BUYING ON MARGIN

Buying on
Margin
Magda
Benashvili
Buying on
Margin
BUYING ON MARGIN
Purchasing stocks on margin means the investor:
1-Pays in cash part of the purchase price of the stock,
2-Borrows the remaining part of the purchase price of the stock
from a broker.
The Board of Governors of the Federal Reserve System limits the
margin loans and argue that at least 50% of the purchase price
must be paid in cash
Thus, Initial Margin Requirement IMR is the minimum % initial
investor equity.
1-IMR= maximum % the investor can borrow from the broker.

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BUYING ON MARGIN
If the stock fall below the borrowing amount, owners’ equity would become negative.
To avoid this possibility, the broker sets a maintenance margin requirement (MMR):
minimum amount of equity before additional funds must be put into the account.
If the percentage margin falls below the maintenance level, the broker will issue a margin
call
Margin call: notification from broker you must put up additional funds or have your
position liquidated
At what price does the investor receive a margin call?
Suppose the maintenance margin is 30%. How far could the stock price fall before the
investor would get a margin call?

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MARGIN CALL

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MARGIN TRADING
Margin Trading: Initial Conditions
X Corp Stock price = $70
50% Initial Margin
40% Maintenance Margin
1000 Shares Purchased

Initial Position

Stock $70,000 Borrowed

$35,000
Equity $35,000

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MARGIN TRADING
(MMR = 40%)
Stock price falls to $60 per share (1000 shares)
New Position1
Stock $60,000 Borrowed $35,000
Equity $25,000

Margin% =$25000/60000=41.67%
How far can the stock price fall before a margin call? (MMR = 40%)
Market Value = Borrowed / (1 – MMR)
Market Value = $35,000 / (1 – 0.40) =$58,333
if the stock price <$58.33, investor will get a margin call.

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MARGIN TRADING
New Position2

Stock $58,333 Borrowed $35,000

Equity $23,333

%Margin = $23,333 / $58,333 = 40%

How much cash must you put up?
To avoid the margin call and restore the IMR you will need
equity = ½ x $58,333 = $29,167
The investor must be put into the account an additional funds
=$29,167- $23,333 =$5834
%Margin =$29,167 / $58,333 = 50%

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MARGIN TRADING
Why do people purchase on margin?

Buy at Sell at $72 Sell at $68

$70

No Margin 11.59% -11.59%

Margin 16.17% -30.17%

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THANKS
FOR
ATTENTI
ON!