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Series 7 Top-off Exam > Margin Accounts > Flashcards

Flashcards in Margin Accounts Deck (112)
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1
Q

Who is the lender in a margin account?

A

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.

2
Q

What are the risk characteristics associated with margin accounts?

A

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.

3
Q

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

A

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.

4
Q

What is hypothecation?

A

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

5
Q

What is re-hypothecation?

A

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

6
Q

How does Regulation T impact margin trading?

A

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.

7
Q

What is loan consent?

A

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.

8
Q

What is street name?

A

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.

9
Q

What Is Regulation T?

A

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.

10
Q

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

A

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.

11
Q

Which securities are exempt from Reg T?

A

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

12
Q

Why would a customer want to open a margin account?

A

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

13
Q

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

A

30 days after the the SEC declares effectiveness

14
Q

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

A
  • For purchases between $0 - $2,000, the customer must deposit 100% of the 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)
15
Q

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

A
  • 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)
16
Q

What are the margin requirements for pattern day trader accounts?

A

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.

17
Q

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

A

Long Market Value

18
Q

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

A

The Debit Balance

19
Q

What can the SMA be used for?

A

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.

20
Q

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

A

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.

21
Q

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?

A

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
22
Q

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?

A

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.

23
Q

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?

A

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.

24
Q

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

A

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.

25
Q

When does an account become restricted?

A

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%.

26
Q

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

A

None

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

27
Q

Can a restricted account still have SMA?

A

Yes

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.

28
Q

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

A

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.

29
Q

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

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.

30
Q

How many days are allowed to satisfy a margin call?

A

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.

31
Q

What type of balance is created when a stock is shorted?

A

A Credit Balance

A credit balance is created when stocks are shorted, because there is a net cash inflow into the account. The credit balance equals the cash from the stock sold short plus the actual equity in the account as well.

32
Q

What is the method to determine the equity in a short account?

A

Total credit in the account minus short market value equals account equity.

33
Q

Which equity level triggers a margin call in a short margin account?

A

Unlike a long account, where a margin call is triggered at 25%, a short margin call is triggered at 30% equity of the short market value.

34
Q

A margin account is set up with an initial short sale of $20,000 of stock. What is the initial margin?

A

$10,000

Reg T covers initial margin only and is always 50% - for both long and short accounts.

35
Q

A new short is established, fully margined and with a market value of $20,000. What is the current market value, equity, and credit balance in the account?

A

Current market value is the same for both long and short - whatever the stock is worth - in this case, $20,000.

Since the sale is fully margined, the customer must have $10,000 in the account to meet Reg T. Thus, 50% of $20k = $10k equity.

The credit balance is initial margin plus sale proceeds, since there is a net cash inflow to the account. $20K + $10K = $30K

36
Q

An investor sells short $20k worth of fully margined stock and the stock declines to $15K. What is the equity and credit balance in the account?

A

Current market value is $15K. The account was opened with an initial deposit of $10K because of Reg T vs. the $20K opening short. Credit balance is the Reg T requirement plus the initial sale proceeds = $30K.

$30K (Credit - stays the same) - $15k ( current market value) = $15K equity.

Put differently, as the short market value decreases, the equity in the account increases.

37
Q

A fully margined initial sale of $20k of stock declines to $15K. What is the current market value, equity, credit, and SMA?

A

“Fully margined” means Reg T, so we know this trade required initial equity of $10K. Credit is $20K + $10K = $30K.

Equity is total credit in the account minus current market value: $30K - $15K = $15K equity.

SMA is excess equity above Reg T - 50% of current market value is $7,500 (50% of $15,000 current market value).

$15K equity - Reg T requirment of $7500 means the short SMA account holds $7500.

38
Q

What is the net equity of a combined long and short margin account if:

Long Market Value = $40,000

Short Market Value = $20,000

Debit Balance = $12,000

Credit balance = $20,000

A

The easiest way to solve this is to break out the elements of the long account and the short account. Long Market value - Debit = Long Margin Equity, so the long side is $28,000. The short side equity is credit balance - short market equity = $0.

Net equity = long equity plus short equity = $28,000

39
Q

Which regulatory body sets margin rules?

A

The Federal Reserve

Remember that anything dealing with the creation of money is regulated by the Federal Reserve. A brokerage firm is effectively creating money for a customer to buy additional stock when opening a margin account. Specifically this is called Regulation T.

40
Q

What is another name for the body of margin rules?

A

Regulation T

This is because in the Act of 1934, margin rules are covered in section “T.”

41
Q

Define:

buying on margin

A

Using borrowed money to pay for stock, usually by borrowing against existing shares held in the account. This is much riskier than stock investing because it both amplifies the gains and the potential losses that can be incurred.

