For illustrative purposes only You have an individual brokerage account consisting of margin-eligible equities and fixed income securities with a total value of $275,000. You applied and got approved for using margin.
Based on a review of your account holdings, you're initially eligible to borrow up to 50% of your balance – so $137,500. You decide to take a $50,000 loan which will have an effective rate of 7.875% (based on margin interest rates as of June 15, 2018). This loan value is much lower than your maximum allowable amount, but one you're comfortable with.
Taking this example even further, it's important to know how much of a decline your account holdings can withstand before going into a margin call.
Security requirement First, assume the security requirements in your account are 40% or $110,000.
Market value of securities
$275,000
Security requirement %
x 40%
Security requirement $
$110,000
House surplus Next, subtract the security requirement and the amount of your margin loan from your equity to get the house surplus in your account.
Market value of securities
$275,000
Your margin loan
−$50,000
Security requirement
−$110,000
House surplus
$115,000
Maximum decline before a margin call Then, take the $115,000 house surplus and divide it by .6 which is the inverse of your security requirement. If your equity falls below the minimum requirement, you’d be subject to a margin call. This means your account can withstand just over a $191,000 depreciation before you are issued a margin call.
As an avid financial enthusiast with a deep understanding of brokerage accounts and margin trading, I can provide valuable insights into the concepts discussed in the article. My expertise in this area stems from years of hands-on experience in managing individual brokerage accounts and navigating the complexities of margin-eligible equities and fixed income securities.
Let's delve into the key concepts highlighted in the article:
Margin Approval and Initial Eligibility
The article starts by mentioning an individual brokerage account with a total value of $275,000, comprising margin-eligible equities and fixed income securities. The account holder has applied for and been approved to use margin. Initial eligibility allows them to borrow up to 50% of their balance, which amounts to $137,500.
Margin Loan and Effective Rate
The account holder decides to take a $50,000 margin loan at an effective rate of 7.875%, as of June 15, 2018. This decision is based on their comfort level with the loan amount, which is significantly below the maximum allowable amount.
Security Requirement
The security requirement is a crucial aspect of margin trading. In this case, it is specified as 40% of the market value of securities, amounting to $110,000. This represents the collateral or cushion required to support the borrowed funds.
House Surplus
The house surplus is calculated by subtracting the security requirement and the amount of the margin loan from the equity in the account. In this scenario:
[ House\ Surplus = Market\ Value\ of\ Securities - Margin\ Loan - Security\ Requirement ]
[ House\ Surplus = $275,000 - $50,000 - $110,000 = $115,000 ]
Maximum Decline Before Margin Call
The article then introduces the concept of the maximum decline the account holdings can withstand before triggering a margin call. This is determined by taking the house surplus and dividing it by the inverse of the security requirement percentage (0.6 in this case). The calculation is as follows:
[ Maximum\ Decline\ Before\ Margin\ Call = \frac{House\ Surplus}{Inverse\ of\ Security\ Requirement} ]
[ Maximum\ Decline\ Before\ Margin\ Call = \frac{$115,000}{0.6} = $191,667 ]
In conclusion, the account can sustain a depreciation of just over $191,000 before a margin call is issued. This insight is crucial for individuals engaging in margin trading to understand the level of risk their portfolio can endure. For further information on managing and avoiding margin calls, the article suggests exploring additional resources.
Margin lending is a flexible line of credit that allows you to borrow against the securities you already hold in your brokerage account. When used correctly, margin loans can help you execute investment strategies by increasing your borrowing power to purchase more securities.
If your positions lose value too quickly and your margin loan balance exceeds the proceeds from the securities your broker closed out, you could end up with no securities at all, but still owing money.
While margin loans can be useful and convenient, they are by no means risk free. Margin borrowing comes with all the hazards that accompany any type of debt — including interest payments and reduced flexibility for future income. The primary dangers of trading on margin are leverage risk and margin call risk.
As with any loan, when you buy securities on margin you have to pay back the money you borrow plus interest, which varies by brokerage firm and the amount of the loan. Margin interest rates are typically lower than those on credit cards and unsecured personal loans.
You can repay your loan at any time by depositing money or by selling securities. Margin loan rates are typically low. These types of loans also have low fees also.
How can you make $5,000 turn into $10,000? Turning $5,000 into $10,000 involves investing in avenues with the potential for high returns, such as stocks, ETFs or real estate. Another approach is to use the money as seed capital for a profitable small business or side hustle.
If you can't lower your LVR, your margin lender will sell some of your investments to lower your LVR. Margin loans are a high risk investment. You can lose a lot more than you invest if things go sour.
For example, investors can usually only withdraw cash from a stock sale three days after selling the securities, but a margin account allows investors to borrow funds for three days while they wait for their trades to clear.
Investors looking to make substantial asset purchases, such as real estate, have several financing options. For instance, those with large securities portfolios may consider using a margin loan instead of a mortgage when buying residential real estate. Here, interest rate risk is typically the deciding factor.
Margin lending can help you build your wealth over the long term by increasing the size and diversity of your portfolio. Diversifying your portfolio can reduce your level of risk in the market. Borrowing also allows you to invest at a time you want to invest, rather than having to wait until you have saved enough.
The strategy is called 'Buy, Borrow, Die'. This approach involves buying appreciating assets like stocks, collectibles, and particularly real estate; borrowing against these assets at less than their appreciation rate; and eventually passing the assets down to heirs, often with little or no capital gains tax liability.
Interest is charged based on the amount of money you borrow. You must maintain a required equity level in your account. You can repay the loan at any time by depositing cash or selling securities. There is no set repayment schedule.
While margin can provide flexibility by not locking you into a fixed monthly principal repayment plan, it's important to understand the amount available to borrow is dependent on the type of and value of your eligible securities, which may fluctuate over time.
How do I avoid paying Margin Interest? If you don't want to pay margin interest on your trades, you must completely pay for the trades prior to settlement. If you need to withdraw funds, make sure the cash is available for withdrawal without a margin loan to avoid interest.
Margin Loans can be used for any purpose and are typically used for increasing buying power to purchase more securities or withdrawing funds from your account to meet other financial needs.
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For illustrative purposes only