B - Margin

Question 1

FRB

Answer 1

The FEDERAL RESERVE BOARD, commonly referred to as THE FED, or the FRB, establishes all rules regarding MARGIN TRANSACTIONS.

Question 2

MARGIN TRANSACTIONS

Answer 2

Margin transactions occur when the customer borrows money or stock to complete the transaction.

Question 3

What determines whether the companies have enough value to allow the stock to be TRADED ON MARGIN.

Answer 3

All LISTED STOCKS, Nasdaq NMS stocks, and some UNLISTED STOCKS can be traded on margin.

Question 4

Listed securities

Answer 4

Stocks and bonds whose companies are listed on a stock exchange.

Question 5

Unlisted securities

Answer 5

(Stocks that are traded OVER THE COUNTER) can be purchased on margin, but only if the Fed has included them on their MARGINABLE SECURITIES LIST.

Question 6

To be eligible for the margin list, unlisted stock must meet two requirements:

Answer 6

1. Number of market makers

2. National public interest in the stock

Question 7

When can a new issue (IPO) be purchased on margin

Answer 7

New issues, such as an IPO, cannot be purchased on margin for the first 30 days after the initial offering is closed.

Question 8

Reg T covers two important issues:

Answer 8

• When a transaction must be paid

* How much money must be paid for the purchase; Reg T specifies the amount, which presently is 50% for stock.

Question 9

Purchasing Stock and the % of payment required on the settlement dayte is?

Answer 9

50%

Question 10

Purchasing Options and the % of payment required on the settlement dayte is?

Answer 10

100%

Question 11

The margin agreement

Answer 11

The margin agreement, also known as the customer agreement, must be filled out and signed by the client prior to placing any orders. The agreement includes the lending authorization and hypothecation agreement.

Question 12

REG T REQUIREMENT

Answer 12

The REG T REQUIREMENT is also known as the INITIAL MARGIN REQUIREMENT. This rule determines the minimum amount of money that a customer must deposit when making an initial stock or corporate bond transaction and borrowing is taking place. Presently, Reg T requires that a person deposit 50% of the market price into an INITIAL MARGIN ACCOUNT when purchasing or selling short.

Question 13

LONG MARGIN ACCOUNT

Answer 13

A LONG MARGIN ACCOUNT is an account in which the customer PURCHASES securities. In a long margin account the customer buys a quantity of stock or bonds and only pays a portion of the purchase price. This portion is according to Reg T, and is presently at 50% of the market value on the day the securities were purchased.

When purchasing securities on margin, the customer borrows money from the broker/dealer to pay for the stock, and the broker/dealer then sets up a LONG MARGIN ACCOUNT (usually referred to as a LONG ACCOUNT). After the customer deposits the amount required for the margin transaction, the remaining purchase balance is paid by the broker/dealer and is called the DEBIT BALANCE, usually abbreviated “Dr” (for DEBIT RECEIPT). The customer must always deposit the Reg T requirement, and the debit balance is the remainder. The customer then pays interest to the broker/dealer for borrowing the remaining amount of the purchase price.

Question 14

SHORT MARGIN ACCOUNT

Answer 14

Selling securities short must be transacted in a margin account as well; the customers are selling stock that they do not own, and therefore, must borrow the securities from the broker/dealer to be sold. Since the securities are borrowed, the account must be a margin account. To initiate this trade, the broker/dealer sets up a SHORT MARGIN ACCOUNT (usually referred to as a SHORT ACCOUNT).

Question 15

MV

Answer 15

Market value

Question 16

Dr

Answer 16

Debit balance: Long account (actually debit receipt, but read as debit balance)

Question 17

Cr

Answer 17

Credit balance: Short account (actually credit receipt, but read as credit balance)

Question 18

E

Answer 18

Equity

Question 19

SMA

Answer 19

Special Memorandum Account or excess equity

Question 20

B/D

Answer 20

Broker/dealer

Question 21

Long Margin Account Formula

Answer 21

MV = Dr + E

Question 22

Short Margin Account Formula

Answer 22

MV = Cr - E

Question 23

MINIMUM MAINTENANCE for Long Account

Answer 23

FINRA requires investors to maintain at least 25% of the market value in equity in a long account. This minimum requirement is called the MINIMUM MAINTENANCE

Question 24

RESTRICTED ACCOUNT

Answer 24

FINRA considers an account restricted when the account’s equity falls below 50% of the market value. Being restricted means nothing as far as the customer is concerned, and an account can continue to do all the normal functions and activities of any margin account.

