'Margin Call' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Margin Call refers to a demand from a broker that the account holding investor (who is utilizing margin) deposit additional funds or securities in order to restore the margin account to a minimum preset maintenance margin level. This could occur with a stock, futures, or commodities margin account. Such margin calls happen as the account value falls to a ratio which that specific brokerage deems unacceptable. Many brokerage houses use their own unique formulas to determine the amount at which they will issue such a call for more funds or securities.
Investors get into this unpleasant position when one or many of their securities they have purchased (utilizing money they borrowed from the brokerage) drops to a specified value point. That is when the call goes out from the broker for more money to restore the account to an acceptable minimum value. Investors will have two choices. They could comply with the request for additional funds and make an urgent deposit. Otherwise, they could sell off some or all of the positions in the account to reduce the need for minimum margin maintenance or raise the account equity position. The third choice of completely disregarding or ignoring the margin call would result in the broker force-selling positions to reduce this maintenance amount required.
Margin calls would not be necessary at all if investors did not buy securities, futures, or commodities with a combination of their own cash plus money they borrow off of the broker. This is why many experts recommend not utilizing such margin accounts unless an investor is a both seasoned and experienced trader.
Investors have equity in these margin-purchased investments. This amount equals the securities market value less the funds they originally borrowed to complete the purchase in the first place. If and when this equity of the account holder drops to lower than the brokerage-set percentage requirement of maintenance margin, then such a margin call becomes issued. Such maintenance margins do vary somewhat significantly from one broker to the next.
The constant is the Federal minimum maintenance margin requirements. These are set at a lowest common requirement of 25 percent, regardless of who the responsible broker is. The brokers can choose to utilize a higher margin maintenance level than this amount, but they can not ever reduce their own limit to less than the 25 percent set by the Feds. Brokers can decide to change their maintenance level higher or lower than their present set one with little to no advance warning or notice, so long as they do not drop it below the government-mandated minimum amount. Raising their margin maintenance requirements may also result in creating a margin call.
Looking at a tangible example helps to clarify the concept and make it more understandable. Investors might purchase $50,000 worth of stocks via a combination of $25,000 of their own funds and through borrowing the balance $25,000 off of the brokerage firm. Assume that this particular broker chooses to utilize the government-set minimum of 25 percent maintenance margin. The investor has no choice but to honor this.
When the investors open the trade, at that point the equity positions of the investments prove to be $25,000 (or $50,000 minus the $25,000 borrowed). This makes the investor equity percentage an even 50 percent (using the $25,000 equity divided by the $50,000 original securities market value). This is twice the required minimum 25 percent margin maintenance.
Yet a week later, our investors suffer a drastic decline in the value of their securities, which precipitously drop to $30,000. The investors’ equity is now down to a mere $5,000 (or $30,000 minus the $25,000 borrowed). Yet the brokerage (and government regulations which are the same in this scenario) requires that they keep a minimally $7,500 worth of equity for the account to remain margin-eligible (which is 25 percent of the borrowed amount of $30,000).
It means that there is presently a $2,500 deficit ($7,500 requirement minus the $5,000 actual market value). The broker will then issue a margin call for $2,500 in additional cash to be deposited immediately. Should the investors refuse or take their time, then the broker is legally bound and permitted to sell off some of the securities to reach the minimum $7,500 in account equity value.
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