Margin loan availability refers to the funds currently available in a margin account that can be used to purchase additional securities. An investor can also withdraw the funds for personal use.
A margin account allows investors to purchase more securities than they would’ve purchased using their actual deposits. When investors use margin loans to purchase more securities, they use the cash deposits and purchased securities in their margin account as collateral.
Margin loan availability refers to the amount currently available in a margin account for use in purchasing securities.
It also tells the broker the amount of money in a customer’s margin account that is currently available for withdrawal.
Any changes in the value of securities held in the margin account affect the margin loan availability.
Understanding Margin Loan Availability
Brokerage firms use margin loan availability to determine the amount of money in a margin account that a customer can use to purchase securities. This amount changes over time as the value of securities purchased changes.
For example, if the value of Company ABC shares changes from $5 to $8 per share, the margin loan availability also increases by a similar margin. In contrast, if the price per share falls from $5 to $3 per share, the number of funds available to the customer also takes a hit.
Generally, brokerages must impose a 25% maintenance margin on customer accounts; however, such a requirement can be higher depending on the brokerage. If a decline in the value of securities purchased causes the margin account balance to fall below the maintenance requirement, the broker will issue a margin call.
A margin call requires the customer to increase their account value by selling some of the securities in the account or depositing additional funds into the account to meet the minimum balance requirement. The investor is allowed up to three days from the date of the margin call to fulfill the maintenance margin requirements.
How Margin Lending Works
Margin lending is a form of financing to purchase financial products, and it is backed by cash deposited into the margin account, as well as the collateral in the form of shares, commodities, derivatives, and other financial products in the account. Margin financing is available to both individual and corporate borrowers, and it helps them borrow up to 50% of the purchase price of an investment.
Simply stated, margin lending allows investors to leverage the amount of marginable stocks they can own. The amount of funds that an investor can borrow depends on their loanable value, the value of assets in their portfolio, and the credit limit set by the brokerage based on the customer’s level of risk.
If John keeps $5,000 in cash deposits in his margin account, his total purchasing power is $10,000. It means that he can spend up to $10,000 in marginable stocks to add to his portfolio. The $10,000 comprises $5,000 (50%) paid in cash and another $5,000 (50%) paid using the brokerage loan.
For most brokerages, customers can borrow up to 50% of the value of marginable stocks, but not many customers are willing to risk that much, especially for high value transactions.
Margin accounts also allow customers to borrow against their marginable securities. For example, if John has $5000 in marginable stocks in their margin account, he can purchase another batch of stocks worth $5000. The marginable securities act as collateral for 50% ($2500) of the newly purchased stocks, while the purchased marginable stocks provide collateral for the other 50% ($2500).
Therefore, the customer’s securities will be worth $10,000, with a margin loan of 50% without an additional cash investment.
What is a Margin Call?
When a margin-approved brokerage account is opened, a customer is required to maintain a specific minimum balance in the account. Usually, the minimum balance is 30% to 40% of the value of securities they own and may vary depending on the broker. The customer’s stocks in the margin account act as collateral, and any changes in the value of the securities affect the value of the collateral.
If a decline in the value of securities causes the equity to fall below the minimum required margin, the brokerage will issue a margin call alert. A margin call requires the customer to immediately deposit additional funds into the margin account to meet the required maintenance margin.
Assume that John owns 100 shares of Company ABC worth $5,000 in his margin-approved account and buys an additional 100 shares at $50 per share on margin. It means that John now owns $10,000 worth of stocks at a 50% margin.
However, a lawsuit filed against Company ABC triggered panic among investors, causing Company ABC shares to fall from $50 to $35 per share. As a result, John’s shares are now worth $7,000. John’s equity is now worth $2,000 ($7,000 less $5,000 margin loan).
Assuming that the brokerage imposes a 40% maintenance requirement, it means that John is required to keep a minimum balance of $2,800 (40% x 7,000) compared to his current balance of $2,000. Therefore, the brokerage will issue a margin call for $800. John will be required to deposit an additional $800 to meet the maintenance margin.
CFI is the official provider of the global Capital Markets & Securities Analyst (CMSA)® certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional CFI resources below will be useful:
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