Margin accounts allow brokerage firms to lend money to clients to purchase securities, with the market value of the securities serving as collateral. Margin debt is the difference between the market value of the collateral and the loan balance. The maximum percentage of securities that can be purchased on credit is set by the Federal Reserve Board in the US. If the market value of the securities falls below the minimum maintenance margin level, a margin call is issued. Margin debt levels are often used as an indicator of investor sentiment.
A margin account is an account that a stock brokerage firm uses to lend money to its clients to purchase securities. The market value of the purchased securities serves as collateral for the loan. Margin debt refers to the difference between the market value of the deposited collateral and the loan balance, plus accrued interest. Not all securities can be bought on margin. Securities that can be purchased on credit in a margin account are called margin. 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 pursuant to regulations issued by the Federal Reserve Board. For example, if the prevailing margin percentage is 50%, a client could purchase $100 United States Dollars (USD) worth of marketable securities with an initial cash deposit of $50 USD. The brokerage firm would then loan the client the other $50 USD to effect the transaction. Individual brokerage firms may set their own credit requirements, which may 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 has initially purchased securities on margin, they must maintain a specified 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 the securities minus the outstanding loan balance) must be at least 25% of the total value of the account. account. Brokerage firms may 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 required minimum 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 account value to the minimum maintenance margin level. If the client fails to meet the margin call, the brokerage firm will sell a number of securities in the account to bring the equity in the account to the minimum margin maintenance level.
The total amount of margin debt outstanding at any time is often used as an indicator of prevailing investor sentiment. In general, an increase in margin debt levels coincides with broad-based stock market rallies. In many cases, a precipitous 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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