Question 25

RETENTION REQUIREMENT

Answer 25

The broker/dealer must keep 50% of a customer’s sale proceeds to cover the debit balance in the investor’s account. This is called the RETENTION REQUIREMENT.

Question 26

SMA

Answer 26

SPECIAL MEMORANDUM ACCOUNT

SMA is generated by leaving the proceeds from stock sales in the account or by rising market values in a long account.

This customer has an account for which the equity is above the requirement for Reg T, and thus, the extra amount is called EXCESS EQUITY, or more commonly, SMA. The amount of the SMA that is generated is the amount of equity in excess of the amount required under Reg T in an initial transaction at the “new” price.

Remember: The SMA is a notation to the account, not part of the account. It is a line of credit.

You never Lose it Till you use it

Question 27

The formula for finding SMA is:

Answer 27

SMA = EQUITY - (REG T × MV)

Question 28

A customer has an account with a market value of $120,000 and a debit balance of $40,000. If Reg T is 50%, how much SMA is in the account?

Answer 28

SMA = $20,000

Question 29

SMA, a line of credit generated by the stock position moving in a positive manner for the investor, can be for a number of uses, such as:

Answer 29

• Purchasing more stock
• Selling stock in a short sale
• Purchasing calls and puts
• For personal use, such as a vacation, purchasing a home or automobile, or any other use at the discretion of the account holder

Question 30

An investor is unable to withdraw any of the SMA if:

Answer 30

• The withdrawal causes the equity to fall below $2,000.

* The withdrawal causes the equity to fall below the required minimum so that the investor would have a margin call.

Question 31

Margin Call

Answer 31

Remember that a margin call is when the broker/dealer asks the customer to deposit additional money.

Question 32

INITIAL MARGIN CALL

Answer 32

To meet the requirements of Reg T

Question 33

MAINTENANCE MARGIN CALL In a long account

Answer 33

To bring equity up to a maintenance level required by FINRA and/or the broker/dealer

MMC = Dr ÷ 75%

The real secret for the test is that the correct answer will be the only answer that lies between the present market value and the debit balance.

Question 34

SMA in a long account increases when:

Answer 34

• The market value rises
• Stock is sold (because the proceeds are used to pay off the debit balance)
• Cash dividends are paid to the account
*For the test, upon sale of securities in a long account, the equity always stays the same and the SMA increases.

Question 35

The SMA declines in a long account when:

Answer 35

• More stock is bought with the SMA

Question 36

The SMA is not affected in a long account when:

Answer 36

• Customers receive stock dividends because there are more shares at a lower price
• The market value of the portfolio goes down

Question 37

MINIMUM MAINTENANCE REQUIREMENTS. The requirement for a long account is:

Answer 37

25% of market value (MV) in a long account:

Minimum maintenance = MV × 25%

Question 38

Two factors can cause an investor’s equity to fall:

Answer 38

• The debit balance increases because the customer borrows money by using all or part of the SMA.
• The market value of the account falls due to falling security prices.

Question 39

You need to know each of the following formulas for a short account:

Answer 39

• SMA = Equity – (LMV × 50%)
• Minimum Maintenance = LMV × 25%
• Maintenance Margin Call = Debit balance ÷ 75% (It will be the only answer between the market value and the debit balance.)

Question 40

Short Sale

Answer 40

Since you don’t have the stock to sell, you must borrow the stock from your broker/dealer. You must be ready to buy the stock and replace it to the broker/dealer later, hopefully at a lower price.

