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 broker-dealer to cover a loan the broker-dealer granted to a client for a margin account.
- A call loan rate is the short-term interest rate that banks charge broker-dealers on loans.
- Call loans are made in order for broker-dealers to cover the loans they make to their clients for margin accounts.
- The call loan rate fluctuates daily, is published in a variety of periodicals, and is payable by the broker-dealer on-call, meaning on-demand or immediately upon receiving a request from the lending institution.
- Brokers seek to profit on the margin loans they make to their clients, as such, margin loan rates are typically priced at the call rate plus a premium.
Understanding a Call Loan Rate
Many clients trade on margin accounts; an account where a broker-dealer lends a client cash that is used to purchase securities. A call loan is made by a bank to a broker so that the broker is able to cover the loan it makes to its client. 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. As brokers seek to make a profit on the loans they make, the margin loan is usually priced as the call loan rate plus a premium. A call loan rate is also called a broker’s call.
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 have caused steep losses once markets begin falling. While having a ratio of 2:1 margin can be considered conservative, 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.
Example of a Call Loan Rate
Bill is looking to purchase 1,000 shares of company XYZ for $50,000. He does not have the cash on hand to do so, so he opens a margin account with Broker ABC to borrow the funds. Per regulations, he deposits $25,000 and borrows the remaining $25,000 from the broker. He is charged 4% to borrow the funds.
To make this loan to Bill, Broker ABC borrows $25,000 from Bank DEF and is charged a call loan rate of 2%. The additional 2% that Broker ABC charges Bill is the margin loan rate and the profit Broker ABC makes on its loan. If in three days Bank DEF decides it wants the $25,000 loan back with interest, Broker ABC will have to make the payment as it is a call loan.