In the world of stock and share distribution, a collateral amount refers to a loan provided by brokers to clients who are looking to invest in the equity market. In other words, it means providing your securities held in an online Demat account as collateral to increase your trading capacity and continue your equity share transactions seamlessly.
Collateral amount in Demat account entails pledging the assets held in your Demat account in return for which the broker provides you with a loan to continue your trading activity. It is the act of increasing the size of your trading capacity by leveraging shares in your Demat account. This transaction is beneficial to both the investor and broker as the investor can obtain a margin against their securities and other assets to increase their trading cap and the broker earns interest in exchange for this value-added provision.
You might ask what is a collateral margin and how does it actually work in the real world? Let’s take an example of a Demat account holder who wants to sell some of his securities but lacks the required liquidity. In such a scenario, he may deposit some of his unused stock with his broker to cover the credit risk posed to either of the two parties involved. This transaction allows the holder to exchange his shares without having to shell out any extra cash. On making the necessary payment to the broker, the securities kept as collateral can be released to the holder. If he fails to do so or incurs any losses, the holder would still have to make the payment, or the broker has the option to sell the pledged securities or stock and recover the loan amount.
However, it is to be noted that collateral margins are a high-risk transaction for both the investor and the broker. In order to qualify for the collateral margin facility, an investor must maintain a minimum cash-to-collateral ratio, which can be challenging. For the broker, the transaction can be a risky proposition, as the pledged securities may not cover 100% of the margin loan.
As an investor, the first step is to simply open Demat account to embark upon your journey of online trading and using the collateral in the Demat fund. From the discussion above, it is quite clear that the collateral amount in Demat account benefits both the holder and the broker. Margin trading is risky but as long as both the parties adhere to the rules and regulatory procedures it can substantially increase the buying power of the holder.
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