CFA CFA Level 1 Margin Call Question

Margin Call Question

  • This topic has 7 replies, 3 voices, and was last updated Jul-17 by Chevalier.
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    • convexity
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      Hey everyone,

      It’s unclear to me about what happens when the margin in an account sinks bellow the maintenance level. As I understood it, when a margin call comes, you need to add enough equity to get the account back to initial margin levels. I had a mock exam where the solution said that upon receiving a margin call, you only need to get the account back to only maintenance margin levels. I should clarify that this is for margin stock investments, not futures. The Equity/FI book doesn’t clarify when margin calls are addressed on page 43.

      Thank you

    • Sophie Macon
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      Hi @convexity, I remember getting confused with this too.

      When you get a margin call, you only need to get it back to maintenance levels, which is normally lower than the initial margin level. But if the amount goes BELOW maintenance levels, you need to bring it up to initial margin requirements.

    • convexity
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      But doesn’t a margin call occur only if your account margin drops bellow the maintenance level? So wouldn’t that mean you always need to fill it back up to initial margin when there’s a margin call?

    • Sophie Macon
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      No that’s may not be necessarily true @convexity. Margin call occurs when the price dips below Po * [ ( 1-IM ) / ( 1- MM) ], assuming a long position.

      where Po is the initial purchase price, at which the transaction is initiated, IM = initial margin, MM= maintenance margin

    • Chevalier
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      Now I get confused ^^

      Say Po is 100, IM is 50%, MM is 25%

      As I understand it, a Margin call occurs, when the price dips 66,7. Than my maintenance margin is 16,7 (66,7 * 0,25) and the funds in my account are also 16,7 (50 – 33,3).

      In case I only have to provide MM if the price dips (but not goes beyond MM), I don’t need to provide any additional funds. Where is my mistake?

    • convexity
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      No that’s may not be necessarily true @convexity. Margin call occurs when the price dips below Po * [ ( 1-IM ) / ( 1- MM) ], assuming a long position.

      where Po is the initial purchase price, at which the transaction is initiated, IM = initial margin, MM= maintenance margin

      I think that saying there is a margin call when price falls bellow Po * [ ( 1-IM ) / ( 1- MM) ] is exactly equivalent to saying there is a margin call if your margin level falls bellow the maintenance margin.

      I did some algebra and I think I can prove this (uploaded here http://www.mediafire.com/download/tn18t91sn52f1jp/Proof.pdf)

    • convexity
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      Now I get confused ^^

      Say Po is 100, IM is 50%, MM is 25%

      As I understand it, a Margin call occurs, when the price dips 66,7. Than my maintenance margin is 16,7 (66,7 * 0,25) and the funds in my account are also 16,7 (50 – 33,3).

      In case I only have to provide MM if the price dips (but not goes beyond MM), I don’t need to provide any additional funds. Where is my mistake?

      I think the condition must be a non-strict inequality

      P < Po * [ ( 1-IM ) / ( 1- MM) ]

      so if your account balance is equal to 16.67 then you have to add funds

    • Chevalier
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      That’s what I thought. Therefore, bringing up funds to MM level would never happen under this condition.

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