculates the loss in a worst-case scenario of the total position. Similarly an investor who creates a
collar Collar may refer to: Human neckwear *Clerical collar (informally ''dog collar''), a distinctive collar used by the clergy of some Christian religious denominations *Collar (BDSM), a device of any material placed around the neck of the submissive ...
has ''reduced'' risk since any loss on the call is offset by a gain in the stock, and a large loss in the stock is offset by a gain on the put; in general, covered calls have less strict requirements than naked call writing.


Margin-equity ratio

The margin-equity ratio is a term used by speculators, representing the amount of their trading capital that is being held as margin at any particular time. Traders would rarely (and unadvisedly) hold 100% of their capital as margin. The probability of losing their entire capital at some point would be high. By contrast, if the margin-equity ratio is so low as to make the trader's capital equal to the value of the futures contract itself, then they would not profit from the inherent
leverage Leverage or leveraged may refer to: *Leverage (mechanics), mechanical advantage achieved by using a lever *Leverage (album), ''Leverage'' (album), a 2012 album by Lyriel *Leverage (dance), a type of dance connection *Leverage (finance), using giv ...
implicit in futures trading. A conservative trader might hold a margin-equity ratio of 15%, while a more aggressive trader might hold 40%.


Return on margin

Return on margin (ROM) is often used to judge performance because it represents the net gain or net loss compared to the exchange's perceived risk as reflected in required margin. ROM may be calculated (realized return) / (initial margin). The annualized ROM is equal to : (ROM + 1)(1/trade duration in years) - 1 For example, if a trader earns 10% on margin in two months, that would be about 77% annualized : Annualized ROM = (ROM +1)1/(2/12) - 1 that is, Annualized ROM = 1.16 - 1 = 77% Sometimes, return on margin will also take into account peripheral charges such as brokerage fees and interest paid on the sum borrowed. The margin interest rate is usually based on the
broker's call a Broker's call, also known as the Call loan rate, is the interest rate relative to which margin loans are quoted. Individuals may borrow on margin (finance), margin a part of the funds they use to buy their securities from their broker. The broker ...
.


See also

* Badla system (Indian stock markets) *
Collateral managementCollateral has been used for hundreds of years to provide security against the possibility of payment default by the opposing party in a trade. Collateral management began in the 1980s, with Bankers Trust and Salomon Brothers taking Collateral (fina ...
*
Credit default swap A credit default swap (CDS) is a financial swap agreement that the seller of the CDS will compensate the buyer in the event of a debt default Default may refer to: Law * Default (law), the failure to do something required by law ** Defaul ...
*
Leverage (finance)In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money available w ...
*
LIBOR The London Inter-Bank Offered Rate is an interest-rate average calculated from estimates submitted by the leading banks in London London is the capital Capital most commonly refers to: * Capital letter Letter case (or just cas ...
* MVA, the x-Valuation Adjustment related to Margin * Portfolio margin *
Repurchase agreement A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of short-term borrowing, mainly in Government debt, government securities. The dealer sells the underlying security to investors and, by agreement bet ...
* Special memorandum account *
Short selling In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money avai ...

Short selling


References

{{Authority control Financial markets Margin policy Credit risk