Module XII·Article III·~3 min read
Margin Call
Leverage, Collateral, and Lombard Loans
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Mechanics of Margin Call: triggers and consequences
Margin Call is a demand by the lender (broker, bank) to post additional collateral or repay part of the loan when the LTV exceeds an acceptable level. Understanding the mechanics of margin call is critically important for managing a leveraged portfolio.
LTV levels and triggers
| Level | Name | LTV | Action |
|---|---|---|---|
| 1 | Initial LTV | 60% | Maximum at loan issuance |
| 2 | Warning Level | 70% | Notification, recommendation to reduce |
| 3 | Margin Call Level | 80% | Requirement to post collateral (24-72 hours) |
| 4 | Liquidation Level | 90% | Forced sale of collateral |
Margin Call Scenario
| Day | Event | Portfolio Value | Loan | LTV | Status |
|---|---|---|---|---|---|
| 0 | Opening | $1,000,000 | $600,000 | 60% | OK |
| 5 | Market -15% | $850,000 | $600,000 | 71% | Warning |
| 8 | Market -25% | $750,000 | $600,000 | 80% | Margin Call |
| 9 | Client didn't post | $720,000 | $600,000 | 83% | Grace period |
| 11 | Market -35% | $650,000 | $600,000 | 92% | Liquidation |
Actions During Margin Call
| Option | Description | Pros | Cons |
|---|---|---|---|
| Post cash | Transfer money to account | Preserves positions | Requires liquidity |
| Post assets | Transfer additional securities | Cash not needed | Increases concentration |
| Partial repayment | Sell part of positions, repay debt | Reduces leverage | Realizes losses |
| Do nothing | Wait for forced liquidation | — | Worst sale conditions |
Cure Amount Calculation
How much needs to be posted to get back to safe LTV (for example, 60%):
$ \text{Cure Amount} = \text{Loan} - (\text{Target LTV} \times \text{Current Portfolio Value}) $
Example: Loan = $600,000, Portfolio = $750,000, Target LTV = 60%
$ \text{Cure} = $600{,}000 - (0.60 \times $750{,}000) = $600{,}000 - $450{,}000 = $150{,}000 $
Timeframes of Margin Call
| Lender | Notice Period | Features |
|---|---|---|
| Retail Broker | Immediate up to 24h | May liquidate without warning |
| Private Bank | 24-72 hours | Relationship-driven, flexibility |
| Prime Broker | Intraday up to 24h | Strict enforcement |
| REPO | Same day | Haircut adjusts daily |
Forced Liquidation Process
- The lender receives the right to sell collateral
- Sells the most liquid positions first
- Sells by market orders (not limit orders)
- In a crisis: sells at the worst moment (low prices, wide spreads)
- The client bears losses from suboptimal execution
Cascade effect in crisis
Margin calls can create a feedback loop:
- Market falls → margin calls
- Forced selling → further price declines
- More margin calls → more selling
- Liquidity crisis → even quality assets fall
Examples: March 2020 (COVID), October 2008 (Lehman)
Strategies for protection from Margin Call
| Strategy | Description | Effectiveness |
|---|---|---|
| Conservative Initial LTV | Start at 40-50% instead of 60% | High |
| Liquidity Buffer | Hold 10-20% in cash/T-bills | High |
| Diversification | Reduces portfolio volatility | Medium |
| Multiple Lenders | Not reliant on a single lender | Medium |
| Stop-Loss Discipline | Delever before margin call | High |
| Put Options | Tail risk hedging | High (expensive) |
CIO Recommendations
- Know your levels — precisely know warning, call, and liquidation levels
- Stress test weekly — how much can the market drop before margin call?
- Have a plan — decide in advance what to do in a margin call
- Maintain relationships — good standing with the lender = flexibility
- Document everything — in a crisis, disputes over liquidation are common
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