42
Q

Define:

initial margin requirement

A

A Federal Reserve requirement that says all margin purchases must be backed by 50% of their worth in cash. Also called Regulation T (Reg T).

43
Q

Define:

long market value

A

The current market value of long securities in a margin account.

44
Q

Define:

margin rate

A

The rate of interest that a brokerage charges on margin balances in a margin account. This is based on the brokers call rate, which is the rate that broker-dealers borrow the money from a bank.

45
Q

Define:

Regulation T

A

A Federal Reserve rule that sets the margin amounts a customer can hold against account equity. Limits the credit a firm can lend a customer to buy securities at 50%.

46
Q

A pattern day trader effects 4 or more day trades within a

A

5 business day period

47
Q

Authorizes the regulation of credit to the Federal Reserve Board

A

Securities Act of 1934

48
Q

Number of days mutual fund shares must be held before they can be used as collateral in a margin account

A

30 days

49
Q

Agreement that gives a broker-dealer permission to pledge customer margin securities as collateral for bank loans

A

Hypothecation Agreement

50
Q

How customer securities must be registered in a margin account

A

Street name

51
Q

The form required for a broker-dealer to loan customer margin securities to other customers for short sales

A

Loan Agreement

52
Q

The regulation that grants authority to regulate the extension of credit in the securities industry

A

Reg T (Securities Act of 1934)

53
Q

Minimum deposit required in margin accounts within 5 business days by Reg T

A

50% of the market value of the transaction

54
Q

Type of securities that cannot be purchased on margin, but can be used as collateral after 30 days

A

Mutual funds

55
Q

Minimum initial deposit required by FINRA Rules

A

$2,000

56
Q

The deposit required to purchase shares with a value of $2,500 in a margin account

A

$2,000

57
Q

The deposit required to purchase shares with a value of $6,000 in a margin account

A

$3,000

58
Q

The deposit required to purchase shares with a value of $1,500 in a margin account

A

$1,500

59
Q

The deposit required to sell short shares with a value of $2,500 in a margin account

A

$2,000

60
Q

The Reg T deposit required to sell short shares with a value of $6,000 in a margin account

A

$3,000

61
Q

The deposit required to sell short shares with a value of $1,500 in a margin account

A

$2,000

62
Q

The recalculation made daily to check the amount of equity in a margin account

A

Mark to the market

63
Q

The impact on the equity in a long margin account when the market value of the securities increases

A

Equity increases

64
Q

The impact on the debit balance in a long margin account when the market value of the securities increases

A

No change

65
Q

The minimum maintenance requirement in a long margin account

A

25% of the long market value

66
Q

The minimum maintenance requirement in a short margin account

A

30% of the short market value

67
Q

An account that has equity of less than Reg T but more than minimum maintenance

A

Restricted

68
Q

Created when equity is greater than the Reg T amount

A

SMA

69
Q

Buying power of SMA

A

$2 of buying power for every $1 of SMA

70
Q

Formula for determining the market value of maintenance in a long margin account

A

Debit balance/.75

71
Q

Use of cash dividends when not removed from a margin account within 30 days

A

Reduce the debit balance

72
Q

Requirement that 50% of sales proceeds must be used to reduce the debit balance when securities are sold in a restricted account

A

Retention requirement

73
Q

The credit to SMA when securities are sold

A

50% of the sales proceeds

74
Q

In a short margin account, the impact on equity when the short market value of securities increases

A

Equity decreases

75
Q

The equation for determining the amount of equity in a short margin account

A

CR - SMV = EQ

76
Q

The equation for determining the amount of equity in a long margin account

A

LMV - DR = EQ

77
Q

The point at which a maintenance call is triggered in a short account

A

Equity below 30% of SMV

78
Q

The equation for determining the short market value at maintenance

A

CR / 1.30%

79
Q

A margin account with both long and short positions

A

Combined account

80
Q

The basic equation for determining equity in a combined account

A

LMV + CR - DR- SMV = Combined Equity

81
Q

The impact on SMA in a short account when the market value of the securities rises

A

No change

82
Q

The impact on SMA in a long account when the market value of securities falls

A

No change

83
Q

The impact on SMA in a short account when the market value of securities falls

A

Increases if the new excess equity is greater than the old SMA

84
Q

The impact on SMA in a long account when the market value of securities rises

A

Increases if the new excess equity is greater than the old SMA

85
Q

What SMA in a margin account creates

A

Buying power

86
Q

A line of credit that a customer can use to borrow from or purchase securities in a margin account

A

SMA

87
Q

The two agreements that are required for an investor to open a margin account

A

Hypothecation Agreement and Credit Agreement (Loan consent is optional)

