Chapter 18 Margin Flashcards

1
Q

The Securities Exchange Act of 1934 granted the Federal Reserve
Board (FRB) with the power to regulate borrowing and it does so through Regulation _

A

Regulation T

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2
Q

Regulation _ governs the extension of credit by broker-dealers. Although the regulation is established by the FRB,
it’s the SEC that’s charged with the responsibility of enforcing the rules.

A

Regulation T governs the extension of credit by broker-dealers. Although the regulation is established by the FRB,
it’s the SEC that’s charged with the responsibility of enforcing the rules.

Under Reg. T, the FRB determines the types of securities that may be purchased on margin through a broker-dealer, when payment is due, as well as the amount of credit that may be extended. For both long purchases and short sales of stock,
the current initial Reg. T margin requirement is 50%.

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3
Q

Marginable securities include:

A

 Securities that are listed on a registered stock exchange (including ETFs)
 Securities that are listed on Nasdaq

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4
Q

Can non-marginable securities be purchased in a margin account?

A

Answer: Yes, but any trades involving these securities must be paid for in full at the time of purchase.

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5
Q

Question: What are examples of non-marginable securities?

A

Answer:

  • OTC equities—those quoted on the OTC Bulletin Board (OTCBB) or in the OTC Markets Group Pink Marketplace
  • Standard listed options (those with nine-month maturities)—buyers must deposit 100% of the premium
  • New issues (e.g., IPOs)—although new issues cannot be purchased on margin, the shares become
    marginable (have loan value of 50%) if they’ve been held and fully paid for 30 days.
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6
Q

Does Regulation T Apply to both Cash and Margin Accounts? Yes. Remember, Reg. T determines the following two components relating to transactions that are executed:

  1. The date by which payment is due for a purchase
    - Whether the purchase is made in a cash or margin account, payment is due no later than four business days after the trade (i.e., two business days after settlement).
  2. The amount of credit that may be extended by the broker-dealer for a purchase
    - In a cash account, no extension may be made; therefore, clients must deposit 100% of the purchase.
    - In a margin account, an extension of 50% is allowed; therefore, clients must deposit 50% of the purchase.
A

Remember,

Payment is due for both cash and margin accounts T+4

Extensions for cash accounts is 0% and for margin 50%

With the margin requirement set at 50%, an investor is able to purchase twice the
amount of securities in a margin account than she otherwise would with the same
amount of money in a cash account.

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7
Q

Is the Use of Margin Available to All Investors?

A

No. Not all types of client accounts are permitted to
engage in margin trading. For example, the owners/custodians of IRAs, custodial accounts, and qualified
retirement accounts (e.g., such as 401(k) and 403(b) plans) are prohibited from trading on margin.

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8
Q

A customer who initiates a margin transaction will receive a margin (Reg. T) call for 50% of the transaction
amount. According to Regulation T, the customer’s margin requirement must be deposited by no later than
_ business days after the trade.

A

A customer who initiates a margin transaction will receive a margin (Reg. T) call for 50% of the transaction
amount. According to Regulation T, the customer’s margin requirement must be deposited by no later than
four business days after the trade.

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9
Q

A customer may meet a Reg. T call by:

A

depositing cash equal to the amount of the call or by depositing fully
paid marginable securities.

If securities are being used in lieu of cash, the customer must deposit
securities with a market value that’s equal to twice the amount of the call. The justification for the
amount of securities to be deposited is that the loan value of securities is only 50%.

For example, if a customer purchases 1,000 shares of XYZ stock at $40, he will
receive a Reg. T call for $20,000. The customer may deposit $20,000 in cash or
marginable securities with a market value of $40,000. Why $40,000? This is
because the securities have a loan value of only 50%.

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10
Q

True or False. Remember, cash is able to be used dollar-for-dollar; however, it takes $2.00 worth of securities to
satisfy every $1.00 owed to the broker-dealer.

A

True

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11
Q

represents the maximum amount that a broker-dealer will lend to a customer based on a percentage of the current market value of eligible securities. Since Reg. T is currently 50%, marginable securities have a _ value equal to 50% of their market value (100% – 50%).

