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Margin Loans Margin Loans..how they work!

Discussion in 'Finance & Banking' started by Jayar, 17th Aug, 2005.

  1. Jayar

    Jayar Well-Known Member

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    G'day,
    For a few weeks now, I have been trying to fully comprehend margin lending and have visited several web sites and downloaded numerous articles on the subject.
    But just after joining this website, I found the article written my Simon and it is exactly what I have been searching for.
    It is full of detail, shows examples and equations, is easy to understand step-by-step, and leaves no questions unanswered.
    And the Excel spreadsheet attached completes the total package.
    Many thanks Simon, and InvestEd, on a great piece of work.
    Jayar
     
  2. Jacque

    Jacque Team InvestEd

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    Simon has a natural talent for explaining things in simple english, which I like too! Thanks for the feedback, Jayar, and I hope you continue to benefit from InvestEd and the articles. There are some terrific ones coming up in the next weeks as well!
     
  3. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Oh gosh - now I've set the expectation that at all my stuff is going to be as useful - I'm going to have to work extra hard now!

    Thanks for the kind words - it really helps to know that this stuff is of use to people.

    I'm really enjoying the content that we've produced already - there's been some useful things to me - especially the "Selecting an Effective Residential Property Manager" by Jacque - I'm currently looking for a new PM, so this will come in handy for me right now.
     
  4. Stevec

    Stevec Member

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    I have also been trying to find info on margin loans and how they work. Sim you are a legend for giving us that detail which I can now use to play with some numbers. Thank you. :D

    Cheers,
    Stevec.
     
  5. dreamworld

    dreamworld New Member

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    HI,

    :confused:

    I have 40000K worth of shares and wish to leverage to 60%.
    I would then acquire a 60K loan bringing the portfolio value to
    $100,000.

    At what point in time would a margin call occur and what dollar amount would
    I need to contribute to bring it back up to 60%.
    There is a 10% buffer and the market drops 20%.

    Could you please also let me know what the figures would be on a 50% margin
    loan, and 70% margin loan.


    I have tried Sims Chart, but unfortunately I still cannot understand margin
    calls.

    Thanks in Advance
    Dreamworld.
     
  6. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    I've done up a version of my chart with three sheets in it.

    The first sheet shows a 50% margin loan (You put in $40K, bank puts in $40K, total $80K)

    Second sheet shows 60% margin loan (You put in $40K, bank puts in $60K, total $100K)

    Third sheet shows 70% margin loan (You put in $40K, bank puts in $93.3K, total $133.3K)

    CAUTION !!!!!

    This chart assumes a maximum gearing ratio of the entire portfolio of 70%. If any of your shares or funds have an MGR of anything less, then these figures will be wrong - the lender will assign a lower margin value to the shares and margin call will happen sooner. You can simulate this by setting the "Max Gearing" figure in each of the sheets to something like 60% or 50% to see what kind of impact it has on margin calls.

    At 70% MGR, you can see that your 50% LVR will survive a 20% market fall, your 60% LVR will also (just!), but your 70% LVR simply doesn't allow enough headroom to handle market falls - with margin call at only 9.09% market fall.

    At 60% MGR, the 60% LVR portfolio also will cause a margin call with a 20% market drop (in fact it only requires 9.09% market drop).

    Note that I'm not indicating at all how much your margin call would be - that's a different exercise.

    Also please note that this is NOT advice - it is general information only. You should seek professional advice before deciding on a strategy here.

    I personally have a 50% LVR margin loan against funds that have a 70% max gearing ratio. (Actually it's about 55% at the moment, but I'm reinvesting distributions and letting the LVR drop before I borrow any more against the portfolio - aiming to keep it around 50%).
     

    Attached Files:

  7. Tom&Don

    Tom&Don Active Member

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    Ive put together the following spreadsheet to show the 'percentage curve' of various margins vs the drop in value that would generate a margin call.

    I expected to see a curve - but its a straight line. You learn something every day.

    Just plug in the amount you want to invest in the share/fund and then the max allowable margin lend and buffer. The spreadsheet will show you all the $ and % drops required to trigger a margin call for a given range of margin lends.

    Let me know what you think - its just a different way of displaying what I think Sim was getting at.. Hopefully the forumale are right? Sim/someone to verify please?


    Tom.
     

    Attached Files:

    Last edited by a moderator: 18th Aug, 2005
  8. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Thanks Tom - at first glance the numbers I punched in seem to match mine.

    Well done - useful spreadsheet.
     
  9. Gonzo

    Gonzo Well-Known Member

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    It's also worth remembering that most margin loan facilities have a basket of stocks funds that they will gear to xx%. Outside of that they will gear to a lesser extent and on speculative stocks they often won't gear. So keep an eye on your LVR to make sure it's in the range you want it to be. If you stick to the Blue Chips you shouldn't have too many problems with getting the max gearing.
     
