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Margin Loan

Borrowing money from a stockbroker by using negotiable securities as collateral. The loan, which bears interest at the margin loan rate until repaid, can be used to take cash out of your brokerage account or to purchase additional securities. Federal Reserve Regulation "T" governs these loans. The Fed allows loans up to 50% of the market value of the stock in your account.

Optionholders can use the borrowing power in the stock that they will receive to pay for an exercise. If the market price of your stock is twice your exercise price (e.g., market price is $10; exercise price is $5), then some brokerage firms will provide you with a margin loan to exercise and hold the stock in the margin account. Alternatively, you could buy the stock with cash and purchase additional stock based on the market value of the stock in your account. The relationship between the loan and the market value of the stock on the day of the loan is called "initial margin." The initial margin may not exceed 50%.

A margin loan can be "called" at any time by the brokerage extending it. The Federal Reserve requires that a loan which exceeds 75% of the market value of the stock collateralizing it (due to the addition of interest charges or the decline of the stock price) be called. Brokerage firms can set their own stricter margin requirements and can restrict certain securities from margin trading. When a call is issued, the brokerage customer must restore his account to initial margin.

If you do not deposit cash or more marginable securities into the account immediately, the broker can sell the stock to repay the loan. While margin loans give you more stock buying power, they come with a significant downside, particularly when volatile stocks are used as the collateral. They should only be tried by investors with high risk tolerance and may be frowned upon or prohibited by your company.

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