A

Loan Value

For example, Mr. Smith purchases securities with a total market value of $20,000. The
securities have a loan value of $10,000 ($20,000 x 50%), which represents the maximum
amount the brokerage firm may lend to the customer for the purchase. If the securities
rise in value to $24,000, the loan value increases to $12,000 ($24,000 x 50%)

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12
Q

To open a margin account, customers are required to sign a margin agreement which states that they’re
willing to abide by the rules and regulations of the Federal Reserve Board, the SRO, and the brokerage
firm. The margin agreement usually contains the following three separate agreements:

A
  1. The credit agreement
  2. The hypothecation agreement
  3. The loan consent agreement
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13
Q

The _ agreement is essentially an acknowledgement that a customer is borrowing funds from the firm and is responsible for both payment of interest and repayment of the loan. The agreement will disclose all of the terms, such as the fact that the interest rate is variable and is typically tied to the broker call loan rate.

A

Credit Agreement

The broker call loan rate is the rate that’s charged to a brokerage firm when it borrows money from a bank to replace the funds being provided to a margin customer. The brokerage firm then charges the customer an additional percentage above this rate.

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14
Q

When a margin account is opened for a customer, the member firm must send the customer a statement
that indicates the following:
- The conditions under which interest charges will be imposed
- The annual rate(s) that may be imposed
- The method of computing interest
- Whether the rates are subject to change without prior notice and the specific condition(s) under
which they may be changed
- The method of determining the debit balance on which interest will be charged

A

Note

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15
Q

The _ or pledge agreement states that the customer is _ (pledging) his securities to the brokerage firm which, in turn, provides the firm with the ability to rehypothecate the securities to secure the loan received from a bank.

A

Hypothecation Agreement

The firm may pledge an amount equal to 140% of the amount that the customer is borrowing (i.e., 140% of the account’s debit balance). All of the securities in excess of 140% must be segregated.

For example, in a margin account, a customer purchases securities with a total market value of $10,000. The customer deposits 50% of the purchase, but borrows the remaining $5,000. To secure the loan from the bank, the brokerage firm is able to pledge up to $7,000 of the customer’s securities (140% x $5,000)

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16
Q

If the _ agreement is signed (this is optional), the customer is
signifying that the broker-dealer is entitled to lend the customer’s securities to other customers.

A

Loan Consent Agreement

The traditional borrowers of these shares are the short sellers who seek to profit from the decline in a security’s price.

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17
Q

True or False. Brokerage firms are
required to furnish all margin customers with a risk disclosure document at both the time of the account
opening and annually thereafter.

A

True

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18
Q

A customer who purchases securities in a margin account establishes a

A

long margin position

The three balances that are used for all computations of a long margin position are the long market value
(LMV), the debit (loan) balance, and the equity (EQ).

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19
Q

The _ reflects the current market price of the securities in the account and will fluctuate as the total
value of the securities increases and decreases. The market value of the positions purchased must be
marked-to-the-market as of the end of each trading day.

This process will determine if a customer is required to deposit additional cash (if the market value of the long positions drop) or may be able to buy additional securities (if the market value of the long positions rise).

A

Long market value (LMV)

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20
Q

The _ represents the amount that a customer has borrowed from and currently owes the brokerage
firm. Assuming that there are no additional transactions, and disregarding interest charges, the _
balance will remain constant.

A

debt (loan) balanc

Any subsequent change in the current market value of the securities has no effect on a customer’s debit
balance. Of course, any interest charged on the loan by the broker-dealer increases the balance.

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21
Q

The _ represents the investor’s ownership interest in the account and is computed by

A

Equity (EQ)

Long Market Value (LMV) – Debit Balance = Equity (EQ)

For example, with a Reg. T requirement of 50%, an investor purchases 1,000 shares of XYZ at $20 per share. The total cost of the purchase is $20,000 (the LMV) and the client must deposit $10,000 (the Reg. T deposit requirement of 50%). The other $10,000 is provided as a loan by the broker-dealer and represents the debit balance.

