What is a hedge fund margin call? A margin call is a term frequently used in the investment world, and if you have any investments, you most likely heard it from your broker. Also, it is frequently used in form of its synonyms, which are “fed call,” or “maintenance call”. So, to give you more data about the work of the hedge fund universe, we would like to give you some knowledge about the hedge fund margin call in the same way as we explained the High Water Mark Definition.
The definition of margin
While big investors like Warren Buffett or George Soros probably should not worry that much about the margin call, for a newly-started investor or hedge fund, an encounter with this term might be not a pleasant experience. To better understand the term of margin call, we should first explain what a margin is. A margin represents an amount of money deposited by a owner of a security to cover for the credit risk, which gets higher if the owner borrowed money from a counter-party (a broker, for example), or short sold some securities.
A hedge fund margin call is used by hedge fund managers in order to cover for the losses caused by a decline in value of some securities. In order to compensate for the decrease, the manager has to put in some more money, or sell some assets in order to bring back the value of an account to a particular minimum point, called a maintenance margin.
So let’s say a hedge fund manager wants to buy 100,000 shares of a company at a price of $10 apiece. However, the manager does not have $10,000 required for purchasing shares, but only can invest $5,000. He still can buy 100,000 shares, but the other $5,000 will come from another source, the brokerage for example.
Now let’s assume, that the share price of the recently acquired company falls, by 25%. In case of such situation happens, the brokerage will make a margin call, which means that the manager must provide cash, or sell assets in order to cover the difference between the stock price and the decline in price. This is done mainly because the broker who lent the manager money wants to make sure that it will get back the money it loaned, because there is a possibility that the hedge fund could default because of the decline.
To sum up, a hedge fund margin call is a term that should be taken into accounts especially by newly-established hedge funds. While the hurdle rate, or the high watermark, aside from reflecting the activity of hedge funds, also has a connection with the rewards earned by a manager, the hedge fund margin call is basically what dictates if the hedge fund has the capability to stay afloat.