Buying securities on margin can be advantageous for an investor. Profit is magnified if there is a gain, and losses are as well if there is a loss. Margin is much like buying stocks on loan. An investor borrows funds from a brokerage firm to purchase stocks and pays interest on the loan. The stocks themselves are held as collateral by the brokerage firm.
There are many set rules the brokerage firm and the investor must follow. The Federal Reserve Board sets the rules for margin requirements. There is an initial margin requirement and a maintenance margin requirement.
The Federal Reserve Regulation T states that an initial margin must be at least 50%, although many brokerage firms set their requirements higher at 70%. This means that an investor must pay 50%, or more if the brokerage firm requires it, of the security's purchase price up front. The brokerage firm must provide the remainder of the funds.
After the initial purchase, a maintenance margin is set. Regulation T sets this requirement at 25%, although many brokerage firms require more, such as 30 to 40%. A maintenance margin at 25% means that there must be a minimum amount of equity valued at 25% or more of the total value of the margin account.
If one or more securities in the account falls below a certain price and these requirements are not met, the investor receives a margin call, sometimes known as a "fed call." In this situation, a brokerage firm then requires the investor to deposit funds to bring the account back up to the minimum maintenance requirement.
