What Is a Call Loan Rate?
A call loan rate is the short-term interest rate charged by banks on loans extended to broker-dealers. A call loan is a loan made by a bank to a to broker-dealer to cover a loan the broker-dealer granted to a client for a margin account. A call loan is payable by the broker-dealer on call (i.e., on demand or immediately) upon receiving such a request from the lending institution. The call loan rate forms the basis upon which margin loans are priced. A call loan rate is also called a broker’s call.
How a Call Loan Rate Works
The call loan rate is calculated daily and can fluctuate in response to factors such as market interest rates, funds’ supply and demand, and economic conditions. The rate is published in daily publications, including the Wall Street Journal and Investor’s Business Daily (IBD).
How a Margin Account Works
A margin account is a type of brokerage account in which the broker lends the client cash that is used to purchase securities. The loan is collateralized by the securities held in the account and by cash that the margin account holder is required to have deposited.
A margin account enables investors to use leverage. Investors are able to borrow up to half of the price to purchase a security and thus trade larger positions than they would otherwise be able to. While this has the potential to magnify profits, trading on margin can also result in magnified losses.
Clients must be approved for margin accounts and are required to make a minimum initial deposit, known as the minimum margin, in the account. Once the account is approved and funded, investors can borrow up to 50% of the purchase price of the transaction. If the account value falls below a stated minimum (known as the maintenance margin), the broker will require the account holder to deposit more funds or liquidate position(s) to pay down the loan.
In prior crises, extreme amounts of leverage has caused steep losses once markets begin falling. While having a ratio of 2:1 margin, this is nothing compared to reports of firms being leveraged 30:1. Margin is great for retail investors when markets are rising with low volatility, and deadly when volatility rises and markets head south. The losses get amplified and the only option at that point is to sell to cover the margin requirements.