The term "margin" refers to a brokerage firm making a loan to a customer using securities held in the customer's account as collateral for the loan. There are two basic reasons for a customer to use margin. The most common is leveraged trading, allowing the purchase of a greater number of shares on margin than would be possible on a cash only basis. When successful investments are made, margin increases the gains achieved. However, when poor investments are made, the use of margin also magnifies the losses. Thus margin is not appropriate for all investors. Investors with insufficient skill or lacking the temperament that leveraged trading demands should not use margin.

The second reason for utilizing margin is to take advantage of the lower interest rates charged on margin loans than almost any other type of loan. A typical example of this would be a customer who has $40,000 worth of fully paid for securities in his account that buys a new boat for $20,000. If he borrows the money to purchase the boat from his bank, he will typically pay several points over the prime lending rate. If he simply borrows the money from his broker, he will typically pay less than the prime rate, with no loan application to deal with and with very flexible repayment terms.


The rules, regulations and requirements regarding margin accounts come from three sources:

1. The Federal Reserve Board sets margin requirements as part of monetary policy. These are collectively known as FED REQUIREMENTS.
2. Stock exchanges also set margin requirements that their member firms are required to observe, and when the exchange setting the requirement is the New York Stock Exchange (NYSE), most or all firms observe the requirement, whether or not they are a NYSE member firm. These are collectively known as EXCHANGE REQUIREMENTS.
3. Most brokerage firms also set their own margin requirements more stringent than those of the Federal Reserve in order to limit risk, much as lending practices vary from bank to bank. These are collectively known as HOUSE REQUIREMENTS.

Brokerage firms make money on margin accounts from the interest charged on the loans and also from higher commissions on the larger transaction sizes that leverage allows. However, lending money carries risks for the brokerage firm similar to the risks that banks face when lending, i.e.: the borrower may default on the loan.

Since margin loans (represented in customer accounts as debit balances) are always secured by the securities held as collateral, the real risk is that the securities held in the margin account will decline in value to a point where they are worth less than the loan balance. True, the margin agreement always makes the customer legally liable for the balance, but some customers are unable or unwilling to pay for something they know has no value to them, thus the best preventive medicine that a firm can employ is to never let customers have a debit balance in their accounts that exceeds the liquidation value of their securities, a condition referred to as an "unsecured debit" in an account.

When establishing a new margin account, the first requirement that must be met comes from the New York Stock Exchange (NYSE), but is universally applied to securities, regardless of whether they trade on the NYSE or whether the firm is a NYSE Member Firm. The NYSE requires brokerage firms to demand that investors deposit a minimum of $2,000 in either cash or equity (paid for marginable securities) in order to open a margin account. This means that if you want to purchase $3,000 in stock, you will have to deposit $2,000 of your money in order to borrow the remaining $1,000. This in an example of an exchange requirement, and is an on going maintenance requirement for a margin account. This means that the value of the customers equity can never fall below $2,000 in a margin account.

A margin account must always have $2000 in account holder equity to use margin provisions.

A new purchase in a margin account is also subject to the initial requirement set by the Federal Reserve. This is the minimum down payment required to buy stock on margin. The current initial requirement is 50%. Thus, an investor wanting to purchase $10,000 worth of stock in his margin account must deposit at least $5,000 worth of equity into the margin account. This is an example of a Fed requirement.

Anyone who has taken accounting knows the basic accounting equation:

Equity = Assets - Liabilities

For margin investing, this equation changes slightly to:

Equity = Market Value - Debit Balance

Stated another way, the equity in a margin account is equal to what the securities could be sold for ( the market value) less the amount of money borrowed on margin (the debit balance).

The account represented by the equation above holds securities with a market value of $200,000. The investor has borrowed (and therefore owes the brokerage firm) $100,000 (the debit balance). Subtracting the amount borrowed from the value of the securities gives the investor's equity of $100,000.


Let's begin with the example of a newly opened margin account where the investor has signed all the paperwork but has not yet sent in any money. For the first trade in the account, the investor buys 100 shares of ABC at $75 per share.

Since the investor has not as yet paid for the purchase, his equity is zero, and he owes the brokerage firm the entire purchase price. All funds have been advanced on his behalf by the brokerage firm. At this point, the account has a margin call of $3,750.00, which is 50% of the purchase price (remember the 50% initial requirement ?). Since this margin call comes by way of the Federal Reserve requirement, it is also referred to as a Fed Call. The investor must send in at least this much.

The investor sends in $5,000, which is more than the minimum amount required.

The deposit of $5,000 reduced the debit balance in the account to $2,500 ($7,500 - $5,000). The equity in the account is now $5,000.


A true "margin call" may be issued when an investor establishes a new long or short position. Although they are commonly called margin calls, the type of call issued when the equity in an account falls below a certain required level is actually a maintenance call. These will be covered shortly but right now we are only concerned with the initial minimum deposit requirement (down payment). The Federal Reserve currently requires that 50% of the market value of any new purchases or short sales must be deposited in a new margin account.

An established account may have sufficient buying power to satisfy all or part of the requirement. If sufficient "buying power" is available, issuing a margin call may not be required.

Proceed to the next lesson, SMA (the Special Memorandum Account) and Excess Equity.