Maintenance Margin
It is the proportion of the value of the securities bought that are used as the collaterals by the brokers.
A maintenance margin is the minimum amount of capital that should be available in an investor's account after an investment has been made by the investor owning that account. This amount makes sure that if losses occur, it acts as a cushion against the loss incurred.
It is presently set at a minimum of 25% of the total worth of the securities invested in a margin account. This limit is set by the Financial Regulatory Authority (FINRA).
To grasp the concept of it, we need to know about the margin accounts and their utility.
A margin account is an account that is to be maintained by investors and is provided by brokerage firms and entities. The brokers also charge an interest on the money lent to the investors.
The loan is always backed with the securities purchased as collateral to recover the amount lent in case there are losses incurred by the investor.
The funds in the margin account must be maintained at or above the minimum required level of the margin account. If the funds fall below this margin, the investor gets a margin call from the brokerage firm.
The brokerage firm can ask the investor to increase the level of equity in the margin account, to sell out your securities, or if not fulfilled the required level, can sue you for the same.
Let us move ahead and see the working of a maintenance margin account.
Key Takeaways
- It is the minimum amount of capital that should be available in an investor's account after an investment has been made by the investor owning that account.
- It is presently set at a minimum of 25% of the total worth of the securities invested in a margin account, which FINRA sets.
- The initial margin and the maintenance margin are more often than not mistaken to be synonymous, even though there are distinctions between them.
- The initial margin is the proportion of the value of the securities bought that are used as the collaterals by the brokers.
- The Federal Reserve Board’s Regulation T states that the margin requirement is currently 50%.
Maintenance Margin Example
A maintenance margin is also called a maintenance requirement. Most brokerage firms would want a minimum maintenance requirement of around 30% to 40% to be on the safer side
The minimum amount of value of stocks or securities to be maintained can be computed as the total value of the investments made minus the borrowing from the brokerage firm, if any.
It is calculated as:
Maintenance margin = Loan amount/ (1 - maintenance margin)
Let us take an example.
Suppose an investor has $1,20,000 worth of stocks that they can purchase. Out of this total amount, $40,000 is borrowed by the investor from the brokerage entity as a margin loan as the investor had an inadequate amount to invest in the securities.
So, if the minimum requirement of maintaining margin is 25%, the account balance to be maintained can be calculated as:
Margin Requirement = [$40,000/ (1 - 0.25)]
Therefore, the minimum margin account value will be $53,333.33, approximately.
So if the value of the margin account fell at the exact level required or even below it, the investor would get a margin call, indicating to them to get the required amount fulfilled.
Even though the margin increases the chances of profits, it also amplifies the losses that the investor is exposed to.
The maintenance margin, however, can be higher than the required percentage as directed by the government. It just provides additional cushion to the customers as well as the brokers.
NOTE
Some brokerage companies keep the limit higher to shield their customers from losses and mitigate as much risk as possible.
The traders could be asked to maintain a higher amount of funds in their margin accounts as the brokerage firms may increase the account requirements for certain securities individually or a group of securities.
This is mostly done by the brokers keeping in mind the behavior of the market at the moment so that they can minimize the possibility of larger amounts of losses.
Breaking Down Maintenance Margin
Along with the maintenance margin, the initial margin is often confused as they are very similar, yet there are distinctions between them.
One must think that not all traders are in for a long haul. There are many who are all-time active traders and keep an eye on the market almost every second. And there are many traders who like to trade a single type of security multiple times in a day.
Shouldn't the requirements, and in fact, the type of account that they would be obligated to maintain, be different from that of a passive trader?
To answer your doubt, you are correct! There are mainly two kinds of margin accounts. One is the portfolio margin, and the other is the day trade margin account.
NOTE
The portfolio margin account is a type of account that limits the risk of the portfolio by combining all kinds of securities constituting that portfolio and balancing their positions to minimize the risk associated with that portfolio as much as possible.
The Portfolio Margin Account is suitable for those traders who deal in derivatives more than any other financial securities. These derivatives may include futures contracts, options, and credit swaps, to name a few.
The combination made by combining the long and short positions taken in this portfolio is utilized to lower the levels of risk by the maximum amount by the method of netting them against each other.
The margin requirement for a portfolio account is comparatively lower than the other type of account.
