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Margin calls Guide - How to handle margin calls

Margin Call

What does it Mean?
A broker's demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin.
This is sometimes called a "fed call" or "maintenance call".

Investopedia Says...
You would receive a margin call from a broker if one or more of the securities you had bought (with borrowed money) decreased in value past a certain point. You would be forced either to deposit more money in the account or to sell off some of your assets.

In finance, a margin is collateral that the holder of a position in securities, options, or futures contracts has to deposit to cover the credit risk of his counterparty (most often his broker). This risk can arise if the holder has done any of the following:

  • borrowed cash from the counterparty to buy securities or options,
  • sold securities or options short, or
  • entered into a futures contract.

The collateral can be in the form of cash or securities, and it is deposited in a margin account. On U.S. futures exchanges, "margin" was formally called performance bond.

Example

Jean buys a share in Universal Widgets SA for $100, using $20 of his own money, and $80 borrowed from his broker. The net value (share - loan) is $20. The broker wants a minimum margin requirement of $10.

Suppose the share goes down to $85. The net value is now only $5, and Jean will either have to sell the share or repay part of the loan (so that the net value of his position is again above $10).

How to manage Margin Calls


Keeping track of your margin loan in times of volatility is easily managed through the CommSec website. Monitoring your margin loan on a regular basis can help minimise the risk of a Margin Call.
If your loan balance exceeds the loan limit by more than the buffer, you are in a Margin Call.


How do I know when I’m in margin call?
The margin call amount is displayed in the Collateral Available field, which appears after opening the Margin Lending page within the CommSec website.


What to do when you are in margin call?
When you are in a Margin Call, you are required to take immediate action to restore your loan balance to your loan limit.
You will need to reduce your loan balance so that it is equal to or below your portfolio’s current lending value.

There are 3 ways to do this:


Lodge additional securities acceptable to CommSec;


Complete and fax the transfer form to lodge additional CommSec accepted shares or accepted managed funds.


Sell some or all of your portfolio;
Selling shares can be easily facilitated through the website and proceeds are immediately deducted from your loan balance.


Repay some or all of your loan balance;
Please call our Margin Lending team to settle your margin loan via direct debit. If you already have a customer reference number you can settle your margin loan with BPAY (Biller Code 999623 and your customer reference number).

Margin call

When the margin posted in the margin account is below the minimum margin requirement, the broker or exchange issues a margin call. The investor now either has to increase the margin that he has deposited, or he can close out his position. He can do this by selling the securities, options or futures if he is long and by buying them back if he is short.

[edit] Price of Stock for Margin Calls

The minimum margin requirement, sometimes called the maintenance margin requirement, is the ratio set for:

  • (Stock Equity - Leveraged Dollars) to Stock Equity
  • Stock Equity being the stock price * no. of stocks bought and Leveraged Dollars being the amount borrowed in the margin account.
  • E.g. An investor bought 1000 shares of ABC company each priced at $50. If the initial margin requirement were 60%:
  • Stock Equity: $50 * 1000 = $50,000
  • Leveraged Dollars or amount borrowed: ($50 * 1000)* (1-60%) = $20,000

So the maintenance margin requirement uses the above variables to form a ratio that investors have to abide by in order to keep the account active.

The point is, let's say the minimum margin requirement is reduced from 60% to 25% - At what price would the investor be getting a margin call? Let P be the price, so 1000P in our case is the Stock Equity.

  • (Stock Equity - Leveraged Dollars) divide by Stock Equity = 25%
  • (1000P - $20,000)/1000P = 0.25
  • (1000P - $20,000) = 250P
  • P = $26.67

So if the stock price drops from $50 to $26.67, investors will be called to add additional funds to the account to make up for the loss in stock equity.

http://en.wikipedia.org/wiki/Margin_(finance)

  • Loan balance – the amount you have borrowed (excluding interest).
  • Total Market Value – the total value of your loan portfolio.
  • Loan Limit – this is the maximum gearing level (amount you can borrow) based on Loan to Value ratios (LVRs) assigned to each security in the loan portfolio.
  • Buffer - amount by which BT may allow to exceed your loan limit to facilitate for small fluctuations in the market.
  • Margin Call- If your loan balance exceeds the loan limit by more than the buffer, you are in a Margin Call.
  • Interest payments due – ensure your monthly variable interest payment does not take you over your loan limit.
  • Trades pending - a fall in the market between the time you place an order for a trade and the settlement of that trade, could mean the trade does not settle because you have insufficient funds available.

Note: The Loan to Value Ratio (LVR) assigned to any security may change - it may even be reduced to zero. This can result in a Margin Call or the cancellation of transactions.

What happens in the event of a Margin Call?

When you are in a Margin Call, you are required to take immediate action to restore your loan balance to your loan limit.

Managing a margin call from NAB

Managing a margin call

Buffer limits and margin calls

What to do if a margin call occurs

Reducing the risk of a margin call

Buffer limits and margin calls

Generally, as long as the security value of your investments exceeds your outstanding loan balance, your Facility is operating within its limits and you may be able to draw additional funds for investment purposes - if that's what suits your goals and circumstances.

In a situation where your outstanding loan balance exceeds the security value of your investments, NAB Margin Lending allows a buffer so that small fluctuations in values do not result in a margin call. The buffer is a percentage calculated as the aggregate of:

  • the value of each share in your portfolio divided by the total value of your portfolio and multiplied by 5%; and

  • the value of each managed fund in your portfolio divided by the total value of your portfolio and multiplied by 10%.

This percentage is then multiplied by the total market value of your portfolio to give a buffer amount in dollar terms.

If your outstanding loan balance exceeds the security value of your investments so you are out of the buffer, you will need to meet a margin call.

Unless a margin call position arises, you are not obliged to take any action to restore the security value of your investments to more than the outstanding loan amount, though it might be in your interests to do so. While you are in the buffer, you will not be able to withdraw funds or make further purchases, and the chance of a margin call increases.

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What to do if a margin call occurs

If NAB Margin Lending makes a margin call, you should undertake one or more of the following steps to restore the security value of your portfolio to more than your outstanding loan amount:

  • Reduce your outstanding loan amount (if you have a variable rate loan)

  • Deposit cash into your Cash Management Account (if you have a fixed rate loan)

  • Sell some investments and apply the net sale proceeds against your NAB Margin Lending Facility

  • Provide additional approved investments as security

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Reducing the risk of a margin call

While a margin loan can increase your gains in a rising market, it can also magnify your losses when the market declines. A margin call may occur in this instance.

A margin call arises when your Current LVR exceeds the Base LVR by more than the buffer. The amount of the buffer will be between 5% and 10% of the value of your portfolio depending on the proportion of shares and managed funds in your portfolio.

To reduce the risk of a margin call you can:

  • Gear conservatively and borrow less than the maximum available

  • Diversify your portfolio across a number of industry sectors and companies

  • Make regular interest payments and don't capitalise your interest

  • Monitor your portfolio and loan balance frequently

  • Reinvest the income from your investments

We recommend that you speak to your financial adviser to discuss your investment strategy and financial circumstances when deciding whether or not to gear your investments.

Taken from

www.comsec.com.au

http://www.investopedia.com/terms/m/margincall.asp

http://www.smh.com.au/business/money/tools/guides/investment/margincall.html

http://www.bt.com.au/margincalls/

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