Series 7 & Margin Accts Flashcards
(67 cards)
1
Q
What is a margin account?
A
A margin account is an account in which a customer is going to make some kind of cash deposit usually like a down payment to buy stock on credit.
2
Q
Contrast a margin acct with a cash account. What are the differences?
A
cash account the customer pays in full for whatever transaction they deal in.
3
Q
What are LONG MARGIN TRANSACTIONS?
A
The use of borrowed funds in brokerage accounts to buy securities using the securities as collateral.
4
Q
Who makes the rules about how we purchase things in margin accounts and what we can purchase in a margin account?
A
The Federal Reserve Board
5
Q
What role does the Federal Reserve Board play in margin accounts?
A
It makes the rules about how we purchase things in margin accounts and what we can purchase in a margin account
6
Q
How does the Fed effect securities?
A
They restrict the kinds of securities that can be purchased in a margin acct.
7
Q
What kinds of securities does the Fed actually concern itself with?
A
Specifically Common Stock.
8
Q
What is marginable stock?
A
Not all stock can be purchased on margin or credit. Stock that can be purchased on margin is called Marginable Stock.
9
Q
What does a stock have to be to be called marginable?
A
Marginable stock is any stock that is listed on an exchange
10
Q
What are the only 2 types of stock that can be purchased on margin?
A
Stock that is listed on an exchange and NASDAQ stocks
11
Q
What is the first step to opening a margin account?
A
The First document - New Account form Is required.
12
Q
If the first document is a New Account Form, what is the second document required to open a margin acct.?
A
2nd document a Margin Agreement or Customer Agreement with several parts.
Part 1 - Credit Agreement - discloses the terms of credit in which a loan will be extended to them. (Similar to getting a loan from a bank).
Part 2 - Hypothecation Agreement - the process of using stock or other securities as collateral for a
Loan.
13
Q
Opening up a Margin acct., what are the Part 1 and Part 2 agreements?
A
Credit Agreement and Hypothecation Agreement.
14
Q
Opening up a Margin acct., what is the Credit Agreement?
A
Discloses the terms of credit in which a loan will be extended to them. (Similar to getting a loan from a bank).
15
Q
Opening up a Margin acct., what is the Hypothecation Agreement?
A
The process of using stock or other securities as collateral for a
Loan.
16
Q
What is the stock they are buying in the margin account on credit will serve as?
A
the collateral for a loan
17
Q
The hypothecated Agree,emt is between who and whom?
A
This agreement between the broker dealer and the customer.
18
Q
What is an optional agreement or form and not always included in a Hypothecation agreement?
A
A Loan Consent form.
19
Q
What is a loan concent form?
A
It allows the brokerage to lend the customer’s stock to other customers who need to borrow it to sell stock short.
20
Q
A Hypothecation agreement may include what particular agreement regarding his stock purchases?
A
a loan consent form
21
Q
What are the 3 basic areas of a balance sheet?
A
- assets on the Left
- liabilities and equity on the right
Like any balance sheet assets must always equal liabilities plus equity
that is true of any kind of financial balance sheet.
22
Q
On a balance sheet what are assets equal to?
A
Liabilities + Equity
23
Q
On a balance sheet, what are liabilities and equity equal to?
A
Assets
24
Q
• When the customer purchases the stock, it is reflected as 100 shares of XYZ and given a monetary value or $10,000, the whole amount is expressed as a?
A
asset.
25
Assets, liabilities and equity values are changed by what?
the fluctuation of the Market
26
What is marking to market?
Mark To Market, or Marking to Market, is when asset values are determined "according to market prices" at the end of each day in order to arrive at the profit or loss status.
• Later these initial values can change with the fluctuation of the Market
○ These values are recalculated daily at the end of the day.
○ These changes in value and their recording are referred to a "Mark to the Market".
Mark to the market = revaluing the account based on new market values.
27
What does the asset side or a balance sheet correspond to? What does it express or show?
the MV or Market Value
28
What does the right side of the chart or balance sheet show?
shows equity of what you actually own
29
What is a debit balance?
