A house call is a brokerage firm’s demand that a customer cover a shortfall in the amount deposited to cover losses in purchases made on margin. This demand is triggered when the customer’s margin account falls below the brokerage firm’s maintenance margin requirements.
How Do House Calls Work?
Margin Accounts and Initial Margin
When investors buy securities on margin, they borrow part of the purchase cost from the brokerage. The investor must initially deposit a certain percentage of the purchase price, known as the initial margin.
Maintenance Margin and Shortfall
Brokerage firms require investors to maintain a minimum amount of equity in their margin accounts. This is known as the maintenance margin. If the value of the securities in the account drops too much, the equity in the account falls below the maintenance margin, leading to a shortfall.
Triggering a House Call
A house call is made when the equity in the margin account falls below the maintenance margin requirement. The investor must then deposit additional funds or securities to bring the account back up to the required level.
Types of Margin Calls
Regulation T Margin Call
Regulation T, established by the Federal Reserve Board, sets the initial margin requirement for securities in the U.S. If this requirement is not met, a Regulation T margin call is issued.
Maintenance Margin Call
This is issued when the equity in the margin account falls below the maintenance requirement set by the brokerage firm.
House Call
Also known as a margin maintenance call, a house call is specific to the brokerage firm’s policy and can be more stringent than regulatory requirements.
Special Considerations
Timely Response
Investors must respond quickly to house calls to avoid forced liquidation of their securities. Brokerage firms usually provide a short window to meet the margin requirement.
Volatile Markets
In volatile markets, the frequency and severity of house calls can increase, making it crucial for investors to closely monitor their margin accounts.
Examples
Scenario 1: Minor Drop in Stock Prices
An investor buys $10,000 worth of securities on margin with an initial deposit of $5,000. The maintenance margin requirement is set at 25%. If the value of the securities drops to $6,000, the equity falls to $1,000, prompting a house call.
Scenario 2: Sharp Decline
If the same $10,000 investment falls sharply to $4,000, the equity in the account becomes negative, and the investor faces a significant house call demanding immediate action.
Historical Context
The concept of margin trading and house calls gained prominence in the early 20th century with the growth of stock markets. The Great Depression highlighted the risks associated with margin trading, leading to stricter regulations and the establishment of Regulation T.
Applicability
House calls are relevant in modern-day trading, especially for investors who use leverage to increase their market exposure. Understanding and managing margin accounts is crucial for avoiding forced liquidations and potential financial losses.
Comparisons to Related Terms
Margin Call
A general term for any demand by a brokerage to deposit additional funds into a margin account.
Margin Requirements
The levels set by regulatory authorities or brokerage firms that must be maintained in margin accounts.
Leverage
The use of borrowed funds to increase the potential return on investment, which also increases potential risk.
FAQs
What happens if I fail to meet a house call?
Can house calls be avoided?
Are house calls common?
References
- Securities and Exchange Commission (SEC) - “Investor Bulletin: Understanding Margin Accounts”
- Financial Industry Regulatory Authority (FINRA) - “Margin: Borrowing Money to Pay for Stocks”
- Federal Reserve Board - Regulation T
Summary
House calls are an essential aspect of margin trading, demanding that investors maintain adequate equity in their accounts to cover potential losses. They ensure the financial stability of both the investor and the brokerage firm. By understanding how house calls work, investors can better manage their risk and avoid the pitfalls of margin trading.