    Last edited by a moderator: 18th Aug, 2005
  10. Tom&Don

    Tom&Don Active Member

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    Here is a spreadsheet that i think will answer dreamworlds question.

    I'm assuming you just need to add back in the difference between the margin call level and how much under that value your share/fund has gone.

    Of course its going to be a little rubbery - i would also assume the exact values involved will depend on when the lending institution does the calculations etc but i think this should be a rough guide..

    Tom.
     

    Attached Files:

  11. Tropo

    Tropo Well-Known Member

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    I have heard that if you borrow against 66% of your holdings you avoid a Margin Call in the event of the share price falling significantly.
    Is it correct?


    Tropo
     
  12. dreamworld

    dreamworld New Member

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    Hi to all,

    I seem to have a clearer understanding now of margin lending.
    Thanks to Tom and Don for the latest chart. This is exactly what I have
    been looking for.
    I could never work out how much the actual top up would need to be.

    If some one could just double check my understanding.

    50000K
    70%mgr
    10% buffer

    50% margin

    if there is a 20-35% drop there is no margin call
    if there is a 35.1% drop then my top up would be $35.06
    if there is a 40% drop top up would be $4935
    if there is a 50% drop top up would be 14935.

    if we are looking at a 60% margin then the first top up would be at 22.1% of
    $27.60 and if it drops by 40% then top up would be 22402

    I hope this is correct.

    thanks
    Dream world
     
  13. Jayar

    Jayar Well-Known Member

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    Hi, Dreamworld,

    I've just checked your figures with the same program, and end up with the same results as you do. We both can't be wrong..........surely???? :D

    Cheers,

    Jayar
     
  14. dreamworld

    dreamworld New Member

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    Great work Jayar

    You are as smart as I am !

    Thankyou to all for the brilliant examples and explanations.


    So the million dollar question is How often does the market fall 40%?
    When was the last time this happened?

    If we talk about a 50% margin lend the top up would be $4935, which won't kill the bank balance, but at 60% margin lend it could very well do.

    Thanks in advance
    Dream world.
     
  15. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    Tropo - the answer is "it depends".

    It depends on what max gearing ratio you are allowed
    It depends on how much you mean by "falling significantly"

    Specifically, the only way to truely avoid a margin call is to not borrow in the first place. Of course, statistcially, if you look at the largest market corrections in history, you could extrapolate that out and ensure that you were geared low enough to survive on of them (which is what I'm attempting to do with a 50% LVR).

    Of course, there are never any guarantees that the market won't fall by more - it's a risk - and something you need to take into account in your risk management strategy.

    So to answer your general question with a general answer - I say "in general" no, that's not true.
     
  16. Tom&Don

    Tom&Don Active Member

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    I had another think about it all .. and the following is probably even clearer to understand the effect on how much a lender is willing to loan on margin vs how much margin you actually take up vs various market drop scenarios.

    Where would we be without spreadsheets?

    So Tropo - to answer your question, this shows that if you take out 65% margin - and in this example the lenders max is 70% with 10% buffer the market would have to drop ROUGHLY around 16% before a margin call.
     

    Attached Files:

  17. Tropo

    Tropo Well-Known Member

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    Thanks All!
    You are a great help. :)
     
  18. jenpalex

    jenpalex Active Member

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    What's Optimal?

    There is the question of the exact arithmetic of what % market drop causes a margin call for a given level of gearing. Then there is the question of what level of gearing is optimal. A higher level of gearing triggers a call after a smaller market drop. But it also allows a higher rate of return on assets between calls.We would expect it to be related to an individual share's volatility. Has anybody seen any work on this?

    jenpalex
     
  19. Simon Hampel

    Simon Hampel Co-founder Staff Member

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    You do make an interesting observation jenpalex, and indeed I read an article in a recent copy of Personal Investor magazine that argued margin calls aren't always the "big bogeyman" that most people make them out to be. I'll see if I can track down the article and summarize it.

    Certainly - the higher returns that can be had from carefully selected funds or stocks at higher gearing levels would certainly go a long way to offset the potential loss that might occur if a sufficiently large downturn or crash were to happen. It would be very interesting to do some more in-depth analysis of the risk versus reward for higher gearing or stocks or funds of varying volatility and in varying market conditions.
     
  20. Nigel Ward

    Nigel Ward Team InvestEd

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    If you're margining into a managed fund and reinvesting distributions then your gearing level is decreasing. So while at the outset you might start at say 50% MGR, after a good distribution you might be down to say 46%...and then after the next distribution say 44% and so on...