The amount that the customer owes to the brokerage
30
MV - DR = EQ or Market Value (of the stock i.e., the total purchase involved) minus the amount owed (by the customer for the loan to purchase) EQUALS what?
= the EQUITY in the margin account.
31
What allows us to see the relationship between the MV, the DR (debit balance) and the Equity in the account?
The structure of the balance sheet
32
What allows us to see the relationship between the MV, the DR (debit balance) and the Equity in the account?
The structure of the balance sheet
• The value of what the customer owns in the account
market value - debit balance = equity
33
What are 2 additional rules that apply to Margin accounts?
Federal Reserve Board Regulation T: 50% equity
| NYSE/NASD Minimum Initial Equity requirement: $2,000, but not more than 100% MV
34
What is the caveat to the NYSE/NASD Minimum Initial Equity requirement and the
Federal Reserve Board Regulation T: 50% equity?
The investor is not required to deposit more than the value of the stock being purchased.
35
Suppose a customer wants to purchase $3,000 of stock in an empty margin account. What must the customer deposit?
- Under Regulation T 50 % or $1,500
- The NASD in the New York Stock Exchange requirement says
▪ that you have to put up at least $2,000 and
▪ we always have to put up whichever of these two requirements is the greater of the two.
▪ In this case, the requirement is going to be $2,000
36
Another Margin acct. case
The customer which is to purchase $1,500 worth of stock in a new account .
- What is the initial Margin requirement?
- We have to come up with the greater amount.
▪ Reg T would say that you have to put up $750.
§ 50% of the amount of the stock you're buying.
▪ The NYSC and NASD requirement is
§ normally $2,000
▪ Does that apply in this situation?
§ That doesn't really seem fair because
□ why should you have to put up $2,000
□ when the stock you're buying is really only worth $1,500?
□ If you did this in a cash account, you would only have to put up $1,500.
§ In fact in this situation the initial equity is only $1,500.
§ because you have to put up no more than 100% of the value of the stock you're purchasing.
37
What is the NYSE/NASD Minimum Initial Equity requirement and the
Federal Reserve Board Regulation T: 50% equity designed to eliminate?
small margin accounts from the industry.
□ Small margin accounts are really not appropriate.
® Margin accounts do involve some risk.
® We don't want investors who can only afford to invest a small amount of money to get involved in a risky transaction like a margin account.
This minimum rule discourages small margin accounts.
38
Why was it important to eliminate small margin accts.?
□ Small margin accounts are really not appropriate.
® Margin accounts do involve some risk.
® We don't want investors who can only afford to invest a small amount of money to get involved in a risky transaction like a margin account.
® This minimum rule discourages small margin accounts.
39
What happens as the MV changes and the value of the account ebbs and flow?
What happens when the stock appreciates? What figure on the balance sheet must change in order to reflect the actual amount(s) of the balance sheet?
Remember the customer
- bought initially $10,000 worth of stock
- 100 shares at $100 a share.
- He had to put up 50% which is the Reg T requirement.
- That's what the customer added to the account.
The broker dealer used 50% or $5,000 of their own money to help the customer purchase the stock.
- Suppose that XYZ then increases to $120 per share?
- The total now for the 100 shares are worth $12,000 so the account value is now $12,000.
- We have a problem.
▪ Notice that the left side and the right side are no longer in balance.
▪ We have to make some other adjustment.
▪ If we change one entry we have to change another entry to keep the two sides in balance.
§ Those changes can't be just arbitrary. They have to fit what's actually going on.
We're going to change either the Debit Balance number or the Equity value number.
▪ Which one would really be changed?
▪ The Debit Balance number represents the amount that you owe to the brokerage.
§ If your stock goes up in value, does that mean that you owe more money to the brokerage?
§ The answer to that is No!
□ You borrowed $5,000 originally
□ and that is still what you owe to the brokerage.
□ An increase in the value of your stock does not increase your debt to the brokerage.
So it must be the Equity figure that is going to change.
40
When the value of a stock goes up, what element of a balance sheet must change (to reflect the actual value of the account)?
