You need sufficient funds in your Demat account to buy securities from the securities market. However, what will you do if you are slightly short of funds? In such cases, taking a loan from a bank or financial institution can be a solution, but the high interest rates associated with it can be financially troublesome.
Some Indian stockbrokers offer you the option to get a collateral amount using the shares held in your Demat account. Read this blog to understand the function of the collateral amount in Demat account and how it can help you when you do not have enough funds to invest.
What is Collateral Amount in Demat Account?
If you have an online Demat account, you can receive the benefit of getting a collateral amount. A collateral amount in Demat account is a loan amount you get from a stockbroker against your securities. You can increase your purchasing limit using this collateral amount to purchase securities rather than disbursing your cash. Few brokers in India provide this value-added service while others do not because of the associated risks.
Collateral in a Demat account keeps your trading limit high. You can use your shares as collateral to buy more securities. It allows you to get a margin against your idle financial assets instead of cash. You will be charged a rate of interest for this collateral amount. As a result, this collateral can be beneficial for both a trader and a broker.
How Does a Collateral in a Demat Account Function?
Understanding the function of the collateral amount in Demat account is important to limit yourself from taking a loan from a financial institution to buy securities. Similar to the way you approach a lender for a loan, you can apply for collateral from your stockbroker and pledge your shares for that amount.
You do not get a cash amount against the shares you pledge. They increase your trading limit, helping you purchase more securities. The stockbroker will charge an interest rate against the collateral amount it provides.
Advantages of Collateral Amount in Demat Account
Using a collateral amount helps you purchase securities while you are short on funds. Below are the advantages that you will get after using the collateral amount in Demat account:
- A collateral amount in Demat account increases your purchasing ability in the market since it expands your trading limit.
- You can use your shares in the Demat account that have not traded for a long time, and those you do not want to sell to get a collateral amount. This means you can use shares as security for this margin trading. It enables you to avail funds without permanently selling your securities.
- A collateral amount in your Demat account assists in increasing the return rate. Since you leverage this collateral for trading activities and generating profits, your overall account balance increases. You may also earn more returns on your investments with a higher account balance.
- A collateral amount in Demat account allows you to avail profit from the short-term market fluctuations. As it increases your purchasing power, you have the flexibility to capitalise on market fluctuations. While anticipating market volatility, you may utilise your collateral to take advantage of the opportunities as they arise. You may buy low and sell high when the market swings to increase your profit margin.
Disadvantages of Collateral in a Demat Account
Besides availing the benefits of the collateral amount in Demat account, you should become aware of the below disadvantages:
- You must become aware of the price fluctuations in the market, as it can decrease the lending value. This results in margin calls or forced liquidation.
- The collateral amount in Demat account includes interest charges, which might impact your profitability if you do not manage these interests carefully.
- You might face the risk of default while using a collateralised amount since the broker can sell your collateralised securities if you fail to repay the loan.
How May Securities be Pledged for Collateral Margin?
Pledging shares helps you to increase your trading limits without selling your securities. Here are the steps to pledge securities for the collateral amount in Demat account:
Step 1: First of all, choose a broker who offers collateral trade service.
Step 2: Now, choose shares from your trading account that have high liquidity and offer stable performance
Step 3: Submit a pledge request from your stockbroker’s platform after you have chosen the securities.
Step 4: Verify and proceed with your pledge request and provide the necessary documentation.
Step 5: The stockbroker goes ahead with the request and seeks the depository’s approval.
Final Thought
Understanding what is collateral amount in Demat account is essential for expanding your trading limit through your Demat account. A collateral amount in Demat account also increases your purchasing ability and return rate. You can use the collateral amount by choosing the appropriate stockbroker.
Do you want to open a Demat account? Download the Torus Digital application and open a Demat account without paying any charges.