88
Q

The three components of a margin agreement

A

Hypothecation agreement, credit agreement, loan consent form

89
Q

Two categories of securities that are exempt from Reg T margin requirements

A

U.S. Government securities, Municipal securities

90
Q

The impact to SMA in a long account when a non-required cash deposit of $1,000 is made

A

SMA will increase $1,000

91
Q

When a maintenance call must be met

A

Promptly

92
Q

Minimum equity to open a day trading account

A

$25,000

93
Q

Under Reg T, payment must be made by

A

S + 2

94
Q

Impact on a long margin account debit balance when $10,000 of SMA is used to buy stock

A

Debit balance increases $20,000 (Buying power of SMA is 2:1)

95
Q

Impact on credit balance in a short account when SMV of securities rises

A

No change to credit balance, but equity falls

96
Q

The ________ margin is the required proportion of your equity to the total value of the stock purchased on margin.

A

maintenance margin

In addition to the initial margin requirement, an important concept is the maintenance margin, which is the required proportion of your equity to the total value of the stock purchased on margin. The minimum maintenance margin required by FINRA is 25% for a long margin account and 30% for a short margin account.

97
Q

Which entity establishes the maximum percentage of a security’s value that may be financed through a margin loan?

A

U.S. Federal Reserve

98
Q

An investor purchased 100 shares of stock A for $50 per share in a margin account. The stock is now worth $60 per share. Assuming, that Reg T is 50%, what is the SMA in the account?

A

$500

When the investor initially opens the account, they must meet Reg T by depositing $2,500 in equity (50% of the total value), which means they are borrowing the other $2,500 from the broker-dealer. An increase in the market value of the account is reflected by an increase in equity, and therefore once the stock price appreciates, the new equity in the account will be $3,500 (reflecting the increase of $10 per share x 100 shares). Reg T in the account is 50% of the total market value or $3,000 (50% of $6,000). Because the investor has equity of $3,500, they have excess equity above Reg T of $500. Excess equity creates the SMA of $500.

99
Q

In a long margin account, a customer will get a margin call if their equity in the account falls below the FINRA minimum requirement of

A

25%

In a long margin account, if the customer’s equity falls below 25% of the market value, they will get a margin call.

100
Q

In a short margin account, a customer will receive a margin call if their equity falls below what percentage of the short market value?

A

30%

101
Q

A customer has a long margin account with a total value of $85,000 and a debit balance of $35,000. How low can the market value fall before the customer has a margin call?

A

$46,667

To find the minimum long market value before the customer has a margin call, take the debit balance of $35,000 divided by 0.75.

102
Q

A customer has a short margin account with a total value of $90,000 and a credit balance balance of $150,000. How high can the market value risebefore the customer has a margin call?

A

$115,384

To find the maximum short market value before the customer has a margin call, take the credit balance of $150,000 divided by 1.3.

103
Q

An investor has a margin account with a long market value of $16,000, a debit of $9,000, and SMA of $1,000. What would be the new SMA if the customer’s long market value declines by $2,000?

A

$1,000

Once SMA is created, it only goes away when used the customer. A decline in the market value will have no impact of SMA.

104
Q

In a margin account, the long market value minus the debit balance equals the

A

investor’s equity

105
Q

In a short margin account, the short market value plus the investor’s equity equals the

A

Credit balance

The credit is the total amount of cash in the account - the equity deposited by the customer plus the sale proceeds from the short sale.

106
Q

After how many days can mutual fund shares be used as collateral?

A

30 days

Mutual fund shares cannot be purchased on margin, but after 30 days the shares can be used as collateral to buy other securities on margin.

107
Q

Define:

credit agreement

A

A component of the margin agreement that outlines the credit terms that a customer will be charged once they begin to trade on margin.

108
Q

Define:

hypothecation agreement

A

A component of the margin agreement that states that the customer is pledging their securities in the account to the broker-dealer as a collateral for margin purchases.

109
Q

Define:

loan consent agreement

A

An optional component of the margin agreement which if signed by the customer allows the firm to lend the customer’s securities to other customers for short sales.

110
Q

Define:

maximum loan value

A

The maximum percentage of the market value that a broker-dealer is allowed to lend to the customer in a margin account. Currently, this is set at 50% under Regulation T.

111
Q

Define:

restricted account

A

A margin account where the customer’s equity in the account has fallen below the Regulation T margin requirement of 50%. The only restriction is that if a customer sells securities in a restricted account then they must use at least half of the sales proceeds to pay down their debit balance.

112
Q

When is an account designated a “pattern day trader?”

A

When there are four or more day trades (buy and sell same day) made within a five-day period - also called a “round trip.”