Definition:

A margin call is a notification from a brokerage firm to a client requesting additional funds to cover a margin loan. Margin loans are loans that investors borrow money from their brokerage firm to purchase securities.

Purpose:

• To maintain the required margin ratio: Margin requirements are typically 50% for most securities. If the value of the client’s securities falls below the required margin ratio, the brokerage firm may require the client to deposit additional funds to maintain their account.
• To protect the firm’s interests: If a client fails to meet a margin call, the brokerage firm may liquidate the client’s securities to cover its losses.
• To ensure orderly market conditions: Margin calls help to prevent panic selling and market instability caused by margin calls.

Types of Margin Calls:

• Full margin call: Requires the client to provide a full margin, typically 100% of the investment cost.
• Partial margin call: Requires the client to provide a partial margin, usually a specified percentage of the investment cost.
• Cash call: Requires the client to provide cash to cover the margin shortfall.
• Stock call: Requires the client to provide additional securities to cover the margin shortfall.

Impact of Margin Calls:

• Limited liquidity: Margin calls can limit the liquidity of an investor’s portfolio, as the investor may not be able to sell securities to raise funds to meet the call.
• Higher borrowing costs: Margin calls can result in higher borrowing costs for the investor, as the brokerage firm may charge additional fees or interest on the loan.
• Stress and anxiety: Margin calls can be stressful for investors, as they may worry about losing their investment or being unable to meet the call.

Example:

If an investor has a margin loan of $10,000 and the value of their securities falls to $8,000, the brokerage firm may require the investor to deposit an additional $2,000 to maintain their margin ratio. If the investor fails to meet the call, the firm may liquidate some of the investor’s securities to cover its losses.