What it is:
Margin debt isobtained from .
How it works/Example:
Buying margin account) to make an .
Let's assume you want to buy 1,000 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 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 . It is margin debt.
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 ), the brokerage firm may make a , meaning that within a few days you must more or sell some of the shares to all or part of the difference between the actual price and the maintenance margin. The does this because it has lent you $2,500 and wants 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.
Getting a margin call means that not only do you have to pay back the original $2,500 of eventually, but you have to pay the margin call. However, if the stock rises from $5 to, say, $15, you've just made $10,000 without all of your own money.
Why it matters:
Margin debt allows investors to makewith their ' . But they can also add to your losses, and in some cases, a brokerage firm can sell your securities without notification or even sue if you do not fulfill a . For these reasons, margin debt is generally for more sophisticated investors who understand and can handle the risks involved.