What is Collateral Amount in Demat Account?
Trading in securities is an exercise that requires a high degree of attention to detail and knowledge of the applicable rules and regulations. For instance, did you know that you can buy securities and trade in them even if you do not have sufficient funds at your disposal? This is where the collateral amount in your demat account comes into the picture.
What is the Collateral Amount in a Demat Account?
The word collateral means an asset you pledge to borrow something or use a service. In the same light, a collateral amount in a demat account is a service you can avail of from your stockbroker to buy shares, debentures, and derivatives in the market. In exchange for this service, the stockbroker holds the assets in your demat account as collateral security and also charges a fee in the form of interest.
Also Read: What Is Dematerialisation of Securities?
How Does the Collateral Amount in a Demat Account Work?
The collateral amount offered to you by your stockbroker is also commonly referred to as a collateral margin. This is because once you pledge the shares and/or debentures held in your demat account, the stockbroker increases your trading margin without any infusion of funds on your behalf. You can, therefore, think of the collateral amount in your demat account as a type of loan issued against the securities you own.
Also Read: Steps of purchasing & selling of Shares
You can purchase securities from your enhanced trading limit. As consideration for the above service, your stockbroker charges a fee termed as interest on collateral. Until the time that you have repaid the collateral amount in your demat account, as well as the applicable interest to your stockbroker, you cannot access or sell the pledged securities.
How is the Collateral Amount in a Demat Account Computed?
The collateral amount in your demat account is computed based on the market value of the securities you are pledging as collateral assets. However, there is a risk of a decline in the market value of the collateral securities, which is why your stockbroker shall not issue the entire value as collateral amount to you. The actual collateral margin issued to you to enhance your trading limit is, thus, lower than the total value of the pledged securities.
Also Read: What is Pleadging of Shares?
What are the Benefits of the Collateral Amount in a Demat Account?
There are several benefits of availing of the facility of collateral margin, some of which have been discussed below:
- It enhances your ability to purchase and trade in securities: Collateral margin is highly useful, particularly if you are facing a liquidity crunch. This facility enables you to purchase and trade securities in the market without adding additional funds to your trading account. Instead, your stockbroker simply enhances your trading limit based on the value of the securities pledged by you.
- It increases your leverage: Since the facility of the collateral amount in your demat account enables you to purchase and trade securities on borrowed money, your leverage gets increased, and so does your ability to earn a higher return without any additional investment.
- It enables you to utilise the securities you own to buy and trade in more securities: Quite often, the securities that you have purchased for the long term stay in your demat account without generating any return in the interim. With the help of the facility of collateral margin, though, you can put those securities to use and engage in more trades.
To Sum It Up
Although the collateral amount in your demat account allows you to have an increased trading limit, it simultaneously strips you of the right to sell the securities that are held as collateral by your stockbroker. You must, therefore, be mindful while availing of the facility of the collateral amount and pay the interest thereof in time.
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Frequently Asked Questions
Your stockbroker's hold on the securities in your demat account that has been pledged as collateral gets released only when you have completed the repayment of the collateral amount as well as the interest outstanding for the extension of the facility of collateral margin to you. Until that time, the pledged securities remain unavailable for you to access, trade, or sell.
If you fail to repay the collateral amount in your demat account or the interest on collateral, you can lose the securities you have pledged as collateral to avail of this facility. The stockbroker is then entitled to sell those securities to recover the collateral amount extended to you as a loan against the pledge.
Therefore, it is extremely important to understand the minutiae of collateral margins before using this facility and to make all the necessary repayments on time.