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Series 7 Top-off Exam > Margin Accounts > Flashcards

Flashcards in Margin Accounts Deck (112)
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Who is the lender in a margin account?

The brokerage firm where the account is held lends cash to the investor to purchase securities. Not only does the firm earn commissions on the resulting trades, it also earns interest on the balance owed on the credit extended in the margin account. 


What are the risk characteristics associated with margin accounts?

When investors use margin to purchase additional shares, they use leverage to own more securities than they have the cash to pay for. This increases the potential for gain and loss. This is unlike options, which also use leverage, since the loss on an option is limited to the premium paid. However, an investor using margin could be subject to one or more margin calls and be forced to add cash or sell securities. 


What is disclosed in the credit agreement of a margin account? 

The credit agreement details the exact terms, fees, and interest costs associated with the margin account, that is, all credit terms. The credit agreement is a seperate document from the margin account and has to be signed by the customer before margin trading can begin.


What is hypothecation? 

This term describes how investors pledge their existing shares as collateral for credit extended by the brokerage firm. 


What is re-hypothecation?

To obtain funds to extend to the customer for margin purchases, the dealer pledges customer securities to a bank as collateral for a loan. 


How does Regulation T impact margin trading? 

Regulation T regulates how much credit a dealer can extend to a customer for margin purchases. A customer's equity must equal 50% of the purchase price. For example, if the customer wants to purchase $100,000 of stock on margin, they must deposit 50% or $50,000.


What is loan consent?

The loan consent agreement is an optional part of the margin agreement, but if signed by the customer it allows the firm  to loan a customer's shares to another customer for short sales.


What is street name?

When a customer opens a margin account, the securities are held in what is called "street name" or the name of the broker-dealer the account is with. This allows for the lending and rehypothecation the customer agrees to in the customer's margin account. 


What Is Regulation T?


Regulation T is a Federal Reserve Board rule that governs how much credit can be extended to any customer. The customer margin requirement stands at 50%; any dealer can increase this amount (meaning the customer can buy less on credit), but no dealer can accept lower margin that what is required by Reg T. 


What could cause a dealer to increase margin requirements beyond Reg T?

During times of extereme volatility, a dealer can increase margin requirement on existing account balances as a defensive measure against a customer going below Reg T requirements or being unable to repay. 


Which securities are exempt from Reg T? 

All exempt securities (e.g. Municipal securities and Treasuries) are also exempt from Reg T. 


Why would a customer want to open a margin account? 

  • Reduces the amount of cash needed to buy securities and Increases potential return 


What time period must elapse before a new issue can be purchased on margin? 

30 days after the the SEC declares effectiveness


What is the initial deposit for a new margin account in a long account under FINRA rulels? 

  • For purchases between $0 - $2,000, the customer must deposit 100% of the must purchase price
  • For purchases between $2,000 - $4,000, the customer must deposit $2,000
  • For purchases above $4,000, the customer must deposit 50% (this is when Regulation T comes into play)


What is the margin requirement for an initital short sale in a new margin account under FINRA rules? 

  • For purchases between $0 - $2,000, the customer must deposit $2,000
  • For purchases between $2,000 - $4,000, the customer must deposit $2,000
  • For purchases above $4,000, the customer must deposit 50% (this is when Regulation T comes into play)


What are the margin requirements for pattern day trader accounts? 

An account is considered a day trading account if an investor buys and sells the same stock four times in 5 trading days. In such cases, the minimium equity would increase to $25,000 before any additional margin trading could occur. 


What is the current market value of a long-only account known as? 

Long Market Value


On what amount is daily interest charged in a margin account?

The Debit Balance


What can the SMA be used for?

SMA is created from excess equity (when the customer's equity in the account exceeds the Reg T requirement). It is effectively a line of credit from the broker-dealer. A customer can use SMA to buy additional securities (they can purchase $2 of stock for every $1 of SMA) or these can take it out on the form of cash ($1 of cash can be withdrawn for every $1 of SMA. Note, that because SMA is not the customer's money, it cannot be used to meet a margin call.


What is the term for an account where the customer's equity is less than the Reg T requirement?

A Restricted Account

If a customer's equity is less than Reg T the account is said to be restricted. A restricted account is not a big deal. A customer can still buy securities in a restricted account as long as they meet Reg T for that specific purchase. If a customer wants to sell securities in a restricted account, at least 50% of the proceeds must be used to pay down their debit.


A new margin account is opened with a current market value of $60,000. What is the current debit and equity of the account? What is the SMA account value?

For this type of question on the exam, it is important to remember that Reg T means 50%. The customer must deposit 50% in equity and the other 50% reflect the customer's debit balance.

  • Debit: $30,000
  • Equity $30,000


A margin account that began with a $60,000 market value and $30,000 in equity increases to $70,000. What is the SMA, Debit, and Equity of the account? 

Importantly, keep in mind that a customer's debit balance is not impacted by a change in market value of the securities. Therefore, to calculate the new equity subtract the debit from the new current market value.

Equity = 70K LMV - 30K DEBIT = 40K 

SMA is the excess equity above Reg T requirement of 50%. The Reg T requirement is 50% of the LMV, which is 70K * 50% = 35K. Since current equity is 40K, excess equity is 5k and therefore SMA is 5k. 


Our fully margined account began at $60k value, with a $30k debit, and increased to $70K, creating both equity and an SMA account balance.

Current Value: $70,000

Debit: $30,000

Equity = $70,000 - $30,000 = $40,000  

SMA: $5,000 (Reg T: current value minus debit)

What would happen to all the above accounts if the SMA were withdrawn in cash?  

Any time the SMA is withdrawn in cash, it is added to the debit balance.

New Amounts: 

Market Value: $70,000 (changes only by price, not SMA)

Debit: $35,000 (increases by the SMA reduction)

Equity: $35,000 (decreases by the SMA reduction)

New SMA: $0

Note that the account is right back at the Reg T fully margined amount. 


If an account has additional equity due to a stock price rise, what is the buying power of that equity? 

In order to calculate buying power, simply double the SMA account value. Let us take an example where SMA is $5,000. This allows an investor to buy $10,000 worth of stock, which would increase the current market value as well. However, this would also increse the Reg T requirement by $5,000 (50% of the new purchase) - this is the exact balance available in the SMA account. 


When does an account become restricted? 

An account becomes restricted when the account value slips below the Reg T requirement of 50% equity. There is no penalty for this and a margin call is generated only at the minimum equity level of 25%.


What are the special margin rules for buying securities in a restricted margin account?


There are no special rules - only the normal Reg T of 50% of new purchases. 


Can a restricted account still have SMA? 


Think of SMA as a "high water mark" for the account's excess equity. The SMA can still be withdrawn, even in a restricted account, as long as it does not bring the customer below the minimum maintenance requirement.


If an account is under Reg T (Restricted), how are the proceeds from sales handled?

When an investor sells any security out of an account that is below the Reg T minimum equity, then 50% of the cash from the sale is retained by the dealer and applied toward the debit balance of the account. 


The current market value of an account is $40,000 with a debit of $30,000. How much is the margin call on this account? 

A margin call is triggered at 25% equity in a long margin account.

$40,000 at 25% equity means the account must have $10,000 in equity before a margin call is triggered.

In this case, CMV of $40,000 - $30,000 debit balance is $10,000, so no margin call would be issued. 


How many days are allowed to satisfy a margin call? 

The rules stipulate that a margin call must be satisfied promptly- usually meaning the end of the business day. If the call is not met, the dealer sells securities and retains 50% of the proceeds to pay down the debit balance.