If the market value of the stock goes up, that in itself doesn't change the debit balance or what you owe to the broker-dealer.
It's the equity that will increase in that situation.
41
If the market value of the stock goes up what would Reg T require as a deposit if we were to purchase the stock in the market at this point?
▪ Remember that's going to be 50% of the MV $12,000 times 50% ($12,000 x 50% = $6,000.00
§ will give us $6,000 as the current Reg T equity Requirement.
- Compare that to the equity actually in the account which is $7,000
▪ the account equity is $1,000 more than is required
▪ so this amount is called Excess Equity.
42
What is Excess Equity?
It's important to understand what excess equity is.
- Sometimes people are under the misconception that it represents a cash balance.
▪ Money that you can simply draw out of the account. That it's your money.
▪ That is really not the case.
- A good way to think about a margin account is to use the analogy of someone purchasing a home.
▪ Say you purchase a home for $100,000 and you put down a $20,000 down payment.
▪ of course that would be your equity what you have in your home.
§ The mortgage company or the bank would loan you the other $80,000 and you would use that to purchase the house.
□ You would have a $100,000 asset,
□ but an $80,000 liability
□ and you only have $20,000 in the house.
▪ If the value of your house rose to say $120,000 would your mortgage increase?
§ You wouldn't owe more money to the bank than you did before, and
§ your equity in your house would increase.
§ Does that mean that there is a pile of cash in your house that you can spend.
§ No. it means is that
□ your house now has more equity.
43
How do you get access to the increased equity in cash from the gains in the Market in a Margin acct?
- That is only one way to get access to that equity/cash/money.
▪ Anyone who has a home that has increased in value may know that,
▪ another way to get access to that equity in your home would be to take out a 2nd mortgage or a home equity loan. 55:07
▪ That is exactly what you can do with a margin account.
§ Your stock has gone up in value but, (that's only stock, not actual money or just instrument that has a fluctuating value in a Market)
□ There's only stock in your account.
□ There is no cash there.
□ How can you get at that increase in the value of the stock (equity)?
§ You can take out a loan against the stock which now has a larger collateral value.
44
How do you borrow the excess equity in a margin acct.?
- The market value of our account is $12,000
▪ $12,000 worth of can serve as collateral for how large a loan? ▪ A $6,000 loan.
▪ Remember that the broker-dealer can lend you up to ½ the value of the stock.
§ The broker-dealer has already loaned the customer (and the customer has already borrowed $5,000.
§ that was the original debit.
§ So, the broker dealer can lend the customer another $1,000
□ the difference between what the collateral (profit in the Market) and what you have actually borrowed.
My notes: Looks like you can borrow another 50% of the increased profit you made. Rule seems to be you can borrow, or have the broker-dealer cover the other half of what you want to borrow. $500 of the $1,000you need.
You can take this loan out in cash if you wanted to do so!
45
What are the not necessarily wanted consequences of borrowing on a loan from a margin acct. to take some of the investment profits that have been made?
§ You've just taken out another smaller loan,
§ the loan is going to increase the customer's DR/DB/ debit balance to $6,000 it is a loan not cash sitting in the account. (My Note: Similar to borrowing on an insurance policy).
▪ The result is, the account equity would be reduced to $6,000 (to keep the statement in balance).
§ Notice when we took cash out of the account, it wasn't like taking cash out of a savings account.
□ You're really taking out another loan from the broker-dealer. "That's great right". You have the cash and you can do whatever you want with it.
□ But since it was a loan,
® your overall debt will go up.
® The stock didn't change in value so the only other thing that could change to keep our balance sheet in balance is the amount of equity.
® Remember, you drew out a loan against some of that equity and so now your equity has decreased in the account.
46
How does taking cash out of a margin account affect the account balance?
Whenever you take cash out of a margin account, the debit balance will go up (you will owe the brokerage more money).
47
What happens in a margin account if you put cash into the account?
the debit balance will go down. § Think about cash coming into the account as being used to pay down your loan.
Your debit will decrease.
48
What is the "Buying Power" in a margin account?
