What is a 'Margin Call'
A margin call is a broker's demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin. Margin calls occur when the account value depresses to a value calculated by the broker's particular formula.
An investor receives a margin call from a broker if one or more of the securities he had bought with borrowed money decreases in value past a certain point. The investor must either deposit more money in the account or sell off some of his assets.
BREAKING DOWN 'Margin Call'
A margin call typically arises when an investor borrows money from a broker to make investments. When an investor uses margin to buy or sell securities, he pays for them using a combination of his own funds and borrowed money from a broker. An investor is said to have an equity in the investment, which is equal to the market value of securities minus borrowed funds from the broker. A margin call is triggered when the investor's equity as a percentage of total market value of securities falls below a certain percentage requirement, which is called the maintenance margin. While the maintenance margin percentage can vary among brokers, the federal laws established a minimum maintenance margin of 25%.
An Example of a Margin Call
Consider an investor who buys $100,000 of stocks by using $50,000 of his own funds and borrowing the remaining $50,000 from his broker. The investor's broker has a maintenance margin of 25% with which the investor must comply. At the time of purchase, the investor's equity is $50,000 (the market value of securities of $100,000 minus the broker's loan of $50,000), and the equity as a percent of the total market value of securities is 50% (the equity of $50,000 divided by the total market value of securities of $100,000), which is above the maintenance margin of 25%.
Suppose that on the second trading day, the value of the purchased securities falls to $60,000. This results in the investor's equity of $10,000 (the market value of $60,000 minus the borrowed funds of $50,000). However, the investor must maintain at least $15,000 of equity (the market value of securities of $60,000 times the 25% maintenance margin) in his account to be eligible for margin, resulting in a $5,000 deficiency. The broker makes a margin call, requiring the investor to deposit at least $5,000 in cash to meet the maintenance margin. If the investor does not deposit $5,000 in a timely manner, his broker can liquidate securities for the value sufficient to bring his account in compliance with maintenance margin rules.