Margins

Question 1

What are margin accounts?

Answer 1

Used to purchase additional securities by leveraging the value of the eligible shares to buy more.
Permits investors to borrow money from a brokerage account for personal purposes at the margin interest rate

Question 1

How can you open a margin?

Answer 1

Accounts at brokerage firms can be either CASH accounts or MARGIN accounts.
Opening a MARGIN account requires some deposit of CASH or SECURITIES such as T-bills, bonds, other equity securities, etc.

Question 2

What is the definition of a margin account?

Answer 2

Part of the total value of a sale of securities that a customer must pay to initiate the transaction, with the other part being borrowed from the broker

Question 3

What is a margin requirement?

Answer 3

The amount of funds the investor must personally provide in a margin account. How much depends on LOAN VALUE
CASH has 100% loan value (i.e. $100,000 in cash deposits = $100,000 margin)
Other assets such as STOCKS may have 50% or lower loan value because of the possible fluctuations (changes) in their market value
Example: you would have to deposit $200,000 worth of common stocks to satisfy a $100,000 margin requirement (in the above case)

Question 4

What are the margin requirements?

Answer 4

Margin requirements for stocks traded in Canada range from 30% to 100% depending on the price at which the stock is selling.
Margin requirements INCREASE as the stock prices DECREASES. Why??? Because there is ADDITIONAL RISK associated with LOWER PRICED STOCKS!!!

Question 5

What are some things you should remember about margins?

Answer 5

As stock prices changes, so does the investor’s equity!

Investor’s Equity is the market value of COLLATERAL stock minus the amount of money borrowed from the broker

Security firms calculate the actual margin in their customer accounts to see if a “MARGIN CALL” is required.

Question 6

What are margin calls?

Answer 6

A demand from the broker for additional cash or securities as a result of the actual margin declining below the margin requirement
Occurs when the market value of the margined securities less the debit balance (amount owed) of the margin account declines below the required margin.
Payable on demand; brokerage house may reserve the right to take action without notice (ie. may sell enough shares from the margin account to satisfy the margin requirement)
If the investor’s equity EXCEEDS the required margin (i.e. the COLLATERAL stock price increases), the investor can withdraw the EXCESS MARGIN or use it to buy more stock

Question 7

Why use margins?

Answer 7

Because they magnify any gains on a transaction by the RECIPROCAL of the margin requirement (1/margin percentage)
BUT margin accounts also magnify any losses on a transaction
REMEMBER, the margin trader must pay the interest costs on the margin account
(ie. the margin interest rate = prime lending rate plus a percentage added by broker)
The stock price must rise and cover the cost of the margin interest rate before an investor can make a profit!