Chapter 6- Margin Accounts 3-7 Questions Flashcards
2 Types of Margin Accounts
- Long margin account- customers purchase securities and pay interest on money borrowed
- Short Margin Account- Stock is borrowed and then sold short, enabling customer to profit if value declines (all short sales run through account)
Leverages return on the account and allows customer to purchase more with less
Margin accounts generate interest income for firm and larger commissions for the firm
Documents in a Margin Agreement
Margin Agreement consists of three parts
- Credit Agreement- Discloses terms of the credit extended by broker/dealer, including Rate computation and how it might change
- Hypothecation Agreement- Gives permission to broker to pledge customer Margin securities as collateral for a loan. Securities are in street name. Broker is nominal or named owner.
- Loan Consent Form- Gives broker/dealer permission to loan customer Margin securities for short sales (Not mandatory)
- Risk Disclosure- States rules of account for example: In a Maintenance Call, customer does not pick what is sold. They are not entitled to extension to meet a margin call. Margin requirement can be raised
Regulation T form The Securities Act of 1934
What Securities can be purchased on margin and used as collateral, cannot be purchased or used, cannot be bought but usable after 30 days
Gives authority to Fed Reserve Board to regulate the extension of credit
Minimum of 50% market value of transaction within 5 business days, firms expect 3 days (applies to cash purchases too, assume 50%)
Also identifies what Securities can be purchased on margin and securities that are marginable (can be used as collateral)
Cannot be purchased or used as collateral:
Put and Call options (except leaps, bought at 75% if over 9 months remain)
Rights
Non-Nasdaq OTC not approved by FRB
Insurance Contracts
Can be used for collateral (after 30 days) but not bought on margin:
Mutual funds
New issues
If a covered call is written:
The underlying stock purchase margin requirement is reduced by premium received
If a Spread is written customer must deposit maximum loss
Securities Exempt from Regulation T
Firms determine the margin requirement
Securities exempt include:
- US treasury bills notes and bonds
- Gov agency issues
- Municipals
Initial Required Deposit
Greater of 50% or 2,000 (FINRA rule)
Unless initial purchase is under $2,000 in total purchase price, then pay whatever the full amount was
Between 2000-4000 you pay 2000
For Short Margin Accounts, have to pay $2000 regardless because it’s more speculative
Deadlines for meeting Margin Calls
No more than 5 business days after trade date
Make deposit of cash or securities valued at 200% the margin call of cash
Amount less than 1,000 no action required to file extension, otherwise you have to file to a designated examining authority.
DEA could be FINRA, an exchange or the Fed Reserve Board
If no extension requested, sell out the securities purchased and freeze account for 90 days
Customers wanting to purchase in frozen account must have funds
Free riding is usually prohibited and will result in an account freeze for 90 days. No new purchases unless assets were already in the account
Free riding
Term used when securities are purchased and sold before payment is made
Marking to the market
Making sure that equity on the account still covers
Calculation
Market value - debit register (amount borrowed) = Equity
LMV - DR = EV
Only Market Value and Equity change
Cash vs fully paid securities
Cash deposited to cover margin is 50% of value
Fully paid securities must be of equal value
Fed Reserve Board Requirement vs FINRA requirement
Fed Reserve is the initial purchasing of stock and Regulation T (50% of market value)
FINRA is the margin requirement, which is 25% of Market Value
Debit Register not affected by decrease in market value
Account will become restricted if Equity falls below regulation T but a maintenance call is not made
Maintenance Requirement
Equity falls below the FINRA minimum maintenance requirement of 25%
Must be brought back to minimum or house minimum (30-35%) or securities can be sold
Customer notified by a maintenance call
Formula to get to market value needed is:
Debt / 75%
Maintenance call is always calculated by the LMV*requirement
Maintenance call is put directly into equity and does not effect market value
Excess Equity and Special Memorandum Account
If MV increases:
Regulation T and Minimum Maintenance is increased, along with Equity
Because equity increases at quicker rate, SMA is created (excess about regulation T requirement)
SMA is buying power in the account, and is a line of credit that a customer has access to
SMA changes at 50% rate of equity upwards, but does not drop when the account goes down (SMA is usually restricted when market value drops)
Excess equity over regulation T is generator of SMA
No drop if excess equity drops at later point
Can be used unless it brings account under the minimum maintenance
Increases in SMA
SMA is increased by:
- Equity increases in the account
- If a customer deposits cash to reduce debit and Increase SMA
- Dividends received are added to SMA (can be removed in 30 day window
- Stock deposited at a value of 50%
- Sale of stock at 50%
Using SMA
A customer can withdraw the cash from SMA, which reduces the amount and increases the debit because SMA is a loan
Can also be used to satisfy initial margin requirement of Reg T
SMA has purchasing power of 2:1
SMA of 20,000 has purchasing power of 40,000
If SMA is withdrawn, Equity falls and DR increases
1:1 increases in both case
Rules regarding restricted margin accounts (under the 50% Reg T)
Must put up 50 % to purchase new securities
Must deposit 50% in cash if securities being wished to withdraw
50% of proceeds must be retained to reduce debit balance at a sale
50% of proceeds are credited to SMA, and can be withdrawn
If securities are sold MV and DR are affected
