Margin Funding: What a Broker Lends Against a Position

Margin funding is a broker putting up part of the price of a position, with the position standing behind what was put up. Afterwards there are three amounts: the position, the part the client paid for, and the part that was borrowed. The borrowed part is a fixed number of rupees, so it does not move when the price does, and the whole of any movement lands on the client's part.

One fact produces this entire guide, and it is not a fact about shares but a fact about loans. A loan does not move with the value of the thing it bought. A borrower who takes Rs 60,000/- owes Rs 60,000/-, and that stays true while the thing the money bought doubles, halves or does nothing whatever. Every reading further down comes out of that sentence and nothing else.

Held beside the arrangement itself, that fact shows where the trouble is. The client puts up one amount, the broker puts up another, and the two amounts buy one position between them. When the position moves, only one of those two amounts is allowed to change. So the client's part is what is left over after a fixed number has been taken out of a moving one. The client's part therefore moves further in proportion than the position does, in both directions, by an amount that was settled the moment the loan was agreed.

What is margin funding, in one sentence?

A client wants to hold a position worth more than the money in the account. The broker puts up the difference and the client puts up the rest, and the position that gets bought is what the broker will look to if the money does not come back. The arrangement has no other parts. The client has borrowed money and bought something with it, and the something is the thing the lender can look to.

A woman runs a small provisions stall. She has Rs 40,000/- and she wants Rs 1,00,000/- of stock on her shelves before the festival week. Full shelves are most of why anybody stops. Somebody puts up the missing Rs 60,000/- and says, plainly, that the stock on those shelves is what they will come to if the money is not repaid. She has not been given Rs 60,000/-. She has been lent it, and the goods she bought with it are the collateralThe particular thing a lender can look to for repayment if the money does not come back. Naming one is what separates this kind of loan from a promise on its own.. Change stock to shares and stall to trading account and nothing else about the shape changes.

The arrangement is not a partnership, and that matters more than it sounds. The person who put up the Rs 60,000/- has not bought three fifths of the stall. The lender is a creditorThe party a sum is owed to. What a creditor is entitled to is a stated number of rupees, rather than a share of whatever the borrower has done with the money., and what a creditor is entitled to is a number, fixed in advance, that does not care how the festival week went. Almost every mistake further on is a version of forgetting that distinction, so the distinction belongs at the front of the mind.

Why does the word margin mean two different things here?

Because two entirely separate things carry that word, and the confusion is all but certain unless somebody puts them side by side once and then leaves them apart. Both appear in this part of the market, both involve money that somebody has to find, and they run in opposite directions between different parties at different companies.

The first meaning came up earlier. The clearing corporation of Kaveri Stock Exchange Limited, invented, holds margins of Rs 11,000 crore collected from its members against obligations that have not settled yet. The margin money is put up as security by a clearing memberA party permitted to settle trades directly with a clearing corporation. What it takes to be admitted as one is set by the authority named below. and it travels towards the party standing in the middle. Nobody lent it to anybody. The money was collected, and it sits there until the obligation it was collected against is discharged.

The second meaning is the subject here. A broker hands its own money to a client so the client can hold more than the client paid for. The lent money travels away from the broker. The loan carries an obligation to repay, and it has a thing standing behind it. One is money put up as security and the other is money handed over as a loan, and the only thing the two share is a word.

What are the three amounts inside one position?

Three, not one, and a reader who keeps all three in view can rebuild everything that follows without being told any of it. Work them on an illustrated position. Every rupee amount from here on is a declared control setting, chosen so the arithmetic comes out clean enough to check on paper. No broker, no client and no position stands behind these figures, so none of these amounts is a level anybody offers or anybody's arrangement.

THE POSITION is Rs 1,00,000/-. THE CLIENT'S OWN PART is Rs 40,000/-. THE PART THE BROKER LENT is Rs 60,000/-. The three amounts are one equation, and they stay one equation at every price on every day: the client's own part is the position less the borrowed part. Not roughly, not usually, not while things are calm. Always. Every other reading further down is that subtraction done at a different price, so the equation is the one line worth carrying away.

