Legal Definitions - margin transaction

A margin transaction occurs when an investor buys or sells financial assets, such as stocks, bonds, or other investment instruments (known as securities), or raw materials like oil or gold (known as commodities), using money borrowed from their brokerage firm. This borrowing takes place within a specialized investment account called a margin account. Essentially, the investor puts up a portion of the total cost, and the broker lends them the remaining amount, allowing them to control a larger investment position than they could with just their own cash. This practice is also commonly referred to as buying on margin.

• Example 1: Purchasing Stocks with Borrowed Funds
  Sarah believes that shares of "Tech Innovations Inc." are poised for significant growth. She has $10,000 in cash but wants to buy $20,000 worth of shares to maximize her potential gains. Through her brokerage firm, she uses her margin account to borrow the additional $10,000 needed. She then purchases 200 shares of Tech Innovations Inc. at $100 per share.

  This is a margin transaction because Sarah bought securities (stocks) through her broker using a margin account, leveraging borrowed money to increase her purchasing power beyond her available cash.

• Example 2: Trading Commodity Futures
  A seasoned trader, Mark, anticipates a rise in the price of corn due to upcoming weather patterns. He wants to enter into a futures contract for 5,000 bushels of corn, which requires a significant capital outlay. Instead of using all his available cash, Mark uses his margin account to meet the initial margin requirement for the futures contract, borrowing the necessary funds from his broker to take a larger position in the commodity market.

  This illustrates a margin transaction because Mark is engaging in a commodities transaction (futures contract) through his broker, utilizing his margin account to borrow funds and control a larger quantity of the commodity than his immediate cash would permit.

• Example 3: Short Selling a Stock
  David believes that "Old Economy Co." is overvalued and its stock price will soon fall. He decides to "short sell" the stock. To do this, he uses his margin account to borrow 100 shares of Old Economy Co. from his broker and immediately sells them in the market. He hopes to buy them back later at a lower price, return them to the broker, and profit from the difference.

  This is a margin transaction because David is selling securities (borrowed shares) through his broker, and the borrowing of these shares is facilitated by his margin account. Short selling inherently involves borrowing assets, which is a key function of a margin account.