What is a Margin Call?
A margin call occurs when the value of a margin account falls below the account’s maintenance margin requirement. A margin call is a demand by a brokerage firm to bring the margin account’s balance up to the minimum maintenance margin requirement. To satisfy a margin call, the investor of the margin account must either deposit additional funds, deposit unmargined securities, or sell current positions.
Formula for Margin Call Price
The formula for margin call price is as follows:
- Initial purchase price is the purchase price of a security;
- Initial margin is the minimum amount, expressed as a percentage, that the investor must pay for the security; and
- Maintenance margin is the amount of equity, expressed as a percentage, that must be maintained in a margin account.
Example of Margin Call
An investor is looking to purchase a security for $100 with an initial margin of 50% (meaning the investor is using $50 of his money to purchase the security and borrowing the remaining $50 from a broker). In addition, the maintenance margin is 25%. At what price of the security will the investor receive a margin call?
The investor will receive a margin call if the price of the security drops below $66.67.
Interpreting the Example Above
To further break down the example above, we can interpret it as:
- The investor is purchasing a security for $100 using $50 of his own money and $50 from a broker; and
- The broker’s maintenance margin is 25%, meaning the investor’s own money must comprise at least 25% of the security.
By determining the margin call price, we are determining the minimum price the security can trade at without falling below the maintenance margin. In the example above, the margin call price is $66.67 because:
- Since the broker lent $50 for the investor to purchase the security and the security is trading at $66.67, the broker’s lent money comprises 75% of the investment ($50 / $66.67) and the investor’s own money comprise 25% of the investment ($66.67 – $50 / $66.67).
Therefore, at the price of $66.67, the broker keeps a 75% position in the security, and the investor holds a 25% position in the security: the margin call price.
If the price of the security falls below $66.67, say $60, the broker would comprise 83.33% ($50 / $60) of the investment, and the investor would comprise 16.66% ($60 – $50 / $60) of the investment. Seeing that the investor now only holds a 16.66% equity position in the investment, he would receive a margin call.
How to Cover a Margin Call
If a margin call is not satisfied, the broker can liquidate the investor’s position. For example, if the investor in the example above did not satisfy the margin call when the price fell to $60, the broker would liquidate the investor’s position at $60 and retrieve the $50 owed by the investor. The investor would face an 80% realized loss, as he is now left with only $10 from his initially invested amount of $50.
A margin call can be covered through:
- Depositing additional funds to meet the account’s maintenance margin requirement;
- Depositing unmargined securities to meet the account’s maintenance margin requirement; or
- Selling margined securities to meet the account’s maintenance margin requirement.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: