Margin Calls

The thriller “Margin Call” has enjoyed widespread success beyond this year's Viennale. Today it’s the only movie showing what events in a major US investment bank caused the current financial crisis and the desperate attempts of the bank’s employees to avoid the infamous margin call, which would mean the end of the bank.

But what exactly is this much-feared margin call?

Margin

A margin is a call from a stock exchange, a clearinghouse or a broker which demands that a trader deposit cash or marginable securities to participate in trading on the stock exchange. There are different types and forms of margins.

A margin is generally a kind of deposit which secures fulfillment of liabilities of a stock exchange trader in case of adverse price movement.

The margin is deposited on a special clearing account which records all the daily wins and losses of all positions held by a trader.

The main advantage of the margin system is that a trader can carry out transactions without securing the full amount of securities or goods (e.g. raw materials) and actually has to provide a security only for a part of his trading positions.

Various arts of margin play an especially important role when trading with futures and option contracts (stock exchange futures transactions). Margin deposits are also required for trades in currencies und precious metals.

Among the various instruments available within the scope of stock exchange futures transactions, there are different types of margins which take into account the specialties of each instrument. For example, when trading with futures, a so-called initial margin is required to cover performance risks. Additionally, a so-called variation margin is required. This serves as a buffer for all potential losses which could arise from open future deals.

The amount of a margin is calculated by each stock exchange depending on the legal regulations and on the basis of various calculation systems. In Europe, a well-known system is risk-based-margining (RBM) which was developed by the Eurex Clearing AG and takes into account various risk factors of all open positions of a trader’s accounts. The main criterion for each calculation system is, however, the volatility of the market price, i.e., the amount of the expected price fluctuation of the held positions.

If the pending transactions of a trader have adverse effects on the trader and the level of the calculated rate of the applied trading instruments drops below the level that is covered by the security, the broker makes the margin call (call for a second security). With this call, the trader is asked to transfer an additional security to his margin account in order to keep his positions open. If the trader cannot fulfill this request immediately, stock exchange regulations allow the broker to close the positions of the trader even if it is against the interests of the trader and thus to realize the losses of the trader. This procedure serves as a guarantee to the broker and other participants of the stock exchange that a trader’s losses will never exceed an amount the trader is able to cover. At the same time, the trader is given the opportunity to “outwait” negative developments of his positions in order to wait for a positive trend. Realization of the losses pending up until this time can swiftly lead, in view of traded volumes and of leverage effects, in particular in the case of the stock exchange futures transactions, to financial solvency of the involved trader.

Thus, all traders are advised to have a reserve of liquid assets that can sufficiently cover the trader’s positions.

One historical example of the dramatic effects of a margin call, is the great stock market crash of 1929. Back then, brokers allowed clients to take very high credit lines for securities trading with very low margins as security. Stock exchange transactions could be performed by a lot of people with little equity capital. After big stock market losses, many traders received margin calls and were requested to make additional payments, but they were not in a position to perform them. Consequently, a lot of positions were compulsorily closed by the brokers and this in turn led to a further series of margin calls.

For more information about the film please see: http://margincallmovie.com/.