Margin Funding or Margin Trading means borrowing money to buy or trade in shares, wherein margin is the difference between the total value of shares purchased and the loan amount provided by the broker/financier. Thus, in a margin trade, shares or securities are purchased by paying only a percentage of the total value of the assets involved.
Paying margin is like paying a collateral on the loan amount taken from the broker. For eg. if a trader buys Rs. 10,000 worth shares of Reliance for a 40% margin, he would be paying Rs. 4,000 and the rest Rs. 6,000 could be borrowed from the broker. Of course interest needs to be paid to the broker on this Rs. 6,000 borrowed.
Why margin funding?
This type of investment can be beneficial when the investor is anticipating a higher rate of return than the interest paid on the loan.
e.g. If margin funding is available at 12% p.a. i.e. per month cost of 1% and the investor is expecting 3% rise in a stock in month on account of some positive triggers, then margin funding becomes attractive.
Margin funding is typically short term in nature. It can be for a few days or few weeks, but generally less than a year. In IPOs, margin funding is very popular with HNIs to bet on high subscription levels for IPO expected to list at a premium. However, correct in share price or adverse market conditions can catch the borrower on the wrong foot and lead to losses.
Some brokers undertake margin funding with security already held by an investor in his portfolio as the collateral. E.g. If an investor already owns shares of TCS worth Rs. 10,000 in his long term portfolio and is expecting a price rise in another stock in next 2-3 days and wishes to convert this opportunity into profits, he can deposit the collateral (TCS shares) with the broker and used that cash (which will be less than Rs. 10,000 – say Rs. 7,000 or 8,000 based on each securities’ beta and value-at-risk) to buy new shares. Once the investor sells these new shares, he pays back the broker the borrowed amount along with the interest and ‘frees’ his TCS shares kept as collateral. The above example can be described as margin funding as a loan for securities against securities.