The term margin call refers to a demand for additional assets to ensure the minimum level of assets is available to support an investment position. A margin call can occur when an investor buys securities using borrowed funds.
When purchasing securities, it is possible for the investor to borrow funds from a brokerage firm to pay for a portion of the purchase price. The investor's margin, or margin requirement, represents the funds the trader must provide to support their investment position.
When purchasing securities on margin, the investor needs to be aware of two thresholds. The initial margin is the percentage of funds the trader must provide when first purchasing the securities. The initial margin for common stock, as established by the Federal Reserve Board, is 50%. If the price of the securities declines, the investor must ensure they maintain sufficient equity in the position. A margin call will be made by the broker to the investor if their equity falls below the maintenance margin threshold, which is typically 30%.
A margin call is a demand by the broker made to the investor to increase their equity position. The investor can do this by placing additional money in their account or by selling securities.
An investor would like to buy 1,000 shares of Company ABC common stock at a price of $60.00 per share on margin. The initial margin provided by the investor is 50% of the purchase price, or $30,000. The maintenance margin required by the broker is 30%, which means if the price of the security falls by 20% or more, a margin call will be made to the investor.
For example, if the price of the security falls 20%, it will be selling at $48.00 per share, which leaves the investor with equity of:
= $48.00 x 1,000 shares - $30,000 (borrowed from broker)
= $48,000 -$30,000, or $18,000
This leaves the investor with margin of:
= $18,000 / $60,000, or 30%
Since the investment has reached the minimum margin threshold of 30%, a margin call would be made to the investor if the price of the security falls below $48.00 per share.