After the transaction and subsequent customer deposit, the account will reflect the following balances:
LMV – DEBIT = EQ
$20,000 - $10,000 = $10,000 (EQ)

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22
Q

A client who purchases securities is hoping that the stock rises in value. If the long market value of the
securities increases, the equity in the account will increase proportionately. The increase may create a
situation in which the equity in the account is above the initial Reg. T requirement, thereby creating
_ equity in the account.

A

Excess Equity

If a margin account generates excess equity based on the increase in the LMV, the amount will be reflected
(kept track of) in a Special Memorandum Account (SMA).

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23
Q

is a separate account within a margin account where excess margin, or buying power, is placed. It acts as a line of credit for purchasing securities.

  • Crucial in margin trading because it provides additional purchasing power to the investor
  • It’s created when the market value of securities in a margin account increases, thus creating excess margin, which is then transferred to this account
  • allows an investor to leverage their investment and buy more securities without adding more cash to the account. This increases the potential for both gains and losses.
  • regulated by the Federal Reserve Board’s Regulation T which stipulates this account cannot exceed the total market value of securities in the margin account.
A

Special Memorandum Account (SMA)

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24
Q

An investor is generally permitted to withdraw _% of the SMA generated.
If a customer does choose to withdraw cash, the debit balance will increase by the amount withdrawn.
However, the withdrawal will also cause the equity in the account to decrease proportionately.

A

An investor is generally permitted to withdraw 100% of the SMA generated.
If a customer does choose to withdraw cash, the debit balance will increase by the amount withdrawn.
However, the withdrawal will also cause the equity in the account to decrease proportionately.

From the previous example, let’s assume that the investor withdraws the $2,000 of SMA
in his account. As shown below, the SMA is reduced to zero and the debit balance will
increase to reflect the additional loan.

LMV. - DEBIT = EQ. SMA
$24K. $10K. $14K. $ 2K
$24K. $ 12K. $ 12K. $0

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25
Q

With a Reg. T requirement of 50%, buying power is equal to two times the SMA balance (SMA x 2).

A

Assuming the SMA was not withdrawn, the $2,000 of SMA will allow him to purchase $4,000 in securities ($2,000 X 2)

See the results.

LMV. - DEBIT. = EQ. SMA
$24K. $10K. $14K. $2K
$28K. $ 14K. $14K. $0

If investors choose to purchase an amount of Securities that exceeds their buying power, they will simply be required to deposit 50% of the net remaining amount

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26
Q

Purchases in a Restricted Account When an account is restricted, the customer is able to make additional purchases in the account and need only meet the initial Reg. T requirement for the new purchase. There’s no provision that requires the customer to deposit enough cash to bring the entire account up to the Reg. T requirement.

Same-Day Substitution When an investor purchases and sells securities on the same day in a restricted account, it’s referred to as a same-day substitution. If the amount being purchased and sold is identical, then no additional deposit is required. For example, if a customer sold $10,000 worth of ABC stock and purchased $10,000 worth of XYZ stock, no margin deposit is required.

If the purchase amount is greater than the sale amount, the customer is required to deposit the Reg. T margin requirement on the difference. For example, if a customer sold $10,000 of ABC stock and purchased $15,000 worth of XYZ stock, the customer is required to deposit the Reg. T margin requirement on the $5,000 net difference, which is $2,500.

If the sale amount is greater than the purchase amount, SMA is credited for an amount equal to 50%
of the net sales proceeds. For example, if a customer purchased $10,000 of ABC stock and sold
$15,000 worth of XYZ stock, SMA will increase by $2,500 ($5,000 x 50%).

A

If the purchase amount is greater than the sale amount, the customer is required to deposit the Reg. T margin requirement on the difference. For example, if a customer sold $10,000 of ABC stock and purchased $15,000 worth of XYZ stock, the customer is required to deposit the Reg. T margin requirement on the $5,000 net difference, which is $2,500.

If the sale amount is greater than the purchase amount, SMA is credited for an amount equal to 50%
of the net sales proceeds. For example, if a customer purchased $10,000 of ABC stock and sold
$15,000 worth of XYZ stock, SMA will increase by $2,500 ($5,000 x 50%).

