If you borrow money to buy a stock, you may face a "cash call," also known as a margin call, if the value of that stock declines. A margin call means you'll have to deposit more money in your account immediately. If you don't, your securities might be sold, and you might face further penalties. The calculations for a margin call are based on the Federal Reserve Board's Regulation T, as well as individual firm policies.
Margin refers to borrowing money to buy securities, usually stocks. Margin amplifies both gains and losses. For example, if you pay cash for 100 shares of stock worth $50 per share, you'll owe $5,000 for your purchase, commissions notwithstanding. If instead you buy on margin, you might only have to put up half of the amount you owe, or $2,500 in this instance. If the stock doubles, investors who paid for the stock in full will have a return of 100 percent. However, as a margin investor, you'll have paid only $2,500 out of pocket for a stock now worth $10,000, for a 300 percent return.
Where you might run into trouble with a margin investment is if the stock you bought goes down. In the above example, if the stock falls to $25 per share, you'll have a 100 percent loss; the stock you paid $2,500 for would only be worth $2,500, and you'd still have the outstanding $2,500 margin loan to pay back. In this instance, you'd face a margin call.
Video of the Day
A margin call is a notification, or "call," for more money from your brokerage firm. Typically, it demands that you put additional money in your account immediately. If you fail to meet a cash call, the securities in your account will be sold to pay off your margin loan. If the value of your loan exceeds the value of your stocks, you'll owe the firm additional money. The details of your margin call depends on which type of margin requirement you violate.
Types of Margin Requirements
The three types of margin requirements that may trigger a cash call are initial margin, minimum margin and maintenance margin. The Federal Reserve Board's Regulation T allows you to borrow up to 50 percent of the value of most stocks at the time of purchase, known as initial margin. Individual firms may require a higher percentage. Under Regulation T, for example, you'd have to put up at least $6,000 to buy 100 shares of a $120 stock, which would be valued at $12,000.
Minimum margin requires you to deposit the lesser of $2,000 or the full purchase price of a stock. For example, buying 100 shares of a $3 stock would require a $300 deposit, while 100 shares of a $30 stock would require only a $2,000 minimum margin deposit.
Maintenance margin is the percentage amount you must keep in your account if the stock value declines. Regulation T sets this amount at 25 percent, but most firms have 30 or 40 percent maintenance margin requirements.
If the equity in your account dips below any of these margin requirements, you'll receive a margin call to increase the account's equity accordingly.