The other type of account, a day trade margin account, involves trading in the same kind of financial instruments many times throughout the day.
The main motive of such types of traders is to speculate on the prices of the securities. That is, any slight movement in the price of security poses a chance of profit or loss for them. If there is a chance of a profit, they will immediately alter their existing position in the security.
Day trading is a very risky activity due to constant proc fluctuations and sudden changes in the market and other information flowing in the market that could easily fluctuate the price of the securities.
Owing to this reason, the margin requirements are usually much higher for such a type of account than for a portfolio account.
Posing a much greater risk of losses, an investor, if the market turns unfavorable, may have to bear more funds than they actually own in the form of the wealth that their securities represent.
This largely explains why the margin requirement is explicitly high for such an account. Now, let us move on to alleviate the perplexity between these two terms.
Initial Margin and Maintenance Margin – How It Works
First, let us know about the initial margin in brief. The initial margin is the proportion of the value of the securities bought that are used as the collaterals by the brokers.
The Federal Reserve Board’s Regulation T states that the margin requirement is currently 50%. However, as stated before, this is just the minimum requirement stated by the Government, and the brokerage firms can upgrade this percentage according to their needs.
The initial margin requirement is required when the person holding the account needs to open a margin account to trade on leverage.
For the same, they need to deposit a certain amount of cash or collateral, which is known as the initial margin requirement.
NOTE
The broker charges interest on the borrowed amount, that is, the leftover amount as the margin balance.
As mentioned above, this mechanism helps amplify the probable profits but also increases the chances of risks.
The main dissimilarities between the maintenance and initial margins are briefly discussed.
- The initial margin places a limit on the amount of loan that can be used for investing in profitable securities, as the margin account holder is required to incur a substantial amount of loss to permit the use of leverage in the first place.
- After the account holder has invested in securities, their margin account should have a minimum amount of equity in their accounts, also called the maintenance margin or minimum margin required, as explained in earlier sections.
This is different from the initial margin as it is the proportion of the value of the securities bought that are used as the collaterals by the brokers.
Maintenance Margin Importance
Maintaining a maintenance margin account can be more important than one may actually perceive it to be. It helps an investor in proactive ways of avoiding any risks that the investor could face in the future.
Margin investing could involve a lot of risks and is not advisable for beginners. Beginners should gain foundational knowledge about such kinds of investing and then operate on a margin account.
NOTE
In layman's terms, a margin account helps create a cushion for probable loss occurrences in the future. In other words, it provides a buffer for the traders.
As mentioned earlier, this type of account should not be operated by beginners, it is completely opposite for those traders who have been trading in the market for quite an appropriate duration now.
This is because the need arises for the borrowing of funds from the broker managing the account by the trader for whom the account is being managed.
Thus, the account acts as a direct medium for the trader to borrow money in the account from their broker in case they run out of money due to any fluctuations in the market or any other reason.
It also becomes an easy way for the dealer to lend money to their customer by directly transferring the amount to their account.
These accounts also help traders in increasing their purchasing power. This simply means that the traders can buy more and more securities in the market with the availability of funds through the margin account.
This is because in the presence of the margin account now, the trader can now buy securities whose value exceeds the amount of capital in the hands of the investor by using their existing investments as collateral.
This leads to their funds in the form of investments being at stake, which poses a danger of losing a large amount of the market and goes against their strategy.
But this also increases the number of possible profits by many folds.
Maintenance Margin FAQ
The maintenance margin in your margin account must have a balance above the required minimum level to keep your position open in future options.
This is necessary to keep your equity invested in securities knowing that there is a sufficient amount in your margin account to cover any losses that you may incur.
The formula used to estimate the margin required to be maintained in the trader’s account is calculated by dividing the margin loan by the account holder by 1 minus the percentage of minimum maintenance required.
The formula to calculate is:
Maintenance margin = Loan amount/ (1 - maintenance margin)
FINRA is an autonomous organization that manages and supervises the regulations to oversee the functioning of all types of brokerage firms and brokers registered with the government of the United States.
It started as a cooperation between the National Association of Securities Dealers, or the NASD, and the New York Stock Exchange (NYSE) in 2007.
A margin call is a message from the brokerage firm telling the account holder that their account value has dropped below the minimum level required to be maintained in the account.
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