Margin Calls and Requirements for Mark To Market (MTM): Finance Trading Times

Margin Calls and Requirements for Mark To Market (MTM)

This is part 2 of the article: Mark to market (MTM) factor & Stock Market Fall Effects-1. Please read the first part before continuing with this one.

Usually, when such a thing happens, the brokers call the client on the phone individually and give them a deadline (usually 12 to 24 hours) to furnish the required money for MTM. But unfortunately, due to the regulations, the brokers cannot accept cash. All transactions should happen in paper or electronic form (cheque, demand draft or online transfer). Hence, though the brokers raised to margin calls, though the clients deposited the cheques with the brokers, the clearing time of 24 hrs to 3 days ensured that money did not reach the broker’s account within the given time limit. Hence, with lack of required cash, the brokers were forced to meet up the MTM requirement by selling stocks.

Now cheques can treated as a guarantee. But there is a fear that cheque may bounce due to lack of money in the clients account. Hence, the brokers need the cheque to be really encashed. Ultimately, they were left with no solution but to sell the shares at the lowest of the low prices for their clients.

Finally, it was the clients who lost. They may have bought the shares at a price of 100. The price starts to fall down, reaches 75, the broker raises a MTM margin call. Though the clients may have money to furnish for the margin requirements, the problem with the clearing mechanism forces the broker to cover for the losses by selling stocks. This panic and forceful selling for MTM further deteriorated the stock prices and they went for a tailspin.

So even if the client has sufficient money, he may have to suffer the loss. Even if he had the capacity to withstand the bear hug, he may have been forced to book the losses because of the MTM and margin requirements.

Hence, it becomes extremely important to discipline your trading activities and your leveraged positions. It sounds good when the broker tells you that you don’t need to have money ready when you place the order, and you can furnish the money within 3 days time for T+3 settlement cycle. You feel happy that your money can earn interest in the bank and there is no need to keep it idle with the broker if you don’t trade.

However, all that money management and interest earnings tactics and trading strategies go off the fly in a split second, when the markets tumble, like the way they have in the past 3-4 days. It therefore becomes extremely important to understand the risk management requirements of the brokers. It is better to Select a broker after proper research & keep the money with a quality broker having strict requirements for advance deposit, rather than going for a cheap and lousy brokerage house giving all kinds of leverages to the clients. What you may not save in the interest part, much more than that you can loose in the MTM and Margin calls requirement. Remember, the more regulations and restrictions you face, the better you are shielded when you are hit by a big loss.

Yesterday I saw on CNBC webcast, people fought with the employees at brokerage firms due to their trades being cut-off for margin calls and MTM requirements. They were forced to book losses. Another piece of news took to the jewelry stores or pawn brokers. People were found selling their gold ornaments and gold bars or keeping them on mortgage to get some cash to suffice for the margin requirements. Ignorance, lack of knowledge about regulations (set by market as well as the brokers), and taking things for granted will force you to learn the things in a costly way. Learn it before jumping in and play it safe!
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3 Comments: Post your Comments

Anonymous said...(on 24 January 2008 at 01:50 )  

Shobhit, I have often wondered, what exactly is the use of a broker? I mean, especially in today's age of electronic trading, if I'm paying upfront for shares or other securities that I'm buying, can't the exchange directly deal with me?

I see no reason for the continued existence of this species, the brokers, who seem to fleece off a cosy brokerage (even 0.15% is a lot of money after all) for not really doing anything essential.

Am I missing something here, or is this a case of a historical insitutional simply carrying on out of inertia? (I expect the former is more likely, but WHAT am I missing?)

Bit of a tangent to Shobhit's post, but could Shobhit or someone else here throw some light?


Anonymous said...(on 24 January 2008 at 21:19 )  

Having thought a bit about this after shooting off that comment yesterday, it appears to me that the one thing that brokers make possible is margin trading.

So fine, we could

(a) have two sets of trading types, one where people who choose to pay upfront deal directly with the exchange and NOT pay brokerage (maybe a very small transaction charge of around 0.01% or something to keep exchanges afloat);


Lump margin trading altogether? I'm not sure that'd be such a bad thing. Stop your proverbial brokers and investors jumping off roofs every time markets slump. Will hurt liquidity, yes, but so what? Markets are getting broader anyway.

And if that's too extreme, you can always do the either-or option I mentioned earlier.

What do you think, Shobhit, the rest of you?

Shobhit said...(on 24 January 2008 at 22:53 )  

First thought is correct that brokers are required for allowing margin based trading. Stock Exchanges are huge. They have to cater ot millions and billions of traders and other market participants, locally and globally. It is not possible for the exchange to simply keep listening to each and every individual. Hence, in having the broker, they try to go for something like a "Distributed Network".
For the exchange, management becomes easy because at the end of the day they need to look at the consolidated position of a broker, not at each of the thousands of individual accounts that the broker is catering to.

Why do brokers exist? Do they simply make money?
Upto a certain extent YES - they simply make money. But they have to pay huge amount of money as membership fee. The brokerage that you pay on each transaction that you carry out, no everything is kept by the broker. A portion of it also goes to the exchange. Hence it's a risky business for the broker. First, he needs to show huge capital and infrastructure to cater to teh needs of its clients - then only he gets the exchange memberrship. Second, he needs to comply with loads and loads of regulations, like MTM, otherwise he will be blacklisted by the exchange. Imagine setting up such a huge infrastructure with so big cost and then failing to meet a single regulation and you are out of business.

Wish you all happy and fruitful trading and investing activities with safety! = = = Post a Comment

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