11Finance Exam 3 Outline Chapter 8 Markets and Transactions Trading on Margin Leverage the use of borrowed funds to buy securities related to margin but the two terms are not the same Margin of investor s equity for example an investor makes a 1000 investment of which 750 is his and the remaining 250 is borrowed from the broker the investor in this scenero is using leverage borrowing money to purchase funds however the margin in his account is a of his money that he has investment equity is ownership so it is his personal ownership of the money the percentage margin is the 750 that he invested divided by the total 1000 of the total investment 75 of the 1000 is his money this is the amount of equity that he has in the account associate margin with the of an investors equity margin is the collateral for a broker s loan if you are putting up some of your money and borrowing some of the brokers money but using both yours and his to buy the stock the stock is the collateral for the loan made to you the loan can either be cash or acceptable securities these generally are stocks bonds mutual funds or derivatives we are always going to use cash investors can hold multiple stocks in the margin account with a broker this is their stock or bond or securities portfolio portfolio a group of financial securities the value of the portfolio is the sum of the individual s holdings recognize that your value of your stock holdings is the number of stock shares you have times the price of the stock the price of the stock varies depending on what the price is at a given time This means the value of the portfolio will vary and this is involved in margin so the of equity of an investor has in a given portfolio or stock will vary also Why do people trade on Margin It magnifies gains it increases the size of your returns However if it magnifies gains it also magnifies your losses no free lunch in finance if you have 5000 to invest and you want shares of a stock costing 50 share if you don t trade on margin you can buy 100 shares of stock 5000 50 100 if you trade on 50 margin you can use your 5000 to borrow another 5000 and then you can buy 200 shares of stock you use 100 you have 5000 and you borrowed nothing if you use 50 margin you have 5000 and you borrow another 5000 doubles what you can buy doubles your profits and doubles yours losses Buying on Margin Advantages magnifies your profits Disadvantages magnifies your losses you borrow money and when you borrow money you have to pay interest on your margin loan possible margin calls Rules of Investing in Margin you must trade in a margin account open one with a broker in order to open a margin account you have to have 2000 equity or 100 of your purchase price of the stock that you wanna buy lets you borrow money from the brokerage to use for investments at the brokerage you borrow the brokerage s money and use that to buy securities these securities are the collateral for the money that you borrowed so the broker will buy or sell the securities as you tell them to but they will not release them to you or the money that you get from selling them until their loan is repaid trading in a margin account lets the brokerage safeguard the money that they lend to you this is where margin calls comes in you converted cash into securities and the price of securities varies if I lend you 5000 then you have to pay me back 5000 but if we turn 5000 into 5000 worth of stock the value of that stock is not going to stay at 5000 it will go up and down if the value of the stock gets too low then you will not have sufficient margin or equity in your account as collateral for the loan because the value of your portfolio has fallen and the broker will generally give you a margin call and this will generally allows you to add money or other securities from another account to bring your margin value in your account back up to where it needed to be if you don t do this then the broker will sell sufficient securities in your account to cover the cost of your loan that you have with them when stocks are dropping rapidly they will not give you the margin call so you can not count on the margin call It is the general way things are done but there are times when they wont they don t have to do it margin of investor s equity minimum margin requirement the least amount of margin that you can have in your account initially when you buy stock set by the fed brokers are not permitted to reduce the initial margin requirement lower than this the minimum margin requirement depends on the securities risk for stock its 50 for bonds its 30 the less margin you have in your account the less collateral there is for the loan the riskier the loan is bonds are generally safer than stocks so the minimum margin requirement is lower the brokerage house is allowed to set the margin higher they can make you have greater security against the loanbut they cant let you have less the brokers mimimum margin requirement can vary OTC stocks CANNOT be margined penny stocks can not be listed on any exchange they are so risky that brokers do not consider them to have any value as collateral they wont let you borrow any money against them Types of Margin Required minimum margin set by the fed assuming that the brokerage firm allows you to keep the minimum margin requirement then the federal minimum margin requirement will be the same as the initial margin requirement of the brokerage house initial margin minimum equity an investor must have in his account at the time that you purchase shares of stock Maintenance margin minimum equity an investor must have in his account at all times you cant go below this amount lower of margin than the initial margin the difference between the two is the timing margin call the notice that equity in your account is below the maintenance margin remember that it cannot be any lower than the maintenance margin at any time you have 3 businesses days to get the equity in your account back up to the maintenance margin or enough account holdings are sold to bring it back up restricted margin account when the equity is below initial margin required but higher than maintenance margin if you have a restricted account you cant make any more purchases on margin until your account comes back up to the initial minimum margin requirement However you are allowed to fall as low as the maintenance requirement minimum equity that you have to have at all times …
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