On United States futures exchanges, margins were formerly called performance bonds.
The broker usually has the right to change the percentage of the value of each security it will allow toward further advances to the trader, and may consequently make a margin call if the balance available falls below the amount actually utilised.
In any event, the broker will usually charge interest and other fees on the amount drawn on the margin account.
If the cash balance of a margin account is negative, the amount is owed to the broker, and usually attracts interest.
The net value—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.
[2] When the stock market started to contract, many individuals received margin calls.
[2] However, as reported in Peter Rappoport and Eugene N. White's 1994 paper published in The American Economic Review, "Was the Crash of 1929 Expected",[3] all sources indicate that beginning in either late 1928 or early 1929, "margin requirements began to rise to historic new levels.
For example, Jane buys a share in a company for $100 using $20 of her own money and $80 borrowed from her broker.
The initial cash deposited by the trader, together with the amount obtained from the sale, serve as collateral for the loan.
This difference has to stay above a minimum margin requirement, the purpose of which is to protect the broker against a rise in the value of the borrowed securities to the point that the investor can no longer cover the loan.
When the total value of the collateral dips below the maintenance margin requirement, the position holder must pledge additional collateral to bring their total balance back up to or above the initial margin requirement.
The broker may at any time revise the value of the collateral securities (margin) after the estimation of the risk, based, for example, on market factors.
To do so, the investor must either pay funds (the call) into the margin account, provide additional collateral, or dispose of some of the securities.
If a margin call occurs unexpectedly, it can cause a domino effect of selling, which will lead to other margin calls and so forth, effectively crashing an asset class or group of asset classes.
This situation most frequently happens as a result of an adverse change in the market value of the leveraged asset or contract.
If the initial margin requirement were 60%, then stock equity = $50 × 1,000 = $50,000 and leveraged dollars (or amount borrowed) = $50,000 × (100% − 60%) = $20,000.
If the maintenance margin changed to 25%, then the customer would have to maintain a net value equal to 25% of the total stock equity.
The margin-equity ratio is a term used by speculators, representing the amount of their trading capital that is being held as margin at any particular time.