What is a Margin Call?
A margin call is when the value of the margin account goes below the account’s maintenance requirements or the broker’s required amount. In order to satisfy the margin call, the investor has to sell his securities or deposit additional funds or deposit unmargined securities. The margin call is issued by the broker requiring the investor to top up his or her account. It must be such that the account value has to be brought up to the minimum value known as the maintenance margin. In case the investor cannot afford to bring up the value of the portfolio, then he or she might have to liquidate his or her securities. It can be mathematically calculated as follows – Margin call = initial purchase price * [(1- initial margin)/ (1-maintenance margin)] Where, The initial purchase price defined as the purchase price of a security, The initial margin is the minimum amount that the investor must pay for the security, The maintenance margin is the amount of equity that must be maintained in a margin account.
How to Cover a Margin Call?
A margin call can be covered through the following three ways - - By selling margined securities to meet the account’s maintenance margin requirement. - By depositing additional funds to meet the account’s maintenance margin requirement. - By depositing unmargined securities to meet the account’s maintenance margin requirement.
How can One Avoid Margin Call?
An investor can avoid margin call by using the following means – - The investor may set aside a cash cushion to provide a stable value that will remain intact even when the value of security fluctuates. - The investor must diversify his or her portfolio and plan for the volatility that he or she is likely to face. - The investor must purchase short term assets that have a high return potential to pay for the margin loan and interest and earn profits at the same time. - The investor must make regular investments to avoid loan accumulation. - The investor can avoid these margin calls altogether by using protective orders to limit losses from equity positions.
