What is Margin?
Margin, in the context of investment and finance, holds a critical role as a protective measure for brokers or exchanges against potential credit risks that could arise from investor activities. This credit risk materializes when investors engage in activities such as trading financial instruments with borrowed funds, short-selling borrowed securities, or participating in derivative contracts.
When an investor opts to purchase securities on margin, it entails paying a portion of the asset's price to the broker while borrowing the remainder. The securities held within the investor's brokerage account serve as collateral for the loan. In essence, the margin refers to the initial payment that an investor submits to the broker for the acquisition of the asset.
Moreover, the term 'margin' can also denote the disparity between the selling price and the production cost of a product or service, or it can represent the ratio of profit to revenue. In an adjustable-rate mortgage (ARM) context, the margin stands for the component of the interest rate that supplements the adjustment-index rate.
Margin Explained
Understanding the concept of margin necessitates an acknowledgment of the equity that an investor maintains within their brokerage account. By availing of a margin account rather than a standard brokerage account, investors can engage in 'buying on margin,' leveraging funds lent by the broker to acquire securities. This mechanism empowers investors to procure a greater volume of securities than their account balance would typically permit. The cash or securities within the account serve as collateral for the loan, which incurs periodic interest. Notably, using borrowed funds heightens the impact of losses and gains, thereby amplifying the risks associated with such endeavors.
The strategy of buying on margin can prove advantageous when the investor anticipates generating returns from the investment that outweigh the interest payment on the loan. Illustratively, if a margin account imposes an initial margin requirement of 50% and an individual intends to purchase securities valued at ₹80,000, their margin would amount to ₹40,000, allowing them to secure the remaining funds through a loan facilitated by the broker