Margin Calls Made Simple

Dealer members are permitted to provide a maximum loan based on the value of the stock owned or being purchased by the client and limits set by IROC. When the price of a stock changes …

Hi everybody, Andre here at the Coaches Hangout, a spot where our students can come and submit their request, knowing this is where our study coaches hang out virtually of course, and will often leave some helpful content.

Have you ever struggled with a concept in a textbook? And by the time you figured it out you thought to yourself, a textbook sure made that way more complicated than it needed to be. In my opinion this is true of long margin calculations and why you need a SeeWhy Learning study guide.

Dealer members are permitted to provide a maximum loan based on the value of the stock owned or being purchased by the client and limits set by IROC. When the price of a stock changes the textbook requires you to consider up to five different figures, but I’m going to show you a method where you really only need to consider two.

To teach this concept I’m going to use a house analogy. Now full disclosure, I acknowledge I’m going to use ridiculously low numbers for a house, but this makes the math simpler and the concept easier to see. Hopefully I don’t get inundated with calls asking me where on earth can I buy a house for only a hundred thousand dollars? Marco is buying a house for a hundred thousand dollars and a bank told him he can borrow up to 70% of the house value. This means the bank can lend him $70,000 in the form of a mortgage loan. It also means that Marco will have to come up with $30,000 of his own money. This is similar to a margin calculation, pretty simple right? But what if the value of the house or in the case of a stock transaction, the stock price then changes.

Let’s assume that a year later Marco’s house has doubled in value. Obviously I’m exaggerating quite a bit, although in this crazy real estate market perhaps not so much. If the bank is still willing to lend Marco up to 70% of the house value what would that mean for Marco? Well, all we have to do is two simple calculations. Calculate the new maximum loan and then compare it to the original loan. If the maximum loan value has gone up he can borrow more and withdraw money. So if the house is now worth $200,000 and the bank can lend 70% of that value, the maximum loan would now be $140,000. You’ll notice that is $70,000 more than what it used to be, which means Marco could borrow an additional $70,000.

To summarize, all we had to do was recalculate the maximum allowable loan and compare it to the previous maximum loan.

You can use the exact same process for margin calculations on a long stock transaction. The only difference is the terminology will be a little bit different. And instead of the house value you would use the stock value. And instead of using 70% you’ll have to refer to the maximum margin loan table for long positions, which is mandated by IROC, and use whatever percentage the table allows.

Rest assured if you’re working with a SeeWhy Learning study guide we’ll provide you with an easy to use template where we’ll also highlight some subtle nuances, and with a little practice these calculations will become a snap.

Now, depending on the exam you are taking you may have to memorize a long margin table for exam day. So before I let you go I want to give you a few pointers in that regard.

First let’s focus on the right side of the table. Memorize 70, 50, 40, 20, and I bet if you say that 10 times it will stick. 70, 50, 40, 20.

Now let’s focus on the left side of the table. The maximum loan is reserved for stocks that meet certain criteria and are considered eligible for reduced margin. This essentially means the client can borrow more and has to put up less of their own money referred to as their margin requirement.

Notice that the stock must trade for at least $1.50 to qualify for a margin loan. Finally, notice the tiers in between have a spread of 25 cents. If you practice writing this table out you will be amazed at how quickly it will get stuck in your brain, and of course practice will make perfect.

Thanks for dropping by the Coaches Hangout and good luck on your upcoming exam.