A:

The main difference between a cash account and a margin account is that in a cash account all transactions must be made with available cash or long positions. When buying securities in a cash account, the investor must deposit cash to settle the trade or sell an existing position on the same trading day, so cash proceeds are available to settle the ‘buy’ order. A margin account allows an investor to borrow against the value of the assets in the account to purchase new positions or sell short. In this way, an investor can use margin to leverage his positions and profit in both bullish and bearish times in the market. Margin can also be used to make cash withdrawals against the value of the account as a short-term loan.

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For investors seeking to leverage their positions, a margin account can be very useful and cost effective. When a margin balance (debit) is created, the outstanding balance is subject to a daily interest rate charged by the firm. These rates are based on the current prime rate plus an additional amount that is charged by the lending firm. Margin interest rates are often much lower than traditional loan rates from banks, making them attractive for short-term loans and for buying investments without increasing cost basis too much.

In a bear market, an investor with a margin account may take a short position in XYZ stock if he believes the price is likely to fall. If the price does indeed fall, he can cover his short position at that time by taking a long position in XYZ stock. Thus, he earns a profit on the difference between the amount received at the initial short sale transaction and the amount he paid to buy the shares at the lower price, less his margin interest charges over that period of time.

In a cash account, the bearish investor in this scenario must find other strategies to hedge or produce income on his account since he must use cash deposits and long positions only. For example, he may enter a stop order to sell XYZ stock if it drops below a certain price, which limits his downside risk.

Margin accounts must maintain a certain margin ratio at all times. If the account value falls below this limit, the client is issued a margin call, which is a demand for deposit of more cash or securities to bring the account value back within the limits. The client can add new cash to his account or sell some of his holdings to raise the cash. Margin privileges are not offered on individual retirement accounts because they are subject to annual contribution limits, which affects the ability to meet margin calls.

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