Buying On Margin
Buying on margin occurs when an investor buys an asset by borrowing the balance from a bank or broker. Buying on margin refers to the initial payment made to the broker for the asset—for example, 10% down and 90% financed. The investor uses the marginable securities in their broker account as collateral.The buying power an investor has in their brokerage account reflects the total dollar amount of purchases they can make with any margin capacity. Short sellers of stock use margin to trade shares.
Definition: Buying on margin refers to the practice of investors borrowing funds from a bank or broker to purchase assets. Typically, investors only need to pay a portion of the initial payment for the asset (e.g., a 10% down payment), with the remainder financed through borrowing. The securities in the investor's brokerage account serve as collateral for the loan.
Origin: The concept of buying on margin originated in the early 20th century in the U.S. stock market, where investors began borrowing funds to expand their investment scale. The 1929 stock market crash was partly due to the excessive use of margin buying, which significantly increased market risk.
Categories and Characteristics: Margin buying can be divided into two main types: 1. Margin Trading: Investors use the securities in their brokerage account as collateral to borrow funds. 2. Leverage Trading: Borrowing funds to increase the investment amount, thereby amplifying both gains and risks. Characteristics include: a. Amplified Gains and Risks: Margin buying can increase potential gains but also potential losses. b. Interest Payments: The borrowed portion requires interest payments, increasing investment costs. c. Margin Requirements: Investors must maintain a certain margin level, or they may face a margin call.
Specific Cases: 1. Case One: Xiao Ming has 10,000 yuan and borrows an additional 90,000 yuan through margin buying, totaling 100,000 yuan to purchase a stock. If the stock price rises by 10%, Xiao Ming's total assets become 110,000 yuan. After repaying the 90,000 yuan loan and interest, Xiao Ming's profit is 10,000 yuan, yielding a 100% return. 2. Case Two: Xiao Hong has 20,000 yuan and borrows an additional 180,000 yuan through margin buying, totaling 200,000 yuan to purchase a stock. If the stock price falls by 10%, Xiao Hong's total assets become 180,000 yuan. After repaying the 180,000 yuan loan and interest, Xiao Hong's profit is 0 yuan, or she may even incur a loss.
Common Questions: 1. What are the risks of margin buying? Margin buying amplifies both gains and risks, and market volatility can lead to significant losses. 2. How to avoid a margin call? Investors should closely monitor their margin levels and promptly add funds or reduce positions as needed.
