Margin trading

Margin Trading
· Buying securities with borrowed money.
· Margin funds provided by brokers at a rate above bank call money rate.
· 100% of the purchase cannot be with borrowed funds. Percentage of own funds (equity) is called margin requirement.
· Fed sets minimum initial margin but brokers can set a higher level.

Initial margin: Initial equity required for margin purchase.

Maintenance margin: Minimum equity required as a fraction of the total value of the stock in the margin account.

Margin call: Request for funds made by the broker if the value of the margin account falls below the maintenance margin level. Investor must deposit sufficient funds to return percentage of equity to the initial margin level.

Variation margin: Money deposited to bring the margin account back to required level.

Leverage factor = 1 / % Initial margin.

Levered return = Holding period return x Leverage factor.

Margin call for long position is triggered when price falls to:
(Purchase price) x (1 – % Initial margin) / (1 – % Maintenance margin).

Margin call for short position is triggered when price rises to:
(Purchase price) x (1 + % Initial margin) / (1 + % Maintenance margin)