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What is Margin Funding? Know How it Works and Its Benefits

Home - Finance - What is Margin Funding? Know How it Works and Its Benefits

Table of Contents

Introduction

Many investors keep on coming up with better ways of improving their returns and take advantage of any chance that comes in the process of online trading. Margin funding is one such significant strategy. It can be defined as the borrowing of capital with which to invest in the stock market. In this post, we will discuss what Margin Funding trading is, how it operates and its advantages.

Understanding Margin Funding

What is Margin Funding?

Margin funding is offered by a brokerage firm or financial institutions whereby the investors take money on the basis of the securities purchased. In its essence, it entails the use of securities or cash available in the investors trading account as collateral to borrow more funds. These borrowed funds are used for investing or trading in the stock market. 

Mechanism of Margin Funding

The process of margin funding involves several key steps:

  1. Opening a Margin Account: An investor must open a margin account for intraday trading to procure margin funding. This is different from a regular brokerage account. It not only permits the holding of stocks and other securities, but also allows getting a loan secured by the balance of the account.

 

  1. Collateral Requirement: This type of finance requires the investor to hold a required amount of equity in the margin account which would act as security for the borrowed money. This process is referred to as a margin requirement, which can be defined as a percentage of the total value of the purchased securities.

 

  1. Borrowing Funds: In accordance with the value of the debt security, the brokerage firm extends a credit to the investor to that amount. The quantity that can be borrowed depends on the initial margin that is set by the brokerage firm and this normally ranges between 50% for the acquisition value of the securities.

 

  1. Purchasing Securities: This means that the borrowed funds combined with the investor’s money go into acquiring securities. The total value becomes higher, and it means higher potential for receiving more funds.

 

  1. Maintenance Margin: After the purchase, the investor also has to keep a predefined minimum amount of money in the account, called the maintenance margin. If the account weakens to this level because of the market movement, then a margin call is issued and the investor is to deposit more money or sell some of their securities.

How does Margin Funding work?

Let’s look at an example. 

  1. Initial Investment: An investor is interested in buying stocks and they have a budget of 10,000 INR. The investor can acquire 10,000 more with the help of margin funding. The firm offers funding with a 50 percent requirement of initial margin. 

 

  1. Purchasing Securities: The investor’s capital now is 20,000 INR. If the stocks they purchase appreciate in value by 10 percent, then their investment increases to 22,000 INR.

 

  1. Calculating Returns: Now the investor has 10 percent profit on 20,000 INR investment, which is 2000. Although they borrowed money from the brokerage firm, they do not share this profit. Therefore 1000 INR is a gain that they made through the margin funding route. 

Margin Call

The maintenance margin is an important part of this facility. If the value of the investor’s securities (in the margin account) goes down, resulting in the equity value going below the maintenance margin mark, the brokerage firm initiates a margin call.  The investor is requested to either add funds to their account, or perhaps sell a part of their investments to raise money. 

Conclusion

Margin trading funding helps investors make the best use of their portfolio to increase their returns and acquire more funds. If one gets a good grasp of this concept, it can offer several benefits. However, this is a risky route to take, and one has to be disciplined and sincere to their risk management strategies to avoid losses.