If the value of equity falls below the maintenance margin (MM) requireent, the buyer gets a margin call, i.e., the request for additional equity.
Now, say the stock is trading at 20, and the initial margin (IM) is 40% or 8. MM is 25%. What is the price for margin call?
The formula is P * (1 - IM) / (1 - MM) = 20 * (1 - 40%) / (1 - 25%) = 16. Can anyone explain this formula to me? I understand that any drop in price beyond a certain level should trigger a margin call because the price is down, and the lender would not receive the real worth even after selling the stock. But I am unable to understand how this works. How the formula has been derived.
Another way is to see the change in equity (IM). “SUBSEQUENT CHANGES IN EQUITY PER SHARE ARE EQUAL TO THE SHARE PRICE CHANGE” – Why? How? Is it because that the fall in price will be totally deducted from the IM. So, this means that if price drops by 4, the new equity is 8 - 4 = 4. And the margin effectively is 4 / 16 = 25%, and as it meets the maintenance margin, this is fine. And stock price below 16 triggers margin call. Say, the new price is 12. So margin is 8 - 8 = 0. And maintenance margin required is 25% or 3. So, at a price of 12, the trader should deposit 3.