Question 41

Short Position vs. Long Position

Answer 41

The fact that this investor makes money as the price goes down is just the opposite of a customer in a long position. A long position allows the investor to make money when the stock is rising, while a short position allows the investor to make money when the stock is falling.

Question 42

The formula for a short account is:

Answer 42

SHORT MARKET VALUE = CREDIT BALANCE - EQUITY
Or
SMV = Cr - E

Question 43

Determining the SMA in a short account is exactly like determining SMA in a long account.

Answer 43

SMA = EQUITY - (MV × 50%)

Question 44

The SMA in a short account increases when:

Answer 44

• The market value falls

Question 45

The SMA in a short account declines when:

Answer 45

• More stock is bought or sold short because the SMA is used

Question 46

The SMA is not affected when:

Answer 46

• The market value of the portfolio goes up

* The value of the stock decreases due to a stock dividend or stock split

Question 47

How SMA is affect in a Long vs a Short Account

Answer 47

Note that the SMA for the short account reacts in the same way as for a long account with one exception: In a long account, SMA increases as the market value of the stock increases, while in a short account, SMA increases as the market value of the stock decreases.

Question 48

Minimum Maintenance of a short account

Answer 48

Minimum Maintenance of a short account = SMV × 30%

Question 49

MAINTENANCE MARGIN CALL IN A SHORT ACCOUNT

Answer 49

The way to calculate when a short margin account will have a maintenance margin call is:
Cr ÷ 130%

The real secret for the test is that the correct answer will be the only answer that lies between the present market value and the credit balance.

Question 50

MMC

Answer 50

Maintenance Margin Call - The MMC is when the market goes above a certain $ ammount

Question 51

MM

Answer 51

Minimum Maintenance Requirement - The MM is when the equity is below a certain $ ammount

Question 52

You need to know each of the following formulas for a short account:

Answer 52

• SMA = Equity - (SMV × 50%)
• Minimum Maintenance = SMV × 30%
• Maintenance Margin Call = Credit balance ÷ 130% (It will be the only answer between the market value and the credit balance.)

Question 53

Purchasing Option on Margin

Answer 53

Investors may not buy an option on margin that expires in less than nine months.
• Investors must pay 100% of the premium, whether purchased in a cash account or a margin account.
• They must fully pay for options that are not marginable, and therefore, the options have no loan value.

Question 54

LEAPS

Answer 54

For options that expire in more than nine months (LEAPS), the customer has to deposit only 75% of the cost of the option. Therefore, LEAPS have a loan value of 25% until their expiration is nine months or less.

Question 55

The margin call for uncovered options

Answer 55

The margin call for uncovered options is a percent of the market value. You do not need to know the percentage.

Question 56

MARKING TO THE MARKET

Answer 56

MARKING TO THE MARKET is a process in which securities prices in a customer or firm account are valued at the closing prices for that day. For most stocks that trade daily, the closing price is used to determine the amount of equity in each customer’s account. For margin accounts, marking an account or a securities position to the market is performed to determine if the customer’s account has the required equity per margin requirements. Broker/dealer firms mark to the market all accounts on a daily basis.

Marking to the market is performed for all margin accounts — in long and short accounts — and anytime securities are borrowed.

Marking to the market only occurs when the market value changes, requiring the customer to deposit more money.

Question 57

The minimum dollar requirement on an initial transaction in a margin account

Answer 57

The minimum dollar requirement on an initial transaction in a margin account is $2,000. If the full purchase price of the stock is less than $2,000, the customer must deposit the entire price of the purchase. If the full purchase price of the stock is over $2,000 but less than $4,000, the customer must deposit the $2,000 minimum. If the full purchase price of the stock is over $4,000, the customer must deposit the amount required by Reg T (currently 50%).

Question 57

Buying power

Answer 57

Buying power is the amount of securities a customer can buy given an amount of money or an SMA. To determine the amount of stock a customer can buy with a given amount of money, divide that money by the Reg T requirement. Since Reg T is 50%, and 50% is used on the test, just multiply the amount of cash or SMA by 2.

MONEY (OR SMA) ÷ REG T = BUYING POWER or SMA x 2