What is Financial Margin: Margin refers to the money that an investor borrows from the brokerage firm to buy an investment. It helps a trader to own a more massive (in terms of price) asset by paying a small amount in return.
It can also be defined as the difference between the amount of loan from the broker and the total amount present in the investor’s account.
The term “Buying on margin” refers to an act of borrowing or acquiring money to purchase securities. This method includes purchasing an asset by paying only a small percentage of the total value of an asset and borrowing the rest part from the broker or banking institutions. In such a case, the broker plays the role of the lender and the securities in the trade’s account as collateral.
In a general finance context margin refers to the difference between the cost of production and selling of the price of service or asset. One can say it is the ratio or gain to revenue.
Understand the Financial Margin
The term “to buy on margin” or” to margin” means to borrow a portion of money from a broker. For purchasing the security, you need a margin account rather than a standard brokerage account. Now the question arises what a margin account is?
It is a type of brokerage account in which the financer lends or deposits the money that can be used by a finance seeker to buy the required asset. It enables a trader to purchase security from a brokerage account rather than with his balance account.
Making use of margin is similar to using the securities or current cash already present in your account (as collateral) for a loan. One has to pay periodic interest on the collateralized loan. When a trader borrows leverage or money, the losses and profits come hand in hand. Either you lose on a particular deal or gain.
Margin investment can prove to be advantageous, especially in the case where the investor predicts a higher rate of return on the expense than the payment of interest on the loan.
For instance, if you want to purchase an asset worth $10,000, and the initial margin requirement for a margin account is 60%, then the value of your margin would be $6,000. You can open a trade by paying just $6,000 as a margin and borrowing the rest money from your broker (broker choice entirely depends on you).
Uses of Margin
1. Accounting Margin
Margin in business accounting refers to the difference between expenses and revenue, where companies typically track net profit margins, operating margin and gross profit margins.
The gross profit margin calculates and signifies the relationship between the cost price of goods sold and the company’s revenues from this.
Operating profit margin considers two things first, operating expenses, and other is COGS (cost of goods sold). It compares these two values with the revenue.
Net profit margin takes all interest, taxes and expenses into account.
2. Margin in Mortgage Lending
For an initial stage or period Adjustable-rate mortgages offer a determined or fixed interest rate. After a particular time, the rate adjusts. To determine this new rate of interest, the bank adds leverage value to a standard index. Throughout the loan life, this margin remains the same in most cases, but the index rate keeps on changing.
For this consider an example of a mortgage. Assume the adjustable-rate margin for this contract as 4%. Now, it is indexed with the standard Treasury Index. If this index is 6%, the interest rate on the contract is 4% margin plus the 6% index rate. The aggregate of this will be 10%.
Types of Margin Requirements
- Current Liquidating Margin– If positions are liquidated at present then-current liquidating margin reflects the value of securities position. In other words, it is the money needed to buy back in case of a short-selling position and considering long; it is the money they can raise by selling.
- Additional Margin– It refers to the fall in the value of a position on the given trading day. In the worst case, it is calculated by using potential loss.
- Portfolio Margins and SMA has different rules for regulatory margin requirements in NYSE and U.S.
- Premium Margin– It refers to the amount required to close out an option position. It helps to cover the risk (credit) associated with a specific position. In the case of short selling a stock, the premium will be the amount used to close the trade.
- The variation margin or mark to market– The amount or value of a fund required to ensure the level of financial margin in trading is known as variation margin. It depends on some factors including the type of asset, market conditions and movements in the market.
Bottom Line – Financial Margin
Margin refers to the total equity a trader has in his brokerage account.
So, it is beneficial to investors who wish to trade a higher value asset by investing just a portion of the total money of trade.
Before jumping directly into business, one should play smart by learning these kinds of fundamental terms because little things like margin can turn the table of trade for you.