Margin Call on a Concentrated Position
A client holds 8,000 shares of his employer's stock, worth $480,000, in a margin account with a $260,000 debit balance. The stock has fallen 22% in three weeks after a disappointing earnings report, and the maintenance requirement on the position is 30%. The client is traveling and unreachable. The firm's margin department calculates that the account is close to a maintenance call and may fall below it if the stock drops another 8%. The client also has $60,000 in a money market fund in the same account and no other liquid assets at the firm. He has repeatedly said he will "never sell the stock" because of loyalty to the company and tax reasons.
1. Calculate the account's equity and determine how close it is to a maintenance call, showing your reasoning.
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The position is worth $480,000 and the debit is $260,000, so equity is $220,000. The maintenance requirement is 30% of the position's market value, or $144,000. Equity of $220,000 exceeds the requirement by $76,000, so the account is not yet in a maintenance call.
To find the price at which a call would occur, let V be the market value of the stock. Equity equals V minus $260,000, and the requirement is 0.30V. A call occurs when V minus $260,000 equals 0.30V, which gives 0.70V equals $260,000, so V equals about $371,429. At 8,000 shares, that is about $46.43 per share. The current price is $60 per share (480,000 divided by 8,000), so the stock would need to fall about 22.6% from here, not 8%, to trigger a call. The 8% figure is therefore incorrect. The money market balance of $60,000 is additional equity and would be counted in the account, which improves the cushion.
2. Given the client's instructions and the concentration, what actions should you take now and what should you recommend?
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You should not wait for the client to become reachable. Document the current equity, the call price, and the client's standing instruction not to sell, and escalate to your supervisor. Because the client is unreachable and the position is concentrated, the firm should follow its margin procedures, which may include sending a maintenance notice and setting a deadline. You should not liquidate without authority unless the account actually falls into a call and the firm's procedures permit it.
The recommendation to the client should be to reduce concentration. Selling enough shares to retire part of the debit, or moving some value into the money market fund, lowers the call risk. Tax consequences matter, but they should be weighed against the risk of a forced sale at a worse price. Explain that loyalty to the employer is not a risk-management strategy, and that a forced liquidation could occur at the worst time. If he refuses, document the refusal and consider whether the account remains suitable.