Question

You purchase shares with a market price of $60 using an 80% margin requirement. If the maintenance margin is 30%, before you would have a margin call the market price could fall to? The answer is $17 but I need specific steps on how to solve this

Answer 1

$17

Step-by-step explanation:

A margin requirement refers to the percentage of marginable securities which an investor is required to pay for using cash from his own pocket. Therefore, the remaining percentage is is a margin loan percentage.

Since margin requirement in the question is 80%, it implies that the remaining 20% is a percentage of margin loan. We therefore have:

Cash payment = $60 × 80% = $48

Margin loan = $60 × 20% = $12

Maintenance margin refers to the the least equity amount an investor must have in his account. Whenever the equity amount falls below the maintenance margin requirement (MMR), there will be a margin call which requires the investor to deposit additional cash.

From the question, the level at which the price could fall to trigger a margin call can be calculated as follows:

Market price level = Margin loan ÷ (1 - MMR) .......................... (1)

Where,

MMR = Maintenance margin requirement = 30% = 0.30

Substituting for margin loan and MMR in equation (1), we have:

Market price level = $12 ÷ (1 - 0.30) = $12 ÷ 0.70 = $17.14

Market price level = $17 approximately

Therefore, the market price could fall to $17 approximately before a margin call could be triggered.