Margin Transactions

Margin Transactions

Leverage Ratio

The leverage ratio can measure the relation between risk and borrowing. The maximum leverage ratio calculates financial leverage if the trader’s equity position is equal to the initial margin requirement.

$$ \text{Leverage ratio} = \frac{ \text{Total value of the position}}{ \text{Equity value of the position}} $$

$$ \text{Maximum leverage ratio} = \frac{1}{ \text{Initial margin requirement}} $$

Return on Margin Transaction

Calculating the rate of return on a margin transaction is similar to an unleveraged one, but you must deduct the margin interest paid. Compute the rate of return using the initial equity investment, not the total asset purchase price. Include upfront costs, like commissions, in the initial equity.

Example of a Margin Transaction

A trader purchases $100,000 worth of a highly volatile stock at a leverage ratio of 2.5, receives a special dividend of $800 after six months, and sells the stock exactly one year after purchase at $200,000. The commission is $10 at purchase. The trader is charged 8% interest on the borrowed money.

To get the rate of return, we just have to find the profit (or loss) and divide it by the initial equity investment.

Let’s first calculate the amount of money the trader had to borrow in order to make this transaction.

We can find the equity investment by dividing the full $100,000 purchase by the leverage ratio of 2.5.

$$ \text{Equity investment} = \frac{$100,000}{2.5} = $40,000 $$

And the remainder has to be borrowed:

$$ \text{Borrowed amount} = $100,000 – $40,000 = $60,000 $$

The amount that the trader will have to pay in interest over one year is the interest rate on the loan multiplied by the loan amount:

$$ \text{Interest paid} = $60,000 × 8\% = $4,800 $$

Moving on to the profit calculation:

\text{Sale Price} & $200,000 \\
\text{Purchase Price} & -$100,000 \\
\text{Realized Gain (Loss)} & $100,000 \\
\text{Purchase commission} & -$10 \\
\text{Dividend} & $800 \\
\text{Margin interest} & -$4,800 \\
\text{Sale commission} & -$10 \\
\text{Return} & $95,980 \\

To find the total initial equity investment, just take the $40,000 calculated above and tack on the small commission on the purchase of $10:

$$ \text{Equity investment plus commission} = $40,000 + $10 = $40,010 $$

Finally, we can calculate the rate of return on this trade:

$$ \text{Rate of return} = \frac{$95,980}{$40,010} = 239.89\% $$

Margin Call Price

A margin call will take place when equity drops below the maintenance margin requirement. After the purchase of a security on margin, any changes in that security’s price will be reflected completely in equity. There is a simple formula that can be used to find the margin call price:

$$ \text{Margin call price} = \frac{ \text{Debt}}{1- \text{Maintenance quad margin}} $$

Example of a Margin Call Price

You have been provided with the following information:

  • Purchase price per share: $30.
  • Leverage ratio: 2.0.
  • Maintenance margin: 25%.

Remember, the equity investment can be found by dividing the total purchase price by the leverage ratio:

$$ \text{Equity investment} = \frac{$30}{2} = $15 $$

So, this trade involves $15 of equity and $15 of debt, and we need to find at what price a margin call would take place:

$$ \text{Margin call price} = \frac{$15}{1-0.25} = \frac{$15}{0.75} = $20 $$


What is a trader’s maximum leverage ratio, given an initial margin requirement of 40%?

  1. 1.00.
  2. 2.50.
  3. 4.00.


The correct answer is B.

As shown above, the maximum leverage ratio is equal to 1 divided by the initial margin requirement.

\( \text{Maximum leverage ratio} = \frac{1}{0.4} = 2.5 \)

Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Shop Actuarial Exams Prep Shop GMAT® Exam Prep

    Sergio Torrico
    Sergio Torrico
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.