What Is Collateral Amount In Demat Account?
- 4m0•
- 02 Mar 2023
Many investors are reluctant to keep cash in their trading account. Check if your brokerage allows a collateral amount in your demat account which can be used as a margin. Here, you can simply pledge your securities to the broker, who will give a margin against such securities. You can then use the margin to buy securities. However, you will lose control of your pledged securities unless you repay the margin amount to the broker. The shares in the interim will be with the broker until you close your positions.
If you make profits with the margin, you can repay the broker easily to win your pledged shares back. However, it may happen that you generate losses by trading with the margin. In this case, you will still have to repay the margin amount. Otherwise, the broker will sell off your pledged shares to recover losses.
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How Does A Collateral Margin Work?
Demat account holders are entitled to collateral margins under a certain condition: They must maintain a certain percentage of cash margin of the value of the collateral. Many brokers extend this facility to their clients. The brokerage as well as the investor benefits from the facility. The amount of margin extended to the investor is calculated by reducing the haircut from the present market price of the share which is being pledged. The haircut is the amount that covers for the risk a broker is exposed to if the collateral share prices move erratically. The haircut amount is calculated as a percentage. Say, you have stocks lying in your demat account and do not intend to sell them in the short run. You can simply pledge these to your broker to earn the margin benefit. The broker will oblige by enhancing your trading limits. In effect, you are using your idle assets to create an opportunity to earn more without spending money from your own pocket. From the point of view of the broker, extending this facility to the client enhances its profitability. The broker charges an interest for the service. Usually, this is 0.05% per day.
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What Are The Risks Associated With Collateral Amount?
Collateral margins are offered by only a handful of brokerages in India. That is because the risks associated with it are high. Many investors also fail to maintain the cash–collateral proportion, which is a prerequisite for getting the collateral margin. The cash–collateral position in the client’s account is calculated in the ratio of 10:90. From the broker’s point of view, the proposition is somewhat risky as the pledged securities do not cover 100% of the margin.
Conclusion
The collateral amount in a demat account should be treated as a loan against idle assets in an investor’s demat account. The facility is a value-added service provided by only a few brokerages as the risks associated with it are high. However, it can be an excellent avenue to create wealth for both the broker and the investor. Find out more about the perks of opening a demat account.
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