Financial Markets Book Financial Markets For The Rest Of Us
An Easy Guide To Money, Bonds, Futures, Stocks, Options, And Mutual Funds
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by Robert Hashemian

Page 137

follow and drop to $400. But what if you decide to hang on to your investment and not sell. Your equity would still be $400 while the margin remains at $1,000, clearly an imbalance situation as you would be overdrawn on your margin. This is when the dreaded "margin call" comes in. The margin call is an account maintenance notice given to you by your broker to remedy the imbalance. This is not only required by the rules, but it is also done because your broker is getting nervous about its money.Why? Suppose that Ford stock continues to plummet to $20 per share. At this point the value of your 40 shares would be $800. Not even enough to cover your margin, and that is the reason behind the margin call (or maintenance call).

Actually brokers allow some leeway for fluctuation before issuing margin calls and your equity to holding ratio of your account is allowed to dip to some reasonable level beneath the 50% before you receive the margin call, for example 35%. But if the ratio goes below 35%, you will then be required to bring the ratio back up to at least the 35% level. So how can you fix the ratio when you receive the margin call? Basically there are two ways to do this. Either deposit enough cash (or stocks) in your account to meet the requirement or sell some or all your stocks to achieve this. Let's get back to our example. Assuming that the Ford stock remains at the $35 level and you receive a margin call, you must either deposit $140 in your account to bring your ratio back up to 35%, or you may sell 8 shares of your holdings where all the proceeds ($280) are applied to your margin. Now your margin amount is reduced to $720 ($1,000-$280) and your equity remains at $400 for a ratio of over 35.7%.

Here's another way to look at this. After selling 8 shares of your stock you will be left with 32 shares. At $35 per share the value of your holdings would be

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Copyright and Disclaimer
Book Chapters
Table of Contents Copyright and Disclaimer Foreword Money
Bonds Futures Stocks Options
Mutual Funds Retirement Final Words Appendix A

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