9.3.1 Long Margin Accounts

Overview

Long margin accounts are financial structures that allow investors to take positions in securities by borrowing funds from dealer members. The amount of credit extended to clients is strictly regulated by the Investment Industry Regulatory Organization of Canada (IIROC) to ensure proper margining of client accounts.

IIROC Regulations

The amount of credit that a dealer member may extend to its clients for the purchase of securities, both listed and unlisted, is closely monitored by IIROC. Regular spot checks and field examinations are conducted to ensure compliance.

Maximum Loan Values

Maximum loan values for listed equities are shown in Table 9.1:

Note: These are IIROC maximums; firms may set more stringent requirements.

Margin Calculation

When a long position is established on margin, several factors need to be estimated:

• Initial Purchase Price: The total cost of buying the securities.
• Loan Amount: The maximum amount that the dealer can lend (based on market value).
• Client’s Margin: The amount financed by the client.

Examples and Scenarios

Let’s walk through an example. Assume a client buys 1,000 shares of ABC Company at $25 per share, on a margin with a loan rate of 50%.

Example Calculation:

• Total Cost: 1,000 shares * $25/share = $25,000
• Loan Amount: 50% * $25,000 = $12,500
• Client’s Margin: $25,000 - $12,500 = $12,500

We now analyze two scenarios: a price decrease and a price increase.

Scenario 1: Margin Call (Price Drops to $22)

• New Loan Amount: 50% * ($22 * 1,000) = $11,000
• New Margin Requirement: $25,000 - $11,000 = $14,000
• Margin Deficiency: $14,000 - $12,500 = $1,500 (Margin call issued)

Scenario 2: Excess Margin (Price Increases to $29)

• New Loan Amount: 50% * ($29 * 1,000) = $14,500
• New Margin Requirement: $25,000 - $14,500 = $10,500
• Excess Margin: $12,500 - $10,500 = $2,000

This excess can be used to purchase additional securities or withdrawn from the account.

Risks Associated with Margin Accounts

Market Risk

Borrowing to buy securities magnifies outcomes. If prices rise, profits soar, but if prices fall, losses worsen.

Loan and Interest Requirements

Clients must pay interest on borrowed funds and will need to pay back the loan irrespective of whether the security’s value increases or decreases.

Potential Margin Call

If the client fails to meet a margin call, the dealer may sell the securities without notice, causing potential losses to the client.

Protective Measures

Clients are advised to maintain additional funds or securities in their accounts to provide a buffer against price fluctuations and reduce the likelihood of a forced sale by the dealer.

Frequently Asked Questions (FAQs)

What is a Margin Call?

A margin call occurs when the equity in a margin account falls below the broker’s required level. The client must deposit additional funds or securities to meet the margin requirement.

How is the Loan Amount Determined?

The loan amount is usually a percentage of the security’s market value, determined by IIROC regulations. Dealer members may set more stringent requirements.

What Happens if I Can’t Meet a Margin Call?

If the client cannot meet a margin call, the dealer member can sell the securities in the account without client notification to cover the shortfall.

Glossary

Margin

The amount of funds put up by a client to cover the direct cost of transactions or maintain invested securities.

Margin Call

A demand for additional capital or securities to be deposited into the margin account when it falls below the required maintenance level.

Loan Amount

The funded percentage of the market value of securities that a dealer or broker lends to the client.

Excess Margin

The amount by which a client’s equity in a margin account exceeds the required margin level, allowing for additional purchases or withdrawals.

Market Risk

The potential for financial loss due to fluctuations in the market prices of securities.

Key Takeaways

1. Understanding: Grasp the core concepts of margin accounts and their regulations by IIROC.
2. Calculation: Capability to calculate margin, loan amounts, and recognize margin calls and excess margin scenarios.
3. Risk Management: Recognize the risks associated with leveraging and margin investing.
4. Practical Insight: Identify real-world scenarios of both favorable and unfavorable fluctuations in market prices and their impact on margin positions.

Stay vigilant in monitoring market conditions, adhere to margin requirements, and employ risk management strategies to ensure balanced and well-managed investments in long margin accounts.