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SIE Study Guide (personal notes, Kaplan) > Cash and Margin Accounts > Flashcards

Cash and Margin Accounts Flashcards

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1
Q

What are the two ways securities trades can be conducted?

A

Using cash or using margin

Most securities trades are done for cash, with only about 10% done using margin.

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2
Q

What does a margin trade involve?

A

The investor borrows a portion of the purchase price from the broker-dealer

The investor pays cash for part of the trade and borrows money for part of the trade.

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3
Q

Who can open a cash account?

A

Anyone eligible to open an investment account

In a cash account, a customer pays in full for any securities purchased.

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4
Q

What is expected by the end of the day on the settlement date (T+1) in a cash account?

A

Payment in full for securities purchased

This is known as regular way settlement.

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5
Q

What is regular way settlement?

A

An industry standard enforced by self-regulatory organizations, primarily FINRA

Payment is expected by the end of the day on the settlement date (T+1).

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6
Q

What does Federal Reserve Regulation T require regarding payment?

A

Payment must occur not later than two business days after the standard settlement period (S+2)

This regulation supports timely payment expectations.

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7
Q

What is one consequence of not respecting regular way settlement?

A

Few broker-dealers will tolerate customers that don’t respect it

This emphasizes the importance of timely payment in trading.

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8
Q

What advantage does trading on margin provide to customers?

A

Allows customers to trade larger positions than they could afford otherwise

Customers can borrow either cash or securities through their broker-dealers.

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9
Q

What are the two types of margin accounts?

A

Long margin account and short margin account

Each serves different trading strategies involving borrowing.

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10
Q

How does a long margin account function?

A

Customers purchase securities with borrowed money and pay interest on the loan

Interest continues until the loan is repaid.

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11
Q

What is the purpose of a short margin account?

A

Allows customers to borrow stock and sell it short, profiting if its value declines

All short sales must be made in a margin account.

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12
Q

What is leverage in the context of margin trading?

A

Using borrowed money or stocks to increase potential returns

This increases both potential gains and risks.

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13
Q

What is the most common source for borrowing stock for short sales?

A

Another customer’s margin account

The other customer must give permission by signing a consent to loan agreement.

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14
Q

List three advantages of margin accounts.

A
  • Purchase more securities with a lower initial cash outlay
  • Leverage the investment by borrowing a portion of the purchase price
  • Leverage increases in the rate of return if the security price moves favorably
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15
Q

What are two downsides of using margin?

A
  • Investor pays interest on the amount borrowed
  • Leverage increases the rate of loss if the security price moves against the investor
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16
Q

What percentage of the value of their securities can an investor borrow?

A

Up to 50%

This limit is set by the Federal Reserve Board.

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17
Q

What are the three forms needed to add margin borrowing to an account?

A
  • Credit agreement
  • Hypothecation agreement
  • Consent to loan agreement
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18
Q

What does the credit agreement disclose?

A

Terms of the credit extended to the customer by the BD

Includes the method of interest computation and situations under which interest rates may change.

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19
Q

What is the purpose of the hypothecation agreement?

A

Allows the BD to hold the securities in the account as collateral for the loan

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20
Q

In a margin account, how must all customer securities be held?

A

In street name (registered in the name of the BD)

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21
Q

What does the consent to loan agreement allow the firm to do?

A

Loan the customer’s margin securities to other customers or BDs

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22
Q

True or False: A broker-dealer is required to provide a risk disclosure document to the margin customer.

A

True

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23
Q

What does Regulation T define?

A

It defines what securities may be purchased with margin as well as those that can’t be purchased on margin.

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24
Q

Which securities may be purchased on margin?

