Call Money

Published Apr 6, 2024

Definition of Call Money

Call money, also known as “call loans,” refers to short-term finance that banks lend to brokers, who then extend it to investors for buying stocks on the stock exchange. These loans can be called back by the lending bank at any time, with very short notice—usually within 24 hours—hence the term “call” money. They are typically used for financing margin loans, where investors borrow money to buy securities.

Example

Imagine a scenario where an investor wants to buy stocks but does not have enough cash on hand. The investor’s broker could use call money to lend the investor the necessary funds. This loan allows the investor to purchase the stocks immediately. In this case, the broker acts as the intermediary between the bank (the lender) and the investor (the end borrower).

If the stock market is doing well and the stocks bought with the call money increase in value, the investor could make a significant profit by selling the stocks at a higher price. However, since the bank can call the loan back at any time, if the call is made, the broker must repay the loan immediately, which could force the investor to sell the stocks at an inconvenient time.

Why Call Money Matters

Call money plays a crucial role in the financial markets by providing liquidity to brokers and, consequently, to stock market investors. This liquidity is vital for maintaining the smooth operation of the stock market, as it ensures that transactions can be completed without delay.

Moreover, the call money market is an essential component of the money market, influencing interest rates and liquidity within the financial system. The interest rate on call money, known as the call rate, is highly volatile and can fluctuate significantly based on the supply and demand for short-term funds. These rates often serve as a benchmark for other rates in the financial market.

Frequently Asked Questions (FAQ)

How does the interest rate on call money differ from other loans?

The interest rate on call money, or the call rate, is typically higher than rates on secured loans but lower than rates on unsecured loans of similar duration. This is because call money loans come with a very high repayment demand risk but are also backed marginally by the securities purchased. The call rate fluctuates significantly due to its short-term nature and the rapid changes in demand and supply for funds in the money market.

What is the impact of call money on the stock market?

Call money can have a substantial impact on the stock market since it directly affects the ability of brokers to extend credit to investors for buying stocks. An increase in the availability of call money can lead to more buying activity in the stock market, potentially pushing stock prices up. Conversely, if banks reduce the availability of call money or if the call money rate increases significantly, it could lead to reduced buying activity and put downward pressure on stock prices.

What risks are associated with using call money?

The primary risk associated with using call money is its callable nature. Since the loan can be called back at any moment with minimal notice, both brokers and investors need to be prepared for sudden liquidity demands. This could force the investor to liquidate holdings at unfavorable market conditions to cover the loan. Additionally, the volatility of the call rates presents a risk as it can increase borrowing costs unexpectedly.

Using call money involves careful management of risk and liquidity by brokers and their clients. While it provides a significant mechanism for facilitating stock purchases and enhancing liquidity in the financial markets, its volatile nature and callable feature require cautious consideration in both trading and financial strategies.