Initial Margin

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21 Aug, 2024

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Initial Margin Meaning

Initial margin refers to the equity to be contributed by the investor trading on margin to the margin account, and it is expressed as a percentage of the total purchase price. It helps distinguish the borrowing capacity of the margin account holder.

The authorized regulatory organization sets the minimum value required to be paid in cash to purchase margin securities. For example, in the United States, according to Regulation T of the Federal Reserve Board, the amount should be a minimum of 50% of the total purchase price of margin securities. Hence, investors can borrow half of the total purchase price.

Initial Margin Meaning

Initial margin refers to the minimum amount required to deposit in the margin account for purchasing securities.
It is expressed as a percentage of the total purchase price. It may vary with the brokerage firm and points to the borrowing capacity of the margin account holder.
In the United States, according to Regulation T of the Federal Reserve Board, the requirement is a minimum of 50% of the total purchase price of margin securities. The brokerage firms can follow the same or increase it.

Initial Margin Explained

Initial margin is an important attribute of every margin account. In margin trading, the margin account representing the brokerage account helps the investors to borrow from the brokerage entity to purchase securities, and such securities are termed margin securities. For investors to utilize this borrowing capacity and brokerages to accept margin accounts as collateral, certain balances are associated with maintaining the margin account.

The minimum value of these balances determined by the Federal Reserve Board or self-regulatory organizations (SROs) such as FINR is portrayed in the margin agreement between investor and brokerage entity. It starts with attaining the minimum margin requirement before trading on margin starts. For example, in the United States, the investor has to deposit $2000 or 100 percent of the purchase price, whichever is less to attain the minimum margin. It is followed by the initial margin requirement that is trading by providing 50% of the purchase price in cash and the remaining 50% financed through borrowing from the brokerage entity.

Other important requirements are maintenance margin and variation margin. The maintenance margin is the minimum equity amount that an investor must always maintain in their account. So, suppose the equity value falls below the maintenance margin requirement. In that case, the firm issues a margin call to make the investor deposit the amount required to increase the equity value sufficient to meet the maintenance margin. This amount is the variation margin. This scenario also adds a point to the initial margin vs. variation margin. Brokerage firms have the right to establish their own margin rules, as long as they comply with minimum requirements formed by the authorities like FINRA.

The basic formula is:

Initial margin = Initial margin requirement set by the authority * purchase price

In the United States, based on the Regulation T of the Federal Reserve Board, the requirement is 50%, then,

Initial margin = 50% * purchase price

Calculation Examples

To better understand the initial margin calculation, consider the following example.

Price per share: The shares of a stock an investor wants to buy are trading for $20 per share
Number of shares: The number of shares the investor wants to buy is 100
Total price: $20 x 1000 = $20,000
The margin requirement is 50% of the total price: 50% $20,000= $10,000

Hence, the investor can borrow only the amount remaining after the margin requirement. The margin requirement can differ from one brokerage firm to another.

Let's consider another example. Daniel purchased the shares of ABC Inc by investing $10,000 cash and $10,000 borrowed on margin. Hence the total purchasing price is $20,000, and the equity value in the margin account is $20,000. If the ABC Inc. stock value increased by 10% the market value of equity will rise to $22,000 (adding 10% of $20,000) giving a 20% gain on original investment of $10,000 ($2000/$10,000). In this case, the investor benefitted from a bullish environment, but on the other hand, if the stock prices decline, the investor experience losses.

Initial vs. Maintenance Margin

Initial Margin	Maintenance Margin
Meaning: It is the amount required to deposit in the margin account for purchasing securities. It ascertains the amount an investor can borrow to initiate the trade.	Meaning: It is the minimum amount of equity to be maintained in the margin account.
Initial requirement: The requirement is to be satisfied before initiating the trade.	Maintenance requirement: Its significance emerges after the purchase of margin securities.
Minimum value: 50% of the purchase price. The Federal Reserve Board sets the minimum, and brokerage firms can use the same or a higher requirement.	Minimum value: 25% of the market value of the margin securities, and brokerage firms can use a value greater than 25% as a maintenance requirement.
Noncompliance: Disrupt the trade.	Noncompliance: If the market value of margin securities falls below the maintenance margin, the brokerage firm issues a "margin call" to demand the user increase the equity in the account.

Frequently Asked Questions (FAQs)

What is the initial margin in futures?

In futures, it means the amount charged by the stock exchange to initiate a futures position. It is only done through a margin account created with the stock exchange as per the margin regulations. It represents 3% to 12% per contract's notional value. In contrast, the initial margin requirement for securities, in general, is approximately 50%.

What is the initial margin example?

Consider an investor engaged in margin trading who purchased shares worth $10,000. The investor paid a margin of $5,000 in cash and financed the balance amount of $5,000 required by borrowing from the brokerage firm. It indicates that 50% of the purchase price is the minimum amount necessary to do the trading.

What is the purpose of the initial margin?

It is an important element in margin trading. Primarily it initiates the leveraged trading process enabling the opening of larger positions using minimum capital from the investor end. In addition, it acts as collateral to the brokerage firm, and the investors benefit by having increased purchasing power since they can buy more securities which otherwise not affordable.