LOS f: Describe methods used by institutional investors in the bond market to finance the purchase of a security (i.e., margin buying and repurchase agreements).

Example: An investor has $5,000 cash, but wants to buy ten $1,000 face value bonds at par (for a total of $10,000). With cash only, he can only purchase five of the bonds. With a 50% margin account, he can buy all ten bonds ($5,000 cash equity contribution and $5,000 from the margin account). With the margin account, he will realize the gain or loss on all ten bonds rather than the five he could have purchased with cash only.

The statements about the rates paid by the parties to a margin transaction are reversed. The statement, “In margin transactions, the broker borrows from the bank at the call money rate plus a spread,” should read, “…borrows…at the call money rate.” The statement, “The rate the investor pays on the loan in a margin transaction is known as the call money rate.” should read, “…known as the call money rate plus a spread.” Remember that the broker needs to make profit, so the investor will pay a rate higher than the broker pays to the bank.

The margin percentage is fixed by contract. The required margin dollars may vary from day to day due to fluctuations in the underlying collateral.