Definition
The term initial margin refers to the portion of the purchase price the investor must pay when buying securities on margin. Initial margin thresholds are enforced by brokers and established by the Federal Reserve Board.
Explanation
When buying securities, it is possible for the investor to borrow funds from a brokerage firm to pay for a portion of the purchase price. The investor's margin, or margin requirement, represents the funds the trader must provide to support their investment position. Regulation T of the Federal Reserve Board governs margin requirements and states the initial margin for stock is 50%.
If the price of the securities declines, the investor must ensure they maintain sufficient equity in the position, which is referred to as maintenance margin. If the investor's equity falls below this second threshold, a margin call will be made by the broker to the investor.
Example
An investor would like to buy 1,000 shares of Company ABC common stock at a price of $60.00 per share on margin. The initial margin provided by the investor is 50% of the purchase price, or $30,000. The remaining funds used to purchase the securities are supplied by the brokerage firm, essentially providing the investor with a loan. All gains associated with the investment would flow only to the trader. In the same manner, losses associated with these securities are the investor's responsibility.
Related Terms
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