Margin loans
A margin loan is a loan made by both brokerages (securities companies) and banks to enable investors to buy stocks using borrowed money, or at margin. A simple example shows how this is usually structured. An investor wishes to buy $100000 worth of stock. The lender agrees to lend the $100 000 but also requires the investor to make a $20 000 deposit with the bank. Interest is usually charged on the whole $100 000 but not earned on the deposit. If the value of the stock lent by the margin borrower falls to $90 000 the lender will make a “margin call”, and require the investor to make an additional $10 000 deposit. If the investor is unable to do so, or for some reason cannot be contacted, the
lender has the right to sell stock to the value of $10 000 in the market. When stock markets fall sharply many investors are likely to receive margin calls and forced selling by margin lenders adds further downward pressure on markets.
Borrowing at margin provides investors with gearing and in a rising market will enhance returns. It is a relatively-low risk business for the lenders unless markets fall sharply and liquidity dries up. The actual margin level required is frequently imposed by bank or securities’ regulators.