Stock markets hit many lows and highs during their normal course of business and this is the very nature of the markets. This volatility which is a part and parcel of investment in stocks has not stopped the investors from taking a plunge into the markets. Especially in the post-pandemic, period, India has seen a tremendous increase in the number of investors and traders that have taken up stocks as not only a source of investment but also as their primary source of income through trading. For this purpose, it is imperative for traders and investors to know the key terms and functionalities of the markets. The collateral amount in DEMAT account is one such key information that needs a thorough understanding for effective and profitable trade.
Given below are details of the basic meaning and related information on the collateral amount in the Demat account.
What is a Demat account?
Before proceeding to the meaning of collateral amount, let us first understand the basic meaning of a Demat account. A Demat account is a digital account where the shares of an investor or trader are held in the digital or dematerialized format. This helps the traders and the investors to buy and sell their shares easily in real-time. Investors and traders can hold assets like shares, mutual funds, government securities, etc. A Demat account can be opened easily through an online portal offered by any registered broker. The investor or trader simply needs to provide the necessary KYC and the requisite fees to open a Demat account.
What is the collateral amount?
Stock trading requires a huge capital influx to buy and sell securities as well as take suitable positions based on the market fluctuations. The timing of taking up the positions is crucial to maximize profits or minimize losses and this requires cash. If the investors are not able to furnish enough cash, brokers help them trade in stock markets by providing them funds in the form of margin money.
This margin money is in the form of a loan and is provided against collateral. Demat account holders can provide this collateral in the form of shares or securities already held in the Demat account to be used as a pledge by the account holders.
The broker will provide a percentage of the value of the securities pledged as a collateral amount or collateral margin that can be used by the traders for their trades. The collateral amount provided varies based on the policies of individual brokers and the maximum margin money that can be provided by them. The shares pledged as collateral are blocked by the broker and cannot be sold till the time the account holder has repaid the collateral margin fully to the broker. In the event the account holder is not able to repay the broker, they can liquidate the pledged shares and recover the collateral amount.
What are the points to consider with regards to collateral amount?
Many brokers provide collateral margin to the traders having a Demat account with them. In order to get this collateral, traders need to consider a few points. Some of such points are highlighted below.
- The collateral amount for any trader is calculated based on the availability of cash in the trading account.
- Before providing the collateral amount, the broker will reduce the value of the shares by a haircut amount which is a nominal amount reduced by the broker from the current value of the shares to be pledged. Such an amount is deducted to reduce the risk of the broker in case the value of the shares pledged decreases due to market volatility.
- The collateral amount can be used to purchase and trade in equity shares, commodities, and futures and options.
- This amount cannot be used to purchase or trade in any bonds, mutual funds units, and money market instruments.
What are the benefits of the collateral amount in the Demat account?
A collateral amount is an important tool that is available to the traders for trading in the stock markets. Some of the key benefits of the collateral amount in the Demat account are mentioned below.
- Availing the collateral amount is an easier way to get funds for trading in stock markets rather than using the trader’s personal cash for this purpose.
- The collateral amount allows the traders to use their stocks already available in the Demat account putting them in good use rather than letting them be idle in the account.
- The collateral amount increases the purchasing power of the trader.
- The collateral amount also helps the traders take advantage of the short-term volatility and maximize their net returns in the process.
Conclusion
A collateral amount is usually provided by brokers to the traders having sufficient shares in their account and trading balance. This facility is provided at nominal charges however, it is important to repay the collateral amount on time to ensure that the pledged shares are not sold off by the brokers to meet the shortfall.
FAQs
Yes. Brokers take the risk of losing the collateral amount in the event of non-payment by the trader and the stock price reducing to a great extent on account of market fluctuations. Due to such market volatility, the broker may further not get the full value of the collateral provided by them.
No, the collateral facility is not provided by all the brokers in India.
Haircut amount is the value deducted by the brokers from the current market value of the stock or security to be pledged. This reduced amount acts as a cushion against the market fluctuations and reduces the risk of the brokers.
Yes. The trader has to repay the collateral amount to the broker despite any situation of profit or loss as the amount is used for trade resulting in such gains or losses.
Yes. The collateral amount is definitely in the form of a loan that is given by the broker to purchase shares or take suitable positions in futures and options markets or on money market instruments.