The three amounts are not made of the same kind of thing. The position is a value, and a value is whatever the market says it is this minute. The borrowed part is an obligation, and an obligation is a number somebody wrote down. The client's own part is neither: it is a residue, the thing left over when the written-down number is taken out of the market-decided one. Residues behave strangely, and the rest of this guide is the strangeness.

What happens to each of the three when the position moves?

Take them one at a time. The answer is different for each, and the difference is the entire subject. The position moves with the price, as a position does. The borrowed part does not move at all: Rs 60,000/- was borrowed and Rs 60,000/- is owed, at any price, on any day, in any weather. And the client's own part is what is left when a number that will not move is taken out of one that will, so it absorbs everything.

Work the fall. A movement of minus 10.00 per cent of the position value takes the position from Rs 1,00,000/- to Rs 90,000/-. The borrowed part stays at Rs 60,000/-. So the client's own part goes from Rs 40,000/- to Rs 30,000/-, and the subtraction that produces it is the same one as before: Rs 90,000/- less Rs 60,000/-. The position lost Rs 10,000/- and the client lost Rs 10,000/-. The identical number of rupees came out of a very much smaller starting amount.

The equal rupee loss is where readers pause, so sit on it a moment. Nobody has taken anything extra from the client. The client has simply been the only party exposed to the movement in the first place. The lender put in Rs 60,000/- and is still owed Rs 60,000/-, so as far as the loan is concerned the fall did not happen. The whole of it had to land somewhere, and there was only one other place for it to go.

Why does the client's part move faster, and by how much?

The position divided by the client's own part gives a number: Rs 1,00,000/- over Rs 40,000/- is 2.50 times. The multiple describes the size of the position relative to the money actually put up, and most readers meet it there and stop. The multiple has a second job, and the second job is the one worth having.

The same 2.50 times is also how much further the client's own part moves in proportion than the position does, and this is an identity rather than a coincidence. The identity has to come out that way. Because the third amount refuses to change at all, both amounts always change by the same number of rupees. One of them started 2.50 times the size of the other. An equal rupee change divided by a starting amount 2.50 times smaller is a proportional change 2.50 times larger. There is no room in that for it to be otherwise.

Check it in both directions rather than taking it. A movement of minus 10.00 per cent of the position value gives Rs 30,000/- against a starting Rs 40,000/-. The fall is minus 25.00 per cent, and 2.50 multiplied by 10.00 is 25.00. A movement of plus 50.00 per cent of the position value puts the position at Rs 1,50,000/- and the client's own part at Rs 90,000/-. The rise is plus 125.00 per cent of a starting Rs 40,000/-, and 2.50 multiplied by 50.00 is 125.00. The multiple is fixed at the instant the loan is agreed and it does not drift afterwards unless the amounts themselves are changed.

What happens when the client's part runs out?

The client's own part runs out at a price that can be named in advance, and the naming is one subtraction. The client's own part is nothing when the position equals the borrowed part, and the position equals the borrowed part at Rs 60,000/-. From Rs 1,00,000/- that is a movement of minus 40.00 per cent of the position value. At that moment the position is still worth Rs 60,000/-, a great deal of money, and the client's own part is Rs 0.00/-. Everything put up has gone while the thing bought is still worth more than half what it was.

Now the half that almost nobody is told. The arithmetic does not stop at nothing, and a loss on borrowed money is not limited to the amount put up. Carry the same subtraction two steps further. At a movement of minus 50.00 per cent of the position value the position is worth Rs 50,000/-, the borrowed part is still standing at Rs 60,000/-, and Rs 50,000/- less Rs 60,000/- leaves Rs 10,000/- owed beyond everything the client put in. The position no longer covers the loan. There is no rule of arithmetic that stops it there either.

None of that deserves a shred of blame. Somebody who has only ever bought things with their own money has spent their whole life with a floor underneath them: the worst that can happen is that the thing becomes worth nothing and the money is gone. The floor is real, and it is a property of buying outright rather than a property of the world. Borrowing removes it, quietly, at the moment the loan is agreed and not at the moment the price falls. Nothing about the removal is obvious. The arithmetic has to be shown rather than assumed, and it is worked out above.

