Initial Margin

What Is Initial Margin?

Initial margin is the percentage of the purchase price of a security that must be covered with cash or collateral while utilizing a margin account. The current initial margin requirement set by the Federal Reserve Board's Regulation T is half. In any case, this regulation is just a base requirement; some equity brokerage firms might set their initial margin requirement higher.

How Does Initial Margin Work?

To open a margin account at a brokerage firm, an account holder first necessities to post a certain amount of cash, securities or other collateral, known as the initial margin requirement. A margin account energizes investors, traders, and other market participants to utilize leverage to purchase securities with a total value that is greater than the accessible cash balance in the account. A margin account is basically a credit extension in which interest is charged on the outstanding margin balance.

Securities in the margin account are paid for with cash advanced to the account holder by the brokerage firm and are designated as collateral. This cycle allows for amplification of likely profits yet in addition amplifies possible losses. In the extreme event that securities purchased in a margin account decline to zero value, the account holder necessities to deposit the full initial value of the securities in cash or other liquid collateral to cover the loss.

Futures and initial margin

For futures contracts, exchanges set initial margin requirements as low as 5% or 10% of the contract to be traded. For instance, in the event that a crude oil futures contract is quoted at $100,000, a futures account holder can enter a long position by posting just $5,000 initial margin, or 5% of the contract value. All in all, this initial margin requirement would give the account holder a 20x leverage factor.

During periods of high market volatility, futures exchanges might increase initial margin requirements to any level they consider fitting, matching the power of equity brokerage firms to increase initial margin levels over those required by Fed regulation.

Initial Margin versus Maintenance Margin

Initial margin is distinct from maintenance margin. The two both connect with the amount of cash versus the amount you can borrow while investing. Nonetheless, the initial margin requirement is the amount of cash or collateral required to really purchase securities; the Federal Reserve Regulation T sets that sum at least somewhere around half of the purchase. At the end of the day, you can't borrow the greater part the price of the investment.

Conversely, the maintenance margin is the amount of equity that must be kept in the margin account going ahead. The base maintenance margin requirement set by Reg T is 25%. That means an investor must keep up with sufficient cash or collateral value in the account to cover 25% of the securities owned.

Maintenance margin guarantees account holders keep up with collateral in the account should the value of their securities fall. A few securities, particularly unpredictable ones, will have higher margin requirements set by brokerages.

Illustration of Initial Margin

For instance, assume an account holder needs to purchase 1,000 shares of Meta, Inc. (META), formerly Facebook, which is quoted at $200 per share. The total cost for this transaction in a cash balance account would be $200,000. Notwithstanding, on the off chance that the account holder opens a margin account and deposits the half initial margin requirement, or $100,000, the total purchasing power will rise to $200,000. In this case, the margin account approaches two-to-one leverage.

Highlights

• Initial margin is the percent of a purchase price that must be paid with cash while utilizing a margin account.
• Initial margin requirements are not the same as maintenance margin requirements, which is the percent of equity that must be retained on a continuous basis in the account.
• Fed regulations currently expect that the initial margin is set at least half of a security's purchase price. Yet, brokerages and exchanges can set initial margin requirements higher than the Fed least.