Why Use a VAT Margin Scheme

Customer margin Accounting

Understanding Margin Accounts, Why Brokers Do What They Do

We are issuing this investor guidance to provide some basic facts to investors about the mechanics of margin accounts. We encourage any investor reading this communication to also read Purchasing on Margin, Risks Involved with Trading in a Margin Account.

How Margin Calls Work in Volatile Times

Many margin investors are familiar with the "routine" margin call, where the broker asks for additional funds when the equity in the customer’s account declines below certain required levels. Normally, the broker will allow from two to five days to meet the call. The broker’s calls are usually based upon the value of the account at market close since various securities regulations require an end-of-day valuation of customer accounts. The current "close" for most brokers is 4 p.m., Eastern time.

However, in volatile markets, a broker may calculate the account value at the close and then continue to calculate calls on subsequent days on a real-time basis. When this happens, the investor might experience something like the following:

Day one close: A customer has 1, 000 shares of XYZ in his account. The closing price is $60, therefore, the market value of the account is $60, 000. If the broker’s equity requirement is 25 percent, the customer must maintain $15, 000 in equity in the account. If the customer has an outstanding margin loan against the securities of $50, 000, his equity will be $10, 000 ($60, 000 - $50, 000 = $10, 000). The broker determines the customer should receive a margin call for $5, 000 ($15, 000 - $10, 000 = $5, 000).

Day two: At some point early in the day the broker contacts the customer (e.g., by an e-mail message) telling the customer he has "x" number of days to deposit $5, 000 in the account. Shortly thereafter, on Day two, the broker sells the customer out without notice.

What happened here?

In many cases, brokers have computer-generated programs that will issue an alarm (and/or take automatic action) in the event the equity in a customer’s account further declines. For example, assume the value of the XYZ stock in the customer’s account continues to decline during the morning of Day two by another $6, 000, that is, the shares are now worth only $54, 000. The customer still has a loan outstanding to the broker of $50, 000, but now the broker only has $54, 000 in market value securing that loan. So, based upon the subsequent decline, the broker decided to sell shares of XYZ before they could decline even further in value.

Had the value of the securities stayed at about $60, 000, the broker probably would have allowed the customer the stated number of days to meet the margin call. Only because the market continued to decline did the broker exercise its right to take further action and sell out the account.

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Popular Q&A

How margin accounts work?

Getting back to our example scenario, you've got $1,000 in equity in an account worth $6,000 in stocks. That's less than 25 percent, so the broker issues a margin call. That means you have a limited amount of time -- usually a day or two, as spelled out in your brokerage agreement -- to put enough cash into the account to bring it back up to the 25 percent maintenance minimum. In this case, you need to send them $500 to bring the equity up to $1,500, which is 25 percent of $6,000. You are essentially buying $500 worth of your own stock when you do this, partially repaying the $5,000 loa…

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