The treatment of a position before it gets anywhere near that point, the level at which that treatment begins, and what anybody is required to do about it, are all set by the Securities and Exchange Board of India (SEBI) at sebi.gov.in. A level is exactly the sort of thing that moves, and a printed one would be acted on after it had changed.

Watching the borrowed part refuse to move

One thing in the calculator below is worth watching for specifically. The dark block at the bottom of the bar never changes height. Not at any setting, not once. Every other thing on the drawing moves, and that block sits there being Rs 60,000/- while the position ranges from Rs 50,000/- to Rs 1,50,000/-. The refusal of that block to move is the fact the whole subject rests on, and it is easier to believe once an attempt to shift it has failed.

At the default setting the drawing reproduces the worked position exactly, in static figures that can be read without moving anything: a movement of 0.00 per cent of the position value, a position of Rs 1,00,000/-, a borrowed part of Rs 60,000/-, a client's own part of Rs 40,000/-, and a position over that own part of 2.50 times.

What stands behind the loan, and who holds it?

The position itself stands behind it, and that is what makes the loan possible in the first place. The lender is not looking at the client's salary, the client's savings or the client's other holdings. The lender is looking at the thing the money bought. Take that away and what remains is unsecuredLending with no particular thing standing behind it, so the lender has only a promise to look to. A different arrangement, settled elsewhere on this platform. lending, a different arrangement decided on completely different questions.

The unusual feature of this loan is that the value of the thing standing behind it and the value of the risk move together, and they move in opposite senses. The joint movement explains why this kind of lending behaves the way it does. When the position rises, the lender is more comfortably covered and there was never any trouble. When the position falls, the lender becomes less well covered at precisely the moment the borrower is least able to help. The security and the danger are the same object. No such joint movement runs through a house loan against a house somebody lives in, or through a loan against a salary.

Where the securities actually sit while they are standing behind borrowed money is a real question with a real answer. Securities live as an electronic record in a depositoryThe institution where a security exists as an entry against a name, so a transfer is a change to a record rather than a movement of paper. Named here by function only. rather than as paper in a cupboard, so what has to be true about that record while a loan stands against it is a matter of how the record is kept. The keeping of that record, and whether the lender may look to anything beyond the position at all, a question of recourseHow far a lender may pursue a borrower beyond the particular thing that stands behind a loan. The answer is set by the authority named below., are both set by SEBI at sebi.gov.in.

What does the broker become the moment it lends?

One question runs through this whole part of the market, and lending gives it a different answer. Everywhere else, a broker stands in the middle and carries somebody else's order, and what it is paid for is the standing in between. Its own money is not in the trade. Whether the price goes up or down afterwards is, to the broker, somebody else's news.

Lend against the position and that stops being true. The broker is still in the middle carrying the order, and it is now also a lender to one side of that same order. Being owed a fixed Rs 60,000/- against a position whose value it does not control gives the broker an interest in what happens to that position, and that interest was not there before. The lending is a second job standing beside the first rather than a larger version of it.

Apply the usual test and see what falls out. Remove the lending and the client can hold only what the client can pay for, the broker is back to being paid for carrying an order, and nothing about the price is any of its concern. So the lending is not a feature of brokerage that happens to sit alongside it. Lending is a separate business, done by the same company, with a different exposure attached. Neither arrangement is better than the other in the abstract, and neither one has to be entered at all. The lending gives the broker a fixed sum to be repaid, and it changes who carries the movement in the price.

How does anybody actually use this?

Who sets the conditions on what may be lent?

Four conditions have been walked all the way up to and then stopped at. Every one of them is a real condition with a real answer attached, and each of those answers is set by an authority rather than by a writer. A reader would act on a stated level. Of every subject in this part of the market, this is the one where stating a level would be most dangerous. So the rows below are drawn with the value column empty on purpose, and the authority is printed inside the row where a value would otherwise sit.

The alternative is worth picturing. A printed figure for what may be lent against a position is something a reader could size a position from, and it would be wrong rather than merely stale on the day the condition changed. Because it stays correct and names exactly what to go and ask for, a sheet with four empty rows and an address inside each one is worth more.