Margin loan is a term used in capital market. Investors buy securities with cash borrowed from a broker, using other securities as collateral.Investors previous securities serve as collateral for the loan. Usually margin loan provided to investors is equal the value of his previous securities.
The loan ratio may be 1:1 or 1:.5 Depends on rules and regulation in brokerage house.It’s a simple math. The difference between the value of the securities and the loan, is initially equal to the amount of one’s own cash used. This difference has to stay above a minimum margin requirement, the purpose of which is to protect the broker against a fall in the value of the securities to the point that the investor can no longer cover the loan.
Investors can enjoy better performance by using different sorts of margin loan like current liquidating margin, variation margin, premium margin and additional margin. It, s absolutely depend on investors how he manages his margin loan. You have to think about some risk factors associated with margin loan. Sometimes it can be disadvantageous to investors. If market is bullish then o key but in a bearish market margin loan is an additional burden. Because you have to pay interest against loan. And your loan is margin is higher than your value of securities then broker has the right to liquid your securities to adjust the loan.
Margin loan gives you leverage. You can more securities with less money. Let’s go with an example. Suppose Tom goes up $20 per share giving you a total unrealized gain on the stock of $2,000. If you had originally paid in full for the stock with $8,000 of your own money, your percentage gain given this $20 per share increase would be 25% ($2,000 divided by $8,000). However, because you used margin and put up only 30 percent of the total purchase price, your percentage gain is ($2,000 divided by $2400) or 83%.
Another benefit is the ability to take a margin loan and withdraw funds using the excess margin or buying power in your account. In addition interest paid on margin loans is tax deductible.
Leverage has also demerits. If instead of rising $20 per share, Tom fell by $20 share, all of the calculations we just talked about would be turned around. Your percentage loss in the margin account would be 83% compared to only 25% in a cash account. In addition, there are circumstances where your account could be liquidated.