Investments, tenth edition

Assets

Liabilities and Owners’ Equity

Value of stock

$10,000

Loan from broker

$4,000

Equity

$6,000

 The initial percentage margin is   

Margin 5

Equity in account

Value of stock

5

$6,000

$10,000

5

.60, or 60%  

 If the price declines to $70 per share, the account balance becomes: 

Assets

Liabilities and Owners’ Equity

Value of stock

$7,000

Loan from broker

$4,000

Equity

$3,000

 The assets in the account fall by the full decrease in the stock value, as does the equity. 

The percentage margin is now

   Margin 5

Equity in account

Value of stock

5

$3,000

$7,000

5

.43, or 43%  

 Example  3.1 

Margin 

contributed by the investor; the remainder is borrowed from the broker. The brokers in 

turn borrow money from banks at the call money rate to finance these purchases; they then 

charge their clients that rate (defined in Chapter 2), plus a service charge for the loan. All 

securities purchased on margin must be maintained with the brokerage firm in street name, 

for the securities are collateral for the loan. 

 The Board of Governors of the Federal Reserve System limits the extent to which stock 

purchases can be financed using margin loans. The current initial margin requirement is 

50%, meaning that at least 50% of the purchase price must be paid for in cash, with the 

rest borrowed. 

  If the stock value in Example 3.1 were to fall below $4,000, owners’ equity would 

become negative, meaning the value of the stock is no longer sufficient collateral to cover 

the loan from the broker. To guard against this possibility, the broker sets a  maintenance 

margin.  If the percentage margin falls below the maintenance level, the broker will issue 

a  margin call,  which requires the investor to add new cash or securities to the margin 

account. If the investor does not act, the broker may sell securities from the account to pay 

off enough of the loan to restore the percentage margin to an acceptable level.  

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6/18/13   7:44 PM

Final PDF to printer

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 eXcel APPLICATIONS: Buying on Margin 

 T

he Online Learning Center (  www.mhhe.com/bkm  ) con-

tains the Excel spreadsheet model below, which makes 

it easy to analyze the impacts of different margin levels 

and the volatility of stock prices. It also allows you to com-

pare return on investment for a margin trade with a trade 

using no borrowed funds.