How does MTF work?

Margin funding is a concept that draws the interest of investors looking to amplify their potential gains in the stock market. It offers the opportunity to leverage your investments and potentially earn higher returns. However, it comes with its own set of complexities and risks. So, before you adopt it, you must understand how MTF works. In this article, we look into the mechanics of margin funding and explore its workings.

What is MTF?

Margin funding is a practice where you can borrow funds from your broker to purchase securities (stocks), using the securities themselves as collateral. In simpler terms, it allows you to buy more shares than you could with just your capital. The collateral serves as a security deposit against the funded amount, and the borrowed amount is used to amplify your purchasing power. A Margin funding Facility is an option given to you by your stock broker. 

How Does Margin funding Work?

Are you curious to know how margin funding works? We are sure you are. Let us start with the basics.

To engage in margin funding, you need to open a demat and trading account with your broker. When you borrow funds for margin funding, you incur interest charges. You need to pay interest on the borrowed amount for the duration it remains outstanding. The interest rates vary depending on market conditions and the broker's policies.

When you purchase securities in the Demat account, and the value of these securities increases over the rate of interest charged on them, then you enjoy higher returns than they would have if you had invested in securities solely with your funds. 

As mentioned above, the broker charges interest on the funds for as long as the funded amount remains outstanding, thereby increasing your cost of purchasing the securities. For this reason, if the securities decline in value, you will suffer losses. And on top of it, you pay the broker interest on margin funds.

Understanding MTF With Example

Let us understand how margin funding works with an example. Mr Sharma wants to engage in margin funding. He has Rs 50,000 in his trading account and wants to buy shares of a company, ABC Ltd., which is currently trading at Rs 100 per share. Mr Sharma's broker offers a 50% margin requirement for margin funding on ABC Ltd., meaning Ramesh can leverage his initial capital by 2x. 

In a cash segment, he can use his capital of 50,000 to buy 500 shares, and if the share price moves to 110, he makes a profit of Rs 5,000. If the share price falls to Rs 90, he loses 10% of his capital.

With margin funding, Mr Sharma can effectively control Rs 1,00,000 worth of ABC Ltd. shares. Mr. Sharma decides to buy 1,000 shares of ABC Ltd. at Rs 100 per share. Since he is leveraging his investment by 2x, he only needs to invest Rs 50,000 of his capital.

Case 1: Share price moves to Rs 120 per share

• Sale of 1000 shares at 120 = Rs 1,20,000
• Initial investments = Rs 50,000
• Profit = Rs 70,000
• ROI = (70,000/50,000) * 100 = 140%

Case 2: Share price moves to Rs 80 per share

• Sale of 1000 shares at 80 = Rs 80,000
• Initial investments = Rs 50,000
• Loss = Initial Investment - Sale Proceed = (30,000)
• ROI = (-30,000/50,000) * 100 = -60%

To use MTF, Mr Sharma will have to pay interest, which is on the higher side. The effective profit/loss will decrease/increase accordingly.

Features of Margin funding Facility

Now that you understand how MTF works, it will be easy for you to understand the features:

• Margin funding allows you to amplify your purchasing power by borrowing funds from your broker. It enables you to control larger positions in the market with a smaller amount of capital.
• With leverage, you have the potential to earn higher returns on your investments. By controlling larger positions, even small price movements in the market can result in significant profits.
• In margin funding, if the value of securities held in the Demat account falls below a certain threshold, the broker may issue a margin call. It requires you to either deposit additional funds or sell securities to meet the margin requirements.
• Margin funding activities are regulated by governing bodies such as the Securities and Exchange Board of India (SEBI).

Importance of Margin funding

Margin funding plays a significant role in the financial markets and offers several benefits to investors, traders, and the overall market ecosystem. Here is the significance of margin funding:

• The reason why MTF is significant is because it allows you to take up ultra-short-term opportunities available in the markets, which you would have otherwise missed out on.
• Margin funding enhances market liquidity by facilitating increased trading activity.
• By leveraging their investments, margin traders have the potential to amplify their returns.
• Margin funding contributes to price efficiency in the financial markets by encouraging active participation and increasing trading volumes. 
• Margin funding facilitates capital formation by providing companies, with access to a larger pool of investors willing to finance their growth through equity investments.

FAQs on Margin funding Facility

How is the Margin Determined?

Margin can be calculated by subtracting the assets' total cost from the total value of assets.

What are the different charges for MTF?

There are two types of charges. First is the delivery brokerage charge, and second is the MTF interest rates.