Margin Call

Equity in a margin account is the market value of the positions minus the amount borrowed from the broker. The loan balance is essentially fixed (it grows slowly with accrued interest), so every dollar of price movement flows directly into equity. That asymmetry is what makes leverage dangerous: a position financed 50 percent with borrowed funds loses equity at twice the percentage rate of the underlying security.

The maintenance margin requirement is stated as a minimum ratio of equity to current market value. As prices move against the investor, the numerator shrinks while the denominator shrinks by the same absolute amount, so the ratio deteriorates faster than the price. When the ratio pierces the maintenance threshold, the account is deficient and the broker issues the call. Restoring compliance requires either depositing cash or marginable securities, or closing part of the position, which reduces both the loan and the exposure.

For a long position, set equity per share equal to the maintenance percentage of price and solve for price. Equity per share is the current price minus the borrowed amount per share, and the borrowed amount equals the purchase price multiplied by one minus the initial margin percentage. The result: the trigger price equals the purchase price times the quantity one minus initial margin, divided by the quantity one minus maintenance margin.

A short sale reverses the arithmetic. The account holds the short-sale proceeds plus the initial margin deposit as assets, and owes the current market value of the borrowed shares. Rising prices destroy equity. The trigger price equals the short-sale price times one plus the initial margin percentage, divided by one plus the maintenance margin percentage. Because a short position's loss is theoretically unbounded, the equity cushion can disappear far faster than on the long side.

In the United States, Regulation T sets the initial margin for equities at 50 percent, while exchange and FINRA rules impose a maintenance minimum of 25 percent for long positions and higher levels for shorts, particularly in low-priced stocks. Brokers routinely apply stricter house requirements, and they may raise them without notice on concentrated, illiquid or volatile names, effectively manufacturing a margin call without any price move.

Derivatives markets operate differently but on the same principle. Futures accounts are marked to market daily, with variation margin settled in cash each session, so deficiencies surface within hours rather than accumulating. Because forced liquidations push prices further in the adverse direction, margin calls are procyclical: a wave of deleveraging can propagate across correlated positions and across brokers, converting an idiosyncratic drawdown into a market-wide liquidity event.

Level I questions expect fluent computation of three quantities. First, the leverage ratio, which is one divided by the initial margin percentage and tells you how a given percentage price move scales into equity return. Second, the margin call trigger price for long and short positions. Third, the total return on a leveraged position, which requires netting margin interest on the loan, dividends received (or, for a short, dividends owed to the lender), and any commissions, then dividing by the investor's own capital committed rather than the full position value.

Candidates should also be able to state the consequences of non-payment: the broker may liquidate at its discretion and without the investor's consent, and the investor remains liable for any residual debit balance after the sale.