Margin Trading Facility Interest Rates Explained

While margin trading is a facility available to traders in the stock market, the big question is what are the costs entailed? Is there interest charged on the MTF and if so what is the rate of interest charged? Is the interest on margin standard across brokers or does it vary from one broker to another? How is the interest on margin account charged and what are the prevailing margin trading interest rates. Above all, how is the margin trading interest calculated and debited to the customer.

While trading on margins, one of the key risk calls you need to take is if you can afford the margin trading interest and whether you can actually make a net profits after considering the margin trading interest. Here we also try and understand how the interest on margin account is actually calculated and executed by the broker. Read on to more about margin trading interest rates in the Indian equity markets.

INTEREST ON MARGIN TRADING

How do brokers charge margin trading interest and what are the margin trading interest rates. Let us look at the interest on margin trading in detail. Brokerages charge interest on margin loans and the revenues from the activity is one of the major revenue streams and profitable models for the broker. As a result of the advantage, they get from funding clients on margins, brokers are able to offer more competitive brokerage rates to customers. That is only due to the advantage of interest on margin.

The rates of interest on margin funding are only broadly fixed but depending on your relationship with the broker and the total business given to the broker, you can negotiate for better rates of interest. How is the loan amount calculated for figuring out the interest on margin balances. Since the calculation of margin can vary, you should speak to your broker directly in case you are not fully clear after reading the information on their website. As a general rule, the interest calculation formula takes the annualized interest rate and multiplies it by the amount borrowed (we will understand this in detail later). Then the output is multiplied by the term of the loan. That means; if you avail the margin funding facility for a period of 25 days, then you will multiple the figure by 25/365 to get the payable interest.

Formula for calculating interest on margin trading positions

Interest payable = (Rate/365) x principal x time.

Here let us understand each of the terms in the formula above.

Rate refers to the annualized Interest rate agreed upon on the loan.

Principal - Amount borrowed or the actual debit amount in the margin account.

Term Is measured in number of days borrowing by dividing by 365 to annualize.

Let us spend a movement on how the principal amount is determined. It is not very complex and you must remember that the margin account operates exactly like an overdraft account. The easiest way to find out how much you have borrowed is to take the equity in your account and subtract it by the market value. If you have a net negative amount, this will be the amount of margin funding borrowed or the amount of loan that you have to pay interest on. You use that amount as the principal and calculate interest on the same. If the difference is zero, then you owe nothing. There is no loan implicit in this case. If the margin account is positive, then you can deploy the surplus cash elsewhere since the margin account does not earn much. However, in case, there is a debit in the margin account, that becomes your margin loan amount and interest is calculated on the same.

Remember that this is a very generic approach and is not all encompassing. Every brokerage has its own set of rules and regulations for margin funding and you must talk to your broker or read the fine print of the agreement to be able to take a proper view on the subject.

WHAT IS THE PENALTY ON UNSETTLED MARGIN

Let us digress for a moment and understand what is margin penalty and how does it work in practice in the Indian context. Under the latest extant SEBI regulations, margin shortfall penalty is levied on trades performed without sufficient margin. Here is sufficient margin has been defined explicitly by SEBI. According to the SEBI definition, in the case of futures and options trades, margin will be defined as (SPAN Margin plus Exposure Margin).

However, in the case of equity markets positions, the margin will be defined as (Value at Risk or VAR + ELM + Adhoc Margins for equity). In addition, the applicable margins are the margins for net buy premium in case you are buying options, additional margins for deemed physical delivery and marked to market margins on a daily basis on all trading days, in the case of prices moving unfavourably for your position in the F&O market.

The penalty is levied in case of shortfall in the margin for F&O positions or equity trades based on the short collection by each client in this case. The penalty percentage levied on such short margins will be as under.

In case the short fall is less than Rs.1 lakh and less than 10% of applicable margin, in that case penalty will be charged at the rate of 0.5%. In case the short fall is equal to or greater than Rs.1 lakh and equal to or greater than 10% of applicable margin, in that case penalty will be charged at the rate of 1.0%.

In short the penalties applicable in case of short margins can be pretty steep. However, it must also be noted that the penalty is applied as a percentage of the shortfall amount and is posted in your ledger with the appropriate narration as an explanatory memorandum.

HOW TO CALCULATE INTEREST ON MARGIN

You must have by now understood that brokers charge interest on margin loans based on the net debit on the margin account. To that extent it works like an overdraft facility. Since the calculation of margin can vary, it is always better to read the fine print of the terms and conditions of the margin trading facility (MTF) before attesting your signature on the same. As a general rule, the formula takes the annualized interest rate, multiplies by the amount borrowed, and also multiplies by the time frame of the margin loan.

Formula for calculating interest on margin trading positions

Interest payable = (Rate/365) x principal x time

Here let us understand each of the terms in the formula above.

Rate refers to the annualized Interest rate agreed upon on the loan

Principal - Amount borrowed or the actual debit amount in the margin account

Term Is measured in number of days borrowing by dividing by 365 to annualize.

The easiest way to find out how much you have borrowed is to take the equity in your account and subtract it by the market value. If you have a negative amount, this will be the amount you owe. You pay interest on the debit amount, which is akin to a loan. So, the MTF account almost operates like an overdraft account for you.