A Margin Call is a demand from a broker to an investor to deposit additional funds or securities into their margin account to bring it up to the required minimum level. This occurs when the value of the investor’s account falls below the broker’s required margin maintenance level due to a decrease in the value of the securities purchased on margin.

Key Aspects of a Margin Call:

1. Margin Account:
   • A margin account allows an investor to borrow money from a broker to purchase securities, using the securities in the account as collateral. This leverage can amplify gains but also increases the risk of losses.
2. Initial Margin and Maintenance Margin:
   • Initial Margin: The percentage of the purchase price that the investor must initially deposit when buying securities on margin. For example, if the initial margin requirement is 50%, the investor must pay 50% of the purchase price with their own funds, and the rest can be borrowed.
   • Maintenance Margin: The minimum account balance that must be maintained after the purchase. If the value of the securities falls below this level, a margin call is triggered.
3. Triggering a Margin Call:
   • A margin call occurs when the equity in the margin account (the value of the securities minus the borrowed amount) drops below the maintenance margin level. This can happen if the price of the purchased securities declines significantly.
   • For example, if an investor buys $10,000 worth of stock on margin with an initial deposit of $5,000 (and borrows the remaining $5,000), and the maintenance margin requirement is 25%, the investor must maintain at least $2,500 in equity. If the stock price falls and the equity drops below $2,500, the broker will issue a margin call.
4. Responding to a Margin Call:
   • The investor must quickly respond to a margin call by either:
     • Depositing Additional Funds: Adding more cash to the margin account to bring the equity back up to the required level.
     • Selling Securities: Selling some of the securities in the account to reduce the amount of the loan and restore the required equity level.
   • If the investor fails to meet the margin call, the broker has the right to sell the securities in the account without the investor’s consent to cover the shortfall.
5. Risks of Margin Calls:
   • Forced Liquidation: If the investor cannot meet the margin call, the broker may liquidate the securities at a potentially unfavorable time, locking in losses.
   • Amplified Losses: While buying on margin can increase potential returns, it also amplifies losses. A small decline in the price of the securities can result in a large percentage loss on the equity in the margin account.
   • Market Volatility: In volatile markets, price swings can trigger margin calls unexpectedly, leading to rapid losses if the investor cannot act quickly.
6. Preventing Margin Calls:
   • Investors can reduce the risk of a margin call by using lower leverage, maintaining a higher equity cushion in their margin accounts, and closely monitoring their positions, especially in volatile markets.

In summary, a margin call is a broker’s demand for an investor to deposit more funds or securities into a margin account when the account’s equity falls below the required level. Failing to meet a margin call can result in forced liquidation of securities, leading to potential losses. Margin calls are a significant risk of trading on margin and require careful management to avoid financial distress.