Margin Call

Submitted by Jim Thesiger on 25 September, 2010 - 16:20

When the balance of a margin loan surpasses the loan limit by more than the buffer, this is when the margin call gets triggered. Say for example, a trader has invested about $200,000 in the ASX where $50,000 was self-financed and rest of the money was borrowed. In that case LVR is going to be 75%.

Now if the portfolio loses its value and slides down to $180,000 from $200,000 then that LVR will be exceeded and the margin call will get activated. You can calculate the LVR by dividing the amount of loaned cash by total value of the trader’s portfolio. So from that we get, 150,000/180,000 = 83.33%.

Here we can see that the LVR has surpassed the permissible LVR (75%). This means the trader is now standing within the territory of margin call.

Standing inside the Territory of Margin Call: What can be done?

Now that the trader has the margin call activated, what are the options available out there for a trader to deal with it? Well one option can be injecting additional fund or stocks in the trader’s account to reduce the amount of loan. Or, the trader may consider selling off stocks to push the LVR down to an acceptable level.

It is important for a trader to keep in mind that if none of these steps are taken within 24 hours then the margin lender will intervene and take necessary measures on behalf of the investor. In that case, a certain amount of shares will be sold from the portfolio to make sure that the LVR has moved back to its actual value.

Some Additional Factors that may trigger Margin Call

It is to be mentioned that sliding share price is not the only reason for which traders may find themselves in the territory of the margin call. It can also happen if the margin lender removes those stocks from their approved lists or lowers the LVR significantly. In such cases, an investor will have to inject additional shares or cash into the selling stock or account as quickly as possible to meet the reduced LVR. The LVR will fall down to zero for certain stocks that are removed from the approved list of the margin lender.

In some extreme cases you may find some investors offloading shares from their portfolio during times when those stocks are wallowing at a low. Sometimes the lower value of certain stocks may lead to their removal from the approved list or reduced LVRs as the margin lender might consider investments on these shares too risky. This is why an investor needs to analyse the entire investment plan carefully to make sure that s/he has a clear idea about what can happen if a stock loses its value in the market and what options are available there to deal with the situation.

It can be said that depending on loans for trading has several drawbacks. As we have seen here that, in such cases an investor does not have to deal with the uncertainties of the market only but in addition to this need to keep an eye on the activities of the margin lender too as the actions taken by the lender can have significant impact over the trader’s investments. This can make life more difficult for a trader.

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