Margin Accounts

  1. Long Margin Accounts
    Customers purchase securities & pay interest on the money borrowed until the loan is repaid
  2. Short Margin Accounts
    Stock is borrowed and then sold short, enabling teh customer to profit its value declines

    All short sales must be executed through and accounted for in a margin account
  3. Advantages of Margin Accounts for CUSTOMERS
    • -Purchase more securities with a lower initial cash outlay
    • -Leverage the investment by borrowing a portion of the purchase price
    • *Leveraging magnifies the customer's rate of return, or rate of loss
  4. Advantages of Margin Accounts for BROKER/DEALERS
    • -Margin account loans generate interest income for the firm
    • -Margin customers typically trade larger positions because of increased trading capital, generating higher commissions for the firm
  5. Margin Agreement
    • Consists of 3 Parts:
    • 1)Credit Agreement
    • 2)Hypothecation Agreement
    • 3)Loan Consent Form (Optional)
  6. Credit Agreement
    Discloses the terms of the credit extended by the broker/dealer, including the method of interest computation and situations under which interest rates may change
  7. Hypothecation Agreement
    Gives permission to the BD to pledge customer margin securites as collateral

    The firm hypothecates customer securities to the bank, and the bank loans money to the BD on the basis of the loan value of these securities

    All customer securities must be held in street name (registered in the name of the firm) to facilitate this process
  8. Loan Consent Form
    (Optional) If signed, the loan consent form gives permission to the firm to loan customer margin securities to other customers or BDs, usually for short sales
  9. Risk Disclosure
    Before opening a margin account, must be provided with a risk disclosure - information must also be provided to margin customers on an annual basis

    • 1)Customers are not entitled to choose which securities can be sold if a maintenance call is not met
    • 2)Customers can lose more money than initially deposited
    • 3)Customers are not entitled to an extension of time to meet a margin call
    • 4)Firms can increase their in-house margin requirements without advance notice
  10. Regulation T
    The Securities Act of 1934 gives the FRB the authority to regulate the extension of credit in the securities industry.

    • -States that customers must deposit a minimum of 50% of the market value of the transaction within 5 business days
    • -The minimum required is 50%, the customer can choose to pay a larger percentage of the purchase price
    • -Regulation T applies to both cash and margin accounts - customers have 5 business days to pay for the purchase regardless of the account type; Firms, however, expect payment the regular way: within 3 business days of trade date
    • -Regulation T also identifies which securities are eligible for purchase on margin and which may be used as collateral for loans for other purchases
  11. Marginable Securities
    • -Refers to securities that can be used as collateral in a margin account
    • 1)Exchange-listed Stocks
    • 2)Nasdaq Stocks
    • 3)Non-Nasdaq OTC issues approved by the FRB

    • Can be used as collateral after 30 days
    • 1)Mutual Funds
    • 2)New Issues
  12. Securities that CANNOT be used as Collateral
    • Cannot be used as collateral or purchased on margin:
    • 1)Put and call options
    • 2)Rights
    • 3)Non-Nasdaq OTC issues NOT approved by the FRB
    • 4)Insurance contracts
  13. Exempt Securities
    • Exempt from Regulation T Margin Requirements (if bought and sold in margin account, they are subject to the firm's determination of an initial requirement and firms must follow maintenance requirements established by FINRA or their SRO rules)
    • 1)US Treasury bills, notes, and bonds
    • 2)Government Agency Issues
    • 3)Municipal Securities
  14. Initial Requirements
    • Regulation T: Deposit of 50% of the market value of the purchase required
    • FINRA: Initial deposit cannot be less than $2,000

    *customer required to deposit the greater of the Regulation T or FINRA requirement
  15. Marking to the Market
    • The practice of recalculation to check the status of the equity in the account
    • -Typically done every business day on the basis of teh closing price of the stock
    • -Applies to both long and short margin accounts
  16. Long Margin Accounting
    LMV = Long Market Value: Current market value of the stock position the investor purchased

    DR = Debit Register: The amount of money borrowed by the customer

    EQ = Equity: The customer's net worth in the margin account; represents the portion of the securities the customer fully owns


    • *Minimum Maintenance = of FINRA is 25% of the LMV
    • *Regulation T = 50% of the LMV
  17. Restricted Accounts
    If the equity in the account is less than the Regulation T amount, but greater than or equal to the minimum maintenance requirement, the account is restricted
  18. Maintenance Requirements
    When the equity in the account falls below the minimum maintenance requirement, the customer receives a Maintenance Call.

    If a payment is not made, the BD will liquidate enough of the securities in the account to bring the account back to minimum

    Customer can meet a maintenance call by depositing cash or fully paid marginable securities
  19. Excess Equity and Special memorandum Account (SMA)
    Excess Equity = amount of equity exceeding the Regulation T Requirement

    Excess Equity = SMA =Buying Power

    • -Line of credit the customer can borrow from or use to purchase securities
    • -When SMA is used, the debit balance in the customer's account is increased and the equity falls
    • -The amount of SMA in the account is equal to the greater of teh excess equity or the amount already in SMA
  20. Other Ways to Generate SMA
    • -Nonrequired Cash Deposits: If a customer deposits cash that is not required to meet a margin call, the full amount reduces the debit and is also credited to SMA
    • -Dividends: Dividends received on securities in the margin account are added to SMA; customer can withdraw these income distributions, even if the account is restricted
    • *If a customer wants to remove cash dividends coming into his margin account, he must do so within 30 days of receipt. Otherwise, the cash dividend will be applied against the debit balance, thereby increasing the equity in the account.
    • -Loan Value: If a customer makes a nonrequired deposit of marginable stock, the stock's loan value is credited to SMA. The credit is equal to half the value of a cash deposit
    • -Sale of Stock: When stock is sold, 50% of the sales proceeds is credited to the SMA
  21. Using SMA
    • *SMA is a line of credit - therefore the investor can use it to withdraw cash or meet the margin requirement on stock purchases
    • *SMA can be used as long as it does not cause a maintenance call
    • *SMA can be used to meet the initial margin requirements on stock purchases
    • *SMA gives the investor buying power
  22. Critical Long Margin Account Concepts
    • -First transaction in a margin account requires a deposit of the greater of 50% of the LMV or $2,000. The $2,000 minimum is waived if 100% of the transaction is less than $2,000
    • -The basic margin equation is : LMV-DR=EQ
    • -Regulation T = 50% of the LMV
    • -Minimum Maintenance = 25% of the LMV
    • -SMA can be borrowed from the account, dollar for dollar - and in utilizing, debit balance increases
    • -The buying power of SMA is 2 to 1
    • -Excess equity and SMA are not necessarily equal
    • -SMA cannot be used to meet a maintenance Margin Call
    • -The Market Value at maintenance = DR/.75 (calculates what the market value can fall to before a maintenace call is sent)
    • -Exempt securities are not subject to Regulation T but are subject to the maintenance requirements of FINRA
  23. Restricted Accounts
    • 1) To purchase additional securities, put up 50%
    • 2) To withdraw securities from the account, the customer must deposit cash equal to 50% of the value of the securities to be withdrawn
    • 3) If securities are sold in a restricted account, at least half the proceeds must be retained in the account to reduce the debit balance. This is called the retention requirement. Also, 50% of teh proceeds are credited to the SMA.

    LMV, DR, and SMA are all affected if an account is restricted
Card Set
Margin Accounts
Margin Account