Margin trading, Financial Management

Margin Trading:

Suppose an investor wants to buy 100 Reliance Energy shares, whose market price is Rs.500. This transaction requires Rs.50,000 but the investor has only Rs.30,000 as bank balance. He can approach a broker who will invest money on his behalf, taking interest for the same. Now he invests 50% of the amount (i.e., Rs.25,000) and the broker puts in the other half on his behalf and buys 100 Reliance shares in his name. Suppose maintenance margin is 40%, and if it falls below 30%, the broker has the right to sell the stock. Now the stock may fall to Rs.410, then the loss is Rs.90 per share. In this case, the loan from the broker is still Rs.25,000 but the investor's own account equity will fall to Rs.16,000. Now his maintenance margin equals 39.02% (Equity Account/Market Value of Holding x 100 i.e., 16,000/41,000 x 100). In this case the broker can ask him for the balance to take the margin to the 40% mark. He has to deposit (41,000 ´ 40% - 16,000) or Rs.400 to maintain the level of 40%.

Now, assume a market crash whereby the Reliance Energy shares fall to Rs.350. The margin loan still remains at what he originally took, i.e., Rs.25,000, but now his equity account falls to Rs.10,000. The maintenance margin has come down to only 28.57% (10,000/3,35,000 x 100). Thus, the investor can sell the shares and recover the balance amount when he is not able to fulfill the margin requirement that newly arose.

Posted Date: 9/10/2012 6:15:24 AM | Location : United States







Related Discussions:- Margin trading, Assignment Help, Ask Question on Margin trading, Get Answer, Expert's Help, Margin trading Discussions

Write discussion on Margin trading
Your posts are moderated
Related Questions
why is agency problem important

Milan Corporation is interested in buying a machine that will cost $50,000, and it will depreciate it on straight-line basis over a 5-year period. The machine is expected to last f

The so-called "cash flow" (net income plus depreciation) is a flow of cash, but is it a flow to the shareholders or to the company? Suppose that net income plus depreciation is

The data on sales performance in LS Company has shown a important downward trend over the last year. The Marketing and Sales Department is blaming the Finance Department for the po


What is the nature of a concessionary loan and how is it handled in the APV model? A concessionary loan is a loan that is provided by a governmental body at below the normal ma

Why does most interbank currency trading worldwide involve the U.S. dollar? Answer:  Trading in currencies worldwide is in opposition to a common currency which has international

Q. Application of concept of TVM Sometime the financial manager has to deal with the varying situation of the decision making where the concept of TVM needs to be applied in th

Tests for Consistency The consistency of the index numbers have been tested over the years. The most important of these tests are: The time reversal test The

If invested 2500 in a bank that pays 1% annually. How long will it take for the funds to double?