A
  • Exchange-listed stocks and bonds
  • Nasdaq stocks
  • Over-the-counter (OTC) issues approved by the Federal Reserve Board (FRB) for margin
  • Warrants
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25
Which securities cannot be purchased on margin?
* Options (both calls and puts) * Rights * Non-National Market System (non-NMS) securities * OTC issues not approved by the Federal Reserve Board (FRB) * Insurance contracts
26
Which securities cannot be purchased on margin but can be used as collateral after being held for 30 days?
* Mutual funds * New issues, if the securities can be used as collateral for a margin loan
27
What types of securities are exempt from the FRB's Regulation T margin requirements?
* U.S. Treasury bills, notes, and bonds * Government agency issues * Municipal securities
28
What determines the initial deposit requirement for exempt securities bought or sold in a margin account?
The firm determines the initial deposit requirement.
29
Fill in the blank: _______ defines the securities that may be purchased with margin.
[Regulation T]
30
True or False: Options can be purchased on margin.
False
31
What agreements must a customer sign to open a margin account?
The credit agreement and hypothecation agreement ## Footnote The consent to loan agreement is optional and not required by regulators.
32
What document must a BD provide before a customer opens a margin account?
A risk disclosure document ## Footnote This document must also be provided to margin customers on an annual basis.
33
What are some risks associated with margin trading?
* Customers can lose more money than initially deposited * Customers are not entitled to an extension of time to meet a margin call * Firms can increase their in-house margin requirements without advance notice
34
What is required for adding margin to an account?
Principal approval before the first margin trade
35
What types of accounts may have margin?
* Most individual and joint accounts with required forms and principal approval * Corporate and partnership accounts, subject to corporate bylaws or partnership agreements * Trust and other fiduciary accounts, if the trust document allows margin
36
What must be checked for corporate and partnership accounts regarding margin?
The corporate charter or bylaws (partnership agreement) to see if a rule against margin exists
37
If a corporate charter or partnership agreement is silent on margin, what does it indicate?
Margin is allowed
38
What must be true for trust accounts to allow margin?
The trust document must specifically allow margin
39
True or False: IRAs and other retirement plans may be margin accounts.
False ## Footnote Accounts with contribution limits and custodial accounts may not be margin accounts.
40
Fill in the blank: A BD may make the _______ mandatory for its margin customers.
consent to loan agreement
41
What is Regulation T?
Regulation T is a Federal Reserve Board regulation that governs the amount of credit that brokers and dealers can extend to customers for the purchase of securities.
42
True or False: Regulation T requires investors to pay 100% of the purchase price of securities in cash.
False
43
What is the standard initial margin requirement set by Regulation T?
The standard initial margin requirement set by Regulation T is 50%.
44
Fill in the blank: FINRA's margin rules are designed to __________ the risks associated with trading on margin.
mitigate
45
What does FINRA stand for?
Financial Industry Regulatory Authority
46
True or False: FINRA's initial margin requirements can be higher than those set by Regulation T.
True
47
What is the primary purpose of initial margin requirements?
The primary purpose of initial margin requirements is to ensure that investors have a financial stake in their investment, thereby reducing the risk of default.
48
Multiple Choice: Which of the following is NOT a factor that can affect margin requirements? A) Type of security B) Market conditions C) Investor's credit history D) Length of time held
D) Length of time held
49
What happens if an investor's equity falls below the maintenance margin requirement?
The investor may receive a margin call, requiring them to deposit additional funds or sell securities to bring the account back into compliance.
50
Short Answer: What is a margin call?
A margin call is a demand by a broker for an investor to deposit additional money or securities to cover possible losses.
51
What is the effect of margin trading on gains and losses?
Margin trading can accelerate both gains and losses.
52
What happens to a customer's equity if a stock's value drops?
The customer's equity in the account will also drop.
53
What is a maintenance call in margin trading?
A maintenance call is issued when a customer's equity drops below 25% of the account's market value.
54
What must a customer do upon receiving a maintenance call?
The customer is required to deposit additional assets to bring the equity up to the 25% minimum.
55
What can happen if a customer fails to make the required deposit after a maintenance call?
The BD may liquidate (sell off) assets from the account.
56
In a margin account, what is the minimum deposit requirement according to Regulation T?
The minimum deposit is the higher of 50% of the purchase price or $2,000.
57
What is the FINRA requirement for minimum deposit in a margin account?
The FINRA requirement is $2,000 or 100% of the purchase price if less than $2,000.
58
Fill in the blank: If a customer's equity drops below _______ of the account's market value, they receive a maintenance call.
25%
59
True or False: A maintenance call requires the customer to withdraw assets from their margin account.
False
60
Discretion is granted to
the representative, not the BD. | If representative leaves the firm or dies, that authority ends.
61
What constitutes a discretionary trade?
* An action (buy or sell) * The amount of the trade (shares or dollars) * The specific asset to be traded (what you are buying or selling)
62
True or False: Allowing the representative to choose the time or the price at which a trade is executed is considered discretion.
**False**: Allowing the representative to choose the **time** or the **price** at which a trade is executed is not considered discretion. This is called **time and price authority**
63
What is a discretionary trade?
A trade where a representative uses their own judgement for one or more of the three A elements.
64
What must a customer provide for a trade to be non-discretionary?
All three of the A elements must be provided or agreed to by the customer.
65
What is considered time and price authority?
Allowing the representative to choose the time or the price at which a trade is executed.
66
What is required for a discretionary trade to be properly entered?
The client must agree, in writing, to grant discretionary trading authority to a representative, and a principal must approve it in writing.
67
Who must approve discretionary trades and when?
A principal must approve discretionary trades promptly after entry.
68
How must a client revoke discretionary authority?
In writing.
69
How are accounts that allow discretionary trades supervised compared to those that do not?
They will be supervised more closely.
70
What is the purpose of supervising discretionary accounts more closely?
To ensure the authority is used in a manner that benefits the customer.
71
What is an unsolicited trade?
A trade that has not been suggested by the BD or a representative ## Footnote The trade ticket or order form for an unsolicited trade should be marked as unsolicited.
72
What is a discretionary trade?
A trade placed in the customer's account by a registered representative without the customer's permission ## Footnote This requires specific authorization from the customer.
73
What must be done to exercise discretion in trading?
Obtain specific authorization from the customer ## Footnote Discretionary authority is a type of power of attorney granted by the customer.
74
What is required for trades that are made under discretionary authority?
They must be marked as discretionary ## Footnote Failure to mark these trades as discretionary is considered a serious violation.
75
True or False: A customer can give trading authority to a registered representative without their permission.
True
76
Fill in the blank: A discretionary authority is a type of _______.
power of attorney
77
What is the purpose of the consent to loan agreement?
Gives the firm permission to loan the customer's margin securities to other customers or BDs for short sales ## Footnote This form is optional but may be made mandatory by firms for margin customers.
78
What agreements must a customer sign to open a margin account?
Credit agreement and hypothecation agreement ## Footnote The consent to loan agreement is not required by regulators.
79
What is the initial margin minimum deposit?
The higher of $2,000 or 50% ## Footnote Initial margin requirements are set by both Regulation T and FINRA.
80
According to FINRA, what must customers deposit if the purchase price is less than $2,000?
$2,000 or 100% of the purchase price ## Footnote Customers will always deposit the higher amount of either Regulation T rule or the FINRA rule.
81
What is the deposit requirement if the purchase price is $4,000 or greater?
50% of the price in the margin account ## Footnote This is a Regulation T requirement.
82
What is the deposit requirement if the purchase price is between $2,000 and $4,000?
$2,000 in the margin account ## Footnote This is a FINRA rule.
83
What is the deposit requirement if the purchase price is $2,000 or less?
100% of the price in the margin account ## Footnote This is a FINRA rule.

SIE Study Guide (personal notes, Kaplan) (17 decks)

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