thefirstbruce said:
When you use the term "x% margin loan", the x refers to "loan to value ratio" or LVR.... i.e. the ratio when you put the $ value of the loan over the $ value of the full investment (or potential investment).
...
However, one of the things the banks confuse the issue with is different nomenclature for another ratio relating to margin loans, and that is the gearing ratio. This relates to how much of the loan you have invested at any one time. Just because you get approval for a margin loan of $200k, you don't have to fully use it.
Not using the full capacity of the margin loan is another way to help avoid margin calls. If you use only 80% of your 70% LVR loan, then you have built in more safety before a margin call is issued.
Does anyone else want to volunteer what percentage a share price must fall to trigger a margin call on a 70% LVR and 80% gearing ratio? Assume a 10% buffer offered by the lender.
Actually TFBruce, margin lenders generally use the terms "gearing ratio" and "LVR" interchangeably ... they mean the same thing.
The term you are referring to above is "Margin Utilisation", or "Loan Utilisation". This is the ratio of your current loan amount to the margin value of your security.
An example:
You have borrowed $150,000 to buy shares, and put in another $100,000 of your own money - so your portfolio has a value of $250,000.
The margin lender assigns a "margin value" to these shares at a fixed rate for each share - often called the "Maximum Gearing Ratio" - possibly something like 70%. This figure represents the maximum they will lend you against this share.
The margin utilisation is the ratio of the loan amount to the margin value amount - showing how much of the loan you have used.
The buffer is how much they will allow you to go above 100% of your margin utilisation. Lenders typically allow a 5% or 10% buffer.
So in our example above:
Loan (L) = $150,000
Value (V) = $250,000
Maximum Gearing Ration (MGR) = 70%
Gearing Ratio (LVR) = L / V = $150,000 / $250,000 = 60%
Margin Value of shares (MV) = V * MGR = $250,000 * 70% = $175,000
Margin Utilisation (MU) = L / MV = $150,000 / $175,000 = 85.7%
... so let's play market fluctuation - market drops the value of your shares by 20% to $200,000
Loan (L) L = $150,000
Value (V) =
$200,000
Maximum Gearing Ration (MGR) = 70%
Gearing Ratio (LVR) = L / V = $150,000 / $200,000 = 75%
Margin Value of shares (MV) = V * MGR = $200,000 * 70% = $140,000
Margin Utilisation (MU) = L / MV = $150,000 / $140,000 =
107.1%
Note that now the MU is above 100% ... this is okay - provided that the lender allowed us a 10% buffer (maximum margin utilisation = 110%) !!!
If they had only allowed a 5% buffer, (maximum margin utilisation = 105%) we would now be in what they term "margin call" because our MU is over 107% - meaning they call you (literally) and demand that you increase your porfolio value (or more likely, reduce your loan value) to restore that margin utilisation to below 100%.
To answer TFBruce's question about when margin call would be made on a 70% maximum gearing ratio and 80% margin utilisation with a 10% buffer offered by the lender (I'm assuming these terms are what he meant) ...
Margin call happens when MU > 100% + buffer, or MU > 110% in our example
this means that margin utilisation has increased from 80% to 110% = 37.5% increase in MU. Original MU = MU1, Margin call MU = MU2
so margin call happens when MU2 > MU1 * 137.5%
but MU2 = L / MV2 and MU1 = L / MV1 (Loan constant, but margin value changes as value changes) ...
L / MV2 > (L * 1.375) / MV1
but MV = V * MGR, ie MV1 = V1 * MGR, MV2 = V2 * MGR ... (MGR constant, margin value changes as value changes) ...
L / (V2 * MGR) > (L * 1.375) / (V1 * MGR)
cancel our L and MGR constants on both sides
margin call happens when 1 / V2 > 1.375 / V1
margin call happens when V2 < V1 / 1.375
ie when the value of our portfolio drops by at least 27.3%
In other words, if we have 80% margin utilised, and we are allowed to go to 110% margin utilisation (a 37.5% increase in MU), then the value would have to drop by 1 - (1 / (1 + 37.5%))
So all you need to do is work out how much your margin utilisation has to increase by before you hit 100% + your buffer, and you can plug that number into the formula 1 - (1 / (1 + X)) to work out how much the portfolio value has to decrease by before you get a margin call.
... or if you want an easier way
X = your current margin utilisation, Y = maximum margin utilisation (100% + buffer)
You will get a margin loan after a 1 - (X / Y) drop in market value
... if you want it even easier still (by not having to work out margin utilisation)
L = Loan amount
V = Initial market value
B = buffer amount (eg 5%, 10%)
MGR = maximum gearing ration (max LVR)
Margin call after 1 - (L / (V * MGR * (1 + B))) drop in market value.
Happy now ?
*phew* sleep time I think !!
Just to make it easier, I've made up a spreadsheet to show you how it all works.
