3. Definition: what is buying on margin?
The investor borrows part of
the purchase price
of the stock from a broker.
Margin: portion of purchase price
contributed by the investor.
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4. Definition: what is buying on margin?
Investments with borrowing.
Borrowing cash: buying on
margin
Borrowing shares of stock: short
sales.
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5. Margin requirement
Limiting the proportion of funds that may
• - Imposed by the Federal Reverse
be borrowed from the brokerage firm to
• - Representing the minimum proportion
make the investment.
of funds that must be covered with cash.
Currently, at least 50% of investor’s
invested funds must be paid in cash.
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6. BUYING ON MARGIN PROCESS
Establishing an account
( called margin account)
Depositing cash
( initial margin: must be at least 50% of the total
investment)
Maintaining the minimum
proportion of equity 6
7. STOCK MARGIN TRADING
Using only a portion of the proceeds for an investment
Borrow remaining component
Margin:
The net worth (Equity) of the investor’s account
Margin =Asset-Liability ( borrowed funds or
stocks)
% Margin=Equity/Value of stock
8. STOCK MARGIN TRADING
Maximum margin is currently 50%; you can
borrow up to 50% of the stock value. (Set by
the Fed)
Minimum margin is:
Minimum level of the equity margin.
Currently 30%, set by the securities
commissions. 8
9. STOCK MARGIN TRADING
Maintenance margin: minimum amount equity
in trading can be before additional funds must
be put into the account.
Minimum maintenance margin of New York
Stock Exchange ( NYSE) and Nasdaq : 25 %.
In Viet Nam, minimum maintenance margin is
up to the broker but not less than 40 %
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10. STOCK MARGIN TRADING
Margin call: notification from broker you must
put up additional funds.
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11. MARGIN TRADING – INITIAL CONDITIONS
IBM price $100
# of shares purchased 100
Total stock value $10,000
Loan from broker $4,000
Assets Liabilities and owner’s equity
Stock $10,000 Loan from broker $4,000
Equity $6,000
Margin = Equity/Stock = 6,000/10,000 = 60%
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12. MARGIN TRADING – MAINTENANCE MARGIN
IBM price $100
# of shares purchased 100
Total stock value $10,000 $70
Loan from broker $4,000
$7,000
Assets Liabilities and owner’s equity
Stock $10,000 $7,000 Loan from broker $4,000
Equity $6,000 $3,000
Margin = 3,000/7,000 = 43% < 50% = Maintenance Margin
Broker issues a Margin Call! 12
13. MARGIN TRADING - MARGIN CALL
How far can the stock price fall before a margin call?
IBM price P
# of shares purchased 100
Total stock value 100P
Loan from broker $4,000
Assets Liabilities and owner’s equity
Stock 100P Loan from broker $4,000
Equity 100P-$4,000
Margin = (100P-$4,000)/(100P) = 50% P=80
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14. WHY BUY SECURITIES ON MARGIN?
Wishto invest more than what your money
would allow.
Greater upside potential
Greater downside risk
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15. IMPACT ON RETURNS
R = (SP- INV – LOAN + D ) / INV
Where: SP = selling price of stock
INV = initial investment by investor, not including
borrowed funds
LOAN= loan payments on borrowed funds,
including both principal and interest
D = dividend payments
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16. WHY BUY ON MARGIN? EXAMPLE
IBM price $100
# of shares purchased 100
Total stock value $10,000
Loan from broker $4,000 (interest rate: 10%)
End-of-Year Repayment of Rate of return
Change in Rate of
Value of Principal and (if not buying
stock price return
shares interest on margin)
30%
$13,000 $4,400 43% 30%
increase
No change $10,000 $4,400 -6.7% 0%
30%
$7,000 $4,400 -57% -30%
decrease
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17. LEVERAGING EFFECT OF MARGIN TRADE
You buy 200 shares of XYZ at $100, expecting a 30%
appreciation of the stock in one year:
Initial margin: 50%
Financed by a 9% loan for one year
Expected net return: 51% = (30%x2-9%)
A 30% drop in the price, though, results in -69%
( -30%x2-9%) return.
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18. EXAMPLE AND EXERCISE 1: MARGIN TRADING
You bought on margin one share of ABC at $70, paying
$35 of your own money.
The minimum margin is set at 30%.
A. Initial position.
Stock $70 Borrowing = ? $35
Equity = ? $35
B. New Position: Stock price=$40
Stock $40 Borrowing =? $35
Equity = ? $5
Margin= $5/$40 = 12.5%
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19. EXAMPLE AND EXERCISE 1: MARGIN TRADING
Margin call
Investor is required to put up $7 to bring up
the margin to $12 ($5+7), or 30% ($12/40) of
current value of stock.
How far can the stock price fall before a
margin call?
(1xP - $1x35)/1xP = 30% P=$50
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20. EXAMPLE AND EXERCISE 2: MARGIN TRADING
X Corp $70
50% Initial Margin
40% Maintenance Margin
1000 Shares Purchased
Initial Position
Stock $70,000 Borrowed $35,000
Equity 35,000
21. EXAMPLE AND EXERCISE 1: MARGIN TRADING
How far can the stock price fall before a
margin call?
(1000P - $35,000)x / 1000P = 40%
P = $58.33
