Question

Describe buying on margin.

Answer 1

Buying On Margin

Buying on Margin is the purchase of an asset or securities by using borrowings from the bank or brokers, In this case initial margin is paid to the Bank or the broker for purchase of the asset or security. There is some minimum percentage of the purchase price that is to be paid by the party itself and the rest is paid by the Bank or the broker. Buying on Margin means you are investing with Borrowed Money.

The Brokers requires you to maintain a maintenance account where there is a margin which is required to be met, If your account falls below the required margin, Broker can sell some of your portfolio to get your account balance back.

Example:

Mr A purchased 1000 shares of ABC Company at $5 per share, His paid half of the Initial Investment i.e, $2500 to the broker and rest is paid by broker himself opening a margin account of Mr A. The next year share prices raised to $10 per share, and thus Mr A sells his stock for $10,000 and paid his debt of $2500, Thus he made $7500 from investing $2500 which is 3 times the Investment, However had he made investment of $5000 by himself it would have fetched him $10,000 making it double. Thus by using Buying on Margin concept Mr A earned 3 times of his Investment