Definition: A margin account is a brokerage account that allows the customer to use leverage to purchase securities. This means the account holder can take a loan from the broker to make investments.
What Does Margin Account Mean?
What is the definition of margin account? Margin accounts are set up by brokers to allow their clients to borrow money from them in order to make an investment in the stock market. These accounts are risky because they are collateralized by the client’s equity. This means that any losses the client experiences on the securities he purchases through the loan can affect their own equity, even the one outside the account.
Margin accounts charge an interest rate on the borrowed funds and demand a maintenance margin, which is a fixed percentage of the total account’s equity. This margin is the least amount of money that is required to be available in the account calculated as total equity value minus current borrowed funds.
If the maintenance margin goes below the fixed percentage, the broker can issue a margin call, which means the account holder must provide new funds within a pre-established time frame or the broker can sell some of the securities without the holder’s approval to increase the maintenance margin to adequate levels.
Let’s look at an example and see how margin accounts work.
Example
Mr. Graham owns a margin account at Ocean View Financial, a financial services firm. Right now he has $12,000 invested in the account, but he wants to invest in some stocks that have proven to be very profitable in the past. With this in mind, he asked his broker to borrow an additional $5,000 as leverage to increase his portfolio returns.
Mr. Graham’s broker approved the loan and the funds were deposited in his account. His broker pointed out that Ocean View requires a minimum of 25% as maintenance margin and the company charges a 1% annual interest rate accrued and charged on a monthly basis.
He now has $17,000 available to be invested. Mr. Graham has to keep a minimum of $4,250 in the account as maintenance margin. His current maintenance margin is $12,000. Let’s say his stocks are down 10% the day after this operation. Total equity will go down to $15,300 and the new maintenance margin will be $10,300, which is still higher than the required $4,250.
Summary Definition
Define Margin Accounts: Margin account means a brokerage account that allows the depositors to borrow funds from the bank to invest in the stock market.
