A margin account is used by securities firms to lend money to clients to purchase securities, with the market value of the securities serving as collateral. Not all stocks can be purchased on margin, and the maximum percentage of securities that can be purchased on credit is set by the Federal Reserve. The amount of margin debt in a client’s account fluctuates based on market value, and a minimum margin must be maintained at all times. If the market value falls below the minimum, a margin call is issued. Margin debt levels are used as an indicator of investor sentiment.
A margin account is an account that a securities firm uses to lend money to its clients to purchase securities. The market value of the securities purchased serves as collateral for the loan. Debt margin refers to the difference between the market value of the deposited collateral and the loan balance, plus accrued interest. Not all stocks can be purchased on margin. Securities that can be purchased on credit in a margin account are called marginable. Most low-priced, highly volatile or speculative stocks are not marginable.
In the United States, the maximum percentage amount of securities that can be purchased on credit, or margin, is set by regulations issued by the Federal Reserve Board. For example, if the margin percentage in effect is 50%, a client could purchase $100 US Dollars (USD) of margin stock with an initial cash deposit of $50 USD. The brokerage firm will then lend the client the other $50 USD to make the transaction. Individual brokerage firms can set their own credit requirements, which can be lower than the maximum levels set by the Federal Reserve.
The amount of margin debt in a client’s account will fluctuate based on the market value of the securities purchased in the account. Because the value of securities in a margin account can change based on general market conditions, after a client initially purchases securities on margin, they must subsequently maintain a specific percentage, or minimum margin, in the account at all times. For example, if the minimum maintenance margin requirement is 25%, the equity in a client’s account — market value of securities minus outstanding loan balance — must be at least 25% of the total account value. Brokerage firms can set minimum margin requirements that exceed those set by the Federal Reserve.
If the market value of the securities in a client’s margin account falls below the minimum required margin maintenance level, the brokerage firm will send the client a margin call. The client must increase the cash or securities in his account to bring the value of the account up to the minimum level of the maintenance margin. If the client fails to meet the margin call, the brokerage firm will sell an amount of securities in the account to bring the equity in the account up to the minimum margin maintenance level.
The total amount of debt margin in effect at any one time is often used as an indicator of prevailing investor sentiment. In general, rising margin leverage levels coincide with broad-based equity market rallies. In many cases, a sharp decline in the stock market can trigger margin calls, resulting in the sale of securities in client accounts, which can exacerbate the market decline.
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