Canadian Securities Course (CSC) Level 1 Practice Exam

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What are the 3 margin risks?

Market risk, deferred interest, stock redemption
Market volatility, increased commissions, dividend premium
Increased market risk, loan repayment, margin calls
Insufficient funds, price volatility, market crashes

The correct answer is: Increased market risk, loan repayment, margin calls

The correct answer identifies three significant risks associated with margin trading: increased market risk, loan repayment, and margin calls. Increased market risk is relevant because when trading on margin, investors are often exposed to greater fluctuations in the value of their investments. A small decline in the value of the stock can lead to a disproportionately larger loss relative to their equity since the investor has borrowed funds to finance their trade. Loan repayment is also a crucial aspect of margin trading. When funds are borrowed, there is an obligation to repay those loans, which can become problematic if the value of the investment decreases significantly or if the investor's financial situation changes. Margin calls occur when the value of the securities in a margin account falls below a certain threshold. The brokerage firm may require the investor to deposit additional funds or sell some of their holdings to bring the account back to the required level, which can lead to forced selling at disadvantageous prices. These elements underscore the risks involved in trading on margin, differentiating them from factors like dividend premiums or increased commission costs, which do not directly relate to the inherent risks of margin trading itself.