Investors can buy stocks on margin from a brokerage firm. It allows them to lend money from the brokerage firm and make investments. However, the brokerage firm holds the stock as collateral for the transaction. These margin accounts may come with various requirements set by the federal jurisdiction. These requirements include initial and maintenance margin.
What is the Initial Margin?
The initial margin represents the percentage of an investment's purchase price that investors must cover by cash or collateral. In the US, the current initial margin set by the Federal Reserves is 50%. Therefore, investors must finance half of the stock price that they purchase through a margin account.
Although margin accounts allow investors to trade on the loaned amount, the investor still must cover a portion of it. Therefore, investors with margin accounts must contribute a particular amount of cash to fund a stock or security purchase. In essence, the initial margin is a collateral amount that allows investors to borrow additional finance from the broker.
Once an investor purchases their desired number of shares, they don't need to worry about the initial margin. Therefore, investors only need to satisfy the requirement at the time of stock purchase. After that, investors don't need to maintain the same cash in their account to continue using it. Instead, they have to deal with the maintenance margin.
What is the Maintenance Margin?
Maintenance margin is the minimum equity that investors must maintain in their margin account once they make a purchase. In the US, the current maintenance margin set by the Federal Reserves is 25%. Therefore, once investors pay the initial margin of 50%, they must also hold 25% equity in the margin account for the value of the shares they purchased.
Like the initial margin, the maintenance margin is also crucial for investors using a margin account. It is a rule by which investors must abide at all times. Therefore, as long as an investor holds a security, they must maintain at least the percentage of maintenance margin in their account. Unlike the initial margin, it is not a one-time requirement.
Maintenance margin is crucial for brokers as well. It is a type of security for them to protect against default risks from investors. When investors hold a maintenance margin in their accounts, the broker's risk associated with the margin account reduces. However, if stock prices fall, the risks may go higher for the brokerage firm.
What are the differences between Initial and Maintenance Margins?
The primary difference between both types of margins is the timing. Initial margins are necessary when investors purchase securities. Once they buy them, they don't need to worry about the initial margin. However, they must uphold a maintenance margin in their account at all times when owning investments.
Similarly, the rates for both types of margins vary. Initial margins are higher for most brokerage firms, while maintenance margins are lower. Initial margins limit the maximum leverage for successful stock investments. Any increase in security prices can bring down the leverage. However, any stock that falls drastically can also bring the leverage level down to the maintenance margin.
Conclusion
Investors using margin accounts must satisfy several requirements, including initial and maintenance margins. Initial margins are the percentage of a stock's value that investors must cover with cash or equity. Maintenance margin is the percentage of the value that they must maintain in their margin account after the initial purchase.
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