The amount of additional stock the amount of additional stock the customer can buy on margin.
The formula is:
Buying Power = Excess Equity / (divided by) Reg T
Ex: Account w/ $1,000 excess equity:
$1,000 / 50% = $2,000
§ Our example this will be $1,000 divided by 50% which equals $2,000 worth of buying power.
□ That does make sense because
® if I buy $2,000, worth of stock on margin in general,
® how much do I have to put up under Regulation T?
50% of the value which would be $1,000
49
Why is it important to know the buying power of a margin account (if the account has appreciated in value)?
- The buying power is something that we want to know about in the account.
▪ We could withdraw $1,000 in cash OR we could buy $2,000 worth of stock.
50
How could the use of buying power affect a margin account?
- The difference of $1,000 is excess equity but. $1,000 excess equity means that we have $2,000 of buying power.
- What does it mean to have $2,000 of buying power?
It means that we could buy another $2,000 worth of stock in our account, without having to deposit any additional money.
51
What are the consequences of the market value of the stock falling?
▪ When the market value goes down, the equity goes down as well.
§ The debit balance is staying constant in these situations.
52
In a margin acct, when the value of the investor's MV goes up, what has to change in order to keep the account numerically balanced?
the EQ (equity) has to go up. The DR (money owed to the broker-dealer does not. (Rather logical since your profit goes up not the debt you owe to the BD)>
53
If you had $1,000 of excess equity in your margin acct, how much additional stock could you purchase?
$2,000
| Formula: excess equity / Reg T requirement 50% =
54
In a margin acct., what happens to the balance sheet when the stock loses market value (MV)?
When the MV goes down, the DR (debt) remains the same but the equity goes down (by the amount of the loss).
55
What is a restricted account?
A margin account in which the equity is less than the current Reg T requirement is called a restricted account.
56
If your margin acct. is restricted, do you have to add funds to the account to bring the Reg T requirement up to 50%?
No, you don't have to bring the acct. up to 50%.
57
Can you purchase additional stock when a margin acct. is restricted?
Yes. You just have to cover the Reg T requirement for the new stock.
58
How does a restriction on a margin account effect the investor?
It really doesn't effect them much at all. Really the restriction is just a restriction on the broker-dealer. They can't loan you additional money on the current collateral in the account because in theory the loan is already too big.
59
What happens to a margin acct. that is restricted and continues to lose market value? Does Reg T step in at any point?
No. Once you meet the initial Reg T requirement, upon the new purchase of that stock, you are not required to meet a Reg T requirement ever again, even if the stock would sink all the way down to zero.
60
If the market value of a margin account continues to lose value, what happens to the debt (DR) in the account
It remains unchanged. The debt is always owed to the BD who contributed 50% on behalf of the investor.
61
What rule is in place by the NYSE/NASD that triggers when a stock continues to lose value in a margin acct.:
The NYSE/NASD maintenance requirement.
| You must maintain equity in your account of at least 25% percent of the market value (MV).
62
What rule is imposed it says that you must maintain equity in your account of at least 25% percent of the market value (MV).
The NYSE/NASD Maintenance Requirement
63
What rule is imposed it says that you must maintain equity in your account of at least 25% percent of the market value (MV).
The NYSE/NASD Maintenance Requirement
| EQ > 25% x MV
64
What is a maintenance call?
If the equity falls below 25% (the NYSE/NASD Maintenance Requirement)
65
What happens if the investor doesn't maintain the equity level at 25%, and does not respond to the maintenance call promptly?
The brokerage can sell the stock (to protect their loan) which was collateral for the loan according to the original agreement.
66
determining when a maintenance call would be declared on an account
Multiply the DR (debt on the balance sheet) by 4/3 = the threshold that if breached will trigger a maintenance requirement call.
Instant Learn: DR X 4/3
If the MV falls below this number, any further loss will trigger a maintenance call.
67
Special Memorandum Account (SMA)
Allows you to Note a past positive gain that at that time you didn't want to withdraw (say $2,000 made in the past but later lost in MV) and allows you to withdraw the funds, even though the account may now be in restriction.
