What is the Call Loan Rate?
The call loan rate refers to the short-term interest rate that the banks charge on the loans made to brokers for funding the margin loans by the brokers to their clients. Since brokers seek to make a profit on their own margin loans, they provide margin loans at a call loan rate premium. The margin loan rate is quoted relative to the call loan rate that is published daily in various periodicals. A call loan rate is sometimes referred to as the broker’s call.
- The call loan rate refers to the short-term interest rate that the banks charge on the loans made to the brokers for funding the margin loans granted by the brokers to their clients.
- It is the interest rate charged on call loans that are payable by the brokers immediately or on-demand once requested by the bank.
- Sometimes, even a fairly well-funded margin account can be called back by the broker-dealer if the bank calls the loan for reasons unrelated to risks in the account.
Understanding Call Loan Rates
The call loan rate is the short-term interest rate charged on call loans that are payable by brokers – immediately or on-demand – once any such request is received from the lending bank. If the broker-dealers suspect that their loan may be called by the bank, they can execute a margin call on traders who have borrowed money from them.
The call loan rate is determined on a regular basis and fluctuates depending on factors such as the supply and demand of funds, market interest rates, and economic conditions. The call loan rate is published every day, including in the Investor’s Business Regular (IBD) and the Wall Street Journal (WSJ). The call loan rate then includes a risk premium dependent on the presumed credit risk of the broker, along with other considerations.
The call loan rate is an essential aspect of the supply chain responsible for supplying leverage to traders from their margin accounts. From the point of view of the margin broker-dealer, the loan originates from their brokerage firms, and the broker-dealers must ensure that there’s sufficient collateral in their account to make sure that their margin loan is not called by the broker.
Sometimes even a fairly well-funded margin account can also be called back by the broker-dealer if the bank calls the loan made to that broker-dealer. Therefore, a margin trader can face a call for a margin for reasons not linked to the degree of risk of his/her own account. While such incidents are uncommon, they do arise in circumstances where financial anxiety extends through economies, such as an economic slowdown.
Working of a Margin Account
A margin account is a form of trading account in which the broker-dealer loans cash to the clients for buying the securities. The loan is backed by shares invested in the portfolio and by cash deposited by the holder of the margin account. A margin account allows clients to take advantage of leverage.
Investors are allowed to borrow funds equivalent to half of the purchase price of a security, and therefore trade a greater position than they would’ve otherwise been able to. Although it comes with the potential to maximize earnings, margin trading can also result in increased losses.
Investors are allowed to borrow funds equivalent to half of the purchase price of a security, and therefore trade a larger position than they would’ve otherwise been able to. Although it comes with the potential to maximize earnings, margin trading can also result in leveraged losses.
Investors have to be authorized to maintain margin accounts and must make a certain initial deposit in the margin account. The required initial deposit is known as the minimum margin. Investors can borrow up to 50% of the purchase price of a trade. If the account value falls below a specified minimum, known as the maintenance margin, the broker will force the account holder to invest additional funds (margin call) or to liquidate the securities to repay the loan.
Margin is perfect for retail investors where markets are growing with little volatility, and risky while volatility is growing and markets are heading south. Losses are compounded, and the only alternative at such a stage is to sell and cover the margin exposure.
CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: