By Evelyn Yong | 22 March 2019
Margin financing is a facility extended to investors to borrow funds to buy a broader portfolio of products. Different investors with the different qualification will entitle to the different margin of finance (MOF). The margin is coming from the ratio of outstanding balance against the equity.
MOF= Outstanding Balance / Equity
Outstanding balance means the amount owed after deducting any cash deposit available. The equity means the sum of the value of securities pledged and purchased. An example, 50% of MOF given means the trader has to maintain an equity value of not less than 2 times of the outstanding balance. By using another word, as a short-term loan from a broker firm.
Benefits
Lower Interest Rate
Every borrowing comes with interest charged. However, the interest charged for margin trade is always the lowest compared to personal loan and credit card cash advance. Besides, this is the easiest way to increase your capital without all the paperwork, documents and application fees.
Repayment Flexibility
The repayment on loan and credit card are by a monthly, and your integrity might be affected if fail to pay on time. However, the terms of repayment on the margin debt are flexible, and you should be able to follow on your schedule as long as you do not exceed the margin given.
Increased Returns
MOF is to leverage your investments and to increase the returns when the capital is limited. Some people might experience short of capital to buy some potential stocks so with a margin account; you can borrow the money from the brokerage firm to buy some instruments and get a higher return with hassle-free.
Risks
Leverage Risk
Rather than saying its wrong way to invest, consider it as a calculated risk that will face by margin traders. When the margin trade makes a loss, the investor can experience losses up to 2 times the average. Before creating the maximum margin positions, it is essential to understand this risk and to be willing to accept it or, if not, to avoid margin trading.
Margin Call Risk
When the value of the underlying equity decrease and the outstanding balance exceed the MOF given, a margin call will be received. The investor will be required to add cash or securities to the account to increase the equity. If the investor does not act promptly, the brokerage firm has the right to sell the securities without the investor’s acknowledgement.
Conclusion
While brokers will execute margin call when the account in substantial losses to protect themselves, the investors may suffer losses beyond the margin call and need to pay back the brokers. The investor should set a personal trigger point in every trade to minimise the damage. Margin trade should only happen in assets with significant return potential as the cost of interest on the loan should be counted as part of the costing.