MAINTENANCE RATIO Meaning and
Definition
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Maintenance ratio refers to the minimum amount of collateral required to be maintained in a margin account when engaging in leveraged trading. It is a financial metric that helps ensure that the borrower or trader has sufficient assets to cover potential losses in the event of a market downturn or decrease in the value of their investments.
In margin trading, individuals can borrow funds from a broker to invest in financial instruments, such as stocks or derivatives, using their existing securities or cash as collateral. The maintenance ratio is set by the broker and specifies the minimum ratio of the value of the collateral to the total value of the investments. It serves as a protective mechanism for the lender to mitigate potential risks in case the borrower is unable to cover their losses.
For example, if the maintenance ratio is set at 25%, it means that the trader must maintain at least 25% of the total value of their investments as collateral. If the value of their investments falls and the collateral value drops below the maintenance ratio, the trader will have to add more collateral to bring it back to the required level. Failure to maintain the maintenance ratio may lead to a margin call from the broker, where the trader needs to deposit more funds or securities to increase their collateral, or face the liquidation of their positions.
The maintenance ratio serves as a risk management tool for both the trader and the broker, ensuring that sufficient assets are maintained to prevent excessive losses and protect the interests of all parties involved in leveraged trading.
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Etymology of MAINTENANCE RATIO
The word "maintenance ratio" is derived from the combination of two words: "maintenance" and "ratio".
1. Maintenance: The word "maintenance" is derived from the Latin word "manu tenere", which means "to hold by hand". It entered the English language through Old French and ultimately refers to the act of keeping something in good condition or preserving its functionality. In the context of finance or investing, maintenance refers to the ongoing effort required to sustain or support an asset or investment.
2. Ratio: The word "ratio" is derived from the Latin word "rationem", meaning "reckoning, calculation, or account". It entered the English language through Old French and refers to the relationship or proportion between two quantities or values. Ratios are commonly used in various fields, including finance, mathematics, and statistics, to compare different variables or express relationships between them.
Similar spelling word for MAINTENANCE RATIO
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