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Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Maintenance Margin

What it is:

A maintenance margin is a limit after which a brokerage firm can make a margin call.

How it works (Example):

How It Works/Example:
A margin account is a loan from a brokerage firm. The loan proceeds are used to make an investment.

Let's assume you want to buy 1,000 shares of Company XYZ for $5 per share but don't have the $5,000 necessary to do so -- you only have $2,500. If you buy the shares on margin, you essentially borrow the other half of the money from the brokerage firm and collateralize the loan with the Company XYZ shares. This original loan amount as a percentage of the investment amount is called the initial margin.

If the value of the Company XYZ shares drops past a certain point, say 25% of the original $5,000 value (or $1.25 per share; this point is called the maintenance margin), the brokerage firm may make a margin call, meaning that within a few days you must deposit more cash or sell some of the shares to offset all or part of the difference between the actual stock price and the maintenance margin.

Why it Matters:

Margin accounts allow investors to make investments with their brokers' money. They act as leverage and can thus magnify gains. They can also magnify losses, and in some cases, a brokerage firm can sell an investor's securities without notification or even sue if the investor does not fulfill a margin call. For these reasons, margin accounts are generally for more sophisticated investors who understand and can handle the risks.

Brokers have maintenance margins because, in our example, they have lent you $2,500 and want to mitigate the risk of you defaulting on the loan. Federal Reserve regulations and the broker's internal policies determine the initial margin and maintenance minimum percentages. Margin accounts must follow a margin agreement, which the investor must sign, as well as regulations imposed by the National Association of Securities Dealers, the Federal Reserve and even the New York Stock Exchange.

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