What is a Margin Trading Facility (MTF) ?
Margin Trading Facility (MTF) is an arrangement or a system where a trader/investor can buy shares or stocks by paying only a part of the total value of shares/stocks and borrowing the rest investment from a broker or agent.
In MTF, investors are allowed to take a leverage position in equities by paying only an initial margin and broker/agent paying the remaining fund. MTF is a beneficial arrangement for traders to maximize the returns by boosting their purchasing power.
Under MTF, investors maintain an initial margin i.e. a certain percentage of the stock’s value. The remaining stock value is paid by the broker in return for some interest in the name of broker charge. Investors can pledge for loans by keeping the same stocks as collateral.
Example: Margin Trading Facility
An investor wants to buy some shares of XYZ company worth Rs. 1,00,000. If the broker allows a margin requirement of 60% under MTF, the investor only needs to pay Rs. 60,000 upfront and the broker will pay the remaining Rs. 40,000. For this service, investors need to maintain this margin and to pay interest on the borrowed figure until they close their position.
Why is it necessary to understand MTF ?
Margin Trading Facility (MTF) is not for every investor. There are various factors/concepts in MTF that need to be acknowledged to gain the advantage from MTF. There are some costs and risks associated with this practice which is must for every investor before making this arrangement. Some of the reasons why it is necessary to understand MTF are:
Risk of Margin Calls
In MTF, there is a certain margin requirement from the broker or agent. Investors need to maintain the maintenance margin. In the example above, the margin requirement is 60%. Suppose the maintenance margin is 40%.
When an investment made at 60% margin requirement drops, the value of the investors’ holdings also decreases. When the value decreases below the maintenance margin i.e. the investors’ equity must be above 40% of the current value of the stocks, the broker requests investors to deposit additional capital to maintain the margin requirement. In case of margin calls, the investors need to add capital even if the stock prices are down or the broker will have the right to actually sell the securities to cover the shortfall amount.
Interest Costs
Interest costs are simply the charge brokers apply on the borrowed amount. If not properly dealt with, these costs can accumulate over time and impact the profitability of the trade.
Leverage and Risk
MTF allows investors to make more investment than their individual investment. This means, if share prices increase, the profit increases by a significant margin. Similarly, we should also consider the conditions for losses.
For Instance,
Without MTF, you invest Rs. 1,00,000 in stocks. If stock prices rise by 10% you earn Rs. 10,000 and if prices decrease by 10%, you lose Rs. 10,000.
WIth MTF, you have the leverage of extra borrowed capital. If the leverage deal is 2:1, inventors will enjoy the investment of Rs. 2,00,000 from his Rs. 1,00,000 investment for some interest costs.
Total Investment: Rs. 2,00,000 (1,00,000+1,00,000)
If the share price dropped by 10%,
Total value of Investment: Rs. 1,80,000 (Rs. 2,00,000-10%)
After paying the borrowed amount of Rs. 1,00,000 + x (interest), the investor will have Rs. 80,000- x
This Rs. 80,000-x will be more than 20% of his investment of Rs. 1,00,000.
In the case of losses, MTF amplified the risk as well.