Purpose credit is extended by brokers to clients for trading securities, allowing for fast trading and risk-taking. Clients must provide a guarantee and meet a maintenance requirement in a margin account. Regulators monitor purpose credit and brokers can be penalized for non-compliance. Clients should be cautious and not take on more credit than they can realistically repay.
The purpose of credit is credit provided to someone for use in trading securities. It is usually extended to clients by a broker, although other credit arrangements can be made. Without purpose credit, people who trade securities would be limited to what they can afford at any given time and the stock markets would be much slower. Credit release allows for fast trading and the ability to take risks to access big rewards.
In a typical purpose credit agreement, a client and a broker draw up an agreement in which the broker agrees to extend a loan to a client for the purpose of trading securities. The client must provide a guarantee for the loan. This may take the form of cash on deposit in an account with the broker or may be provided with other securities held in an account with the broker. The broker is assigned an interest in the assets used to secure the loan, so that in the event the loan is not repaid, the broker has a method to recover the debt.
The account that secures the credit of the client’s purpose is known as a margin account. Individuals are required to meet a maintenance requirement in order to have a margin account. Under this requirement, a set percentage of the total loan amount must be held on escrow. If a client does not have enough money to meet the minimum maintenance requirement, the broker issues a margin call. Margin calls alert clients to the fact that their accounts are not in order and that they need to sell shares or deposit more cash into the account to be in good standing again.
Regulators monitor purpose credit and other aspects of the securities trading industry. There are set minimum requirements that must be followed by brokers and other representatives. If these requirements are not met, regulators can intervene. A brokerage can be fined or subject to other penalties for failing to comply with financial regulations and putting clients at risk.
People interested in trading securities should be careful about the purpose of credit. There is a chance to make a lot of money by buying the right stocks at the right time. Conversely, it is possible to experience a significant loss by making a poor buying choice. While brokers can provide advice and guidance if asked, they cannot prevent all mistakes. Taking on more purchase credit than can realistically be repaid can be a dangerous decision.
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