Note

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27
Q

Long margin account customers are not required to maintain a constant 50% equity level; instead, industry
rules set a minimum maintenance requirement for equity to be at least 25% of the LMV. Therefore a
restricted account is one with equity that’s below 50%, but at or above 25% of the LMV.

If the equity drops below 25% of the LMV, a maintenance call is issued and the call must be met
promptly. A client may satisfy the call by depositing cash equal to the amount of the call, by liquidating
securities, or by depositing fully paid securities.

A

If a margin customer intends to take a withdrawal from SMA, but the withdrawal causes the account’s
equity to fall below the minimum maintenance requirement, he will be unable to withdraw the funds. In
this type of situation, the SMA is referred to as phantom SMA and may only be withdrawn when the
equity returns to an acceptable level.

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28
Q

Not all margin customers start with substantial purchases. For that reason, industry rules establish minimum equity requirements for initial transactions in their margin accounts.

For a long position, the customer’s minimum required deposit is the lesser of $2,000 or 100% of the purchase price. This requirement may override the 50% Reg. T requirement for initial purchases that are less than $4,000.

A

Example 1: A customer makes an initial purchase of $1,800 in a margin account.
Although the FRB requires a 50% Reg. T deposit ($900), this amount doesn’t meet
the industry requirement of the lesser of $2,000 or 100% of the purchase price.
Therefore, the customer is required to deposit the full $1,800.

Example 2: A customer makes a $3,000 initial purchase in a margin account. Again, although the FRB requires a 50% Reg. T deposit ($1,500), this amount doesn’t meet the overriding industry requirement of the lesser of $2,000 or 100% of the purchase price. Therefore, the customer is required to deposit $2,000.

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29
Q

A customer who sells securities short must do so through the use of a short margin account. The three
balances that are used for all computations in a short margin account are the

A

credit balance (CR), the
short market value (SMV), and the equity (EQ).

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30
Q

There are two components which make up the credit balance—the total proceeds generated by the
short sale plus the margin requirement on the value of the sale. For a short sale, the initial Reg. T
margin requirement of 50% is the same as if a margin purchase had been made.

The SMV represents the current market value of the securities that have been sold short and will fluctuate
as the value of the securities increases or decreases. The short seller wants the SMV to decline, but has a
potential unlimited loss if the stock rises.

The EQ balance initially represents the amount that has been deposited by the customer. The EQ is the
CR balance minus the SMV.

                 - Credit Balance (CR) – Short Market Value (SMV) = Equity (EQ)
A

For example, an investor sells short 1,000 shares of ABC at $20 which generates proceeds
of $20,000. The customer must deposit margin of $10,000 ($20,000 x 50%). After making
the deposit, the credit balance is $30,000 ($20,000 of short sale proceeds plus the margin
deposit of $10,000). The account will be established as follows:

                  -              CR         –    SMV       =      EQ
                             $30,000           $20,000           $10,000

If the SMV decreases, the EQ will increase; on the other hand, if the SMV increases, the EQ will
decrease. Interestingly, the CR balance (i.e., all of the cash) is not influenced by the fluctuation in the
market value; it remains the same. Due to the potential upside risk, customers may choose to hedge
their short positions by either purchasing calls or placing buy-stop orders.

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31
Q

The amount of excess equity for a short position is determined by the difference between the

A

current equity balance and the amount of equity that’s required by Reg. T.

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32
Q

A restricted account is one with Equity that’s below _%, but at or above _% of the LMV

A

A restricted account is one with Equity that’s below 50% but at or above 25% of the LMV.

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33
Q

True or false. If the equity in a margin account drops below 25% of the LMV, a maintenance call is issued and the call must be met promptly.

A

True

A client May satisfy the call by depositing cash equal to the amount of the call, by liquidating securities, or by depositing fully paid securities.

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34
Q

For a long position, the customer’s minimum required deposit is the lesser of $_or _% of the purchase price.

A

For a long position, the customer’s minimum required deposit is the lesser of $2,000 or 100% of the purchase price.

However, this requirement May override the 50% regulation T requirement for initial purchases that are less than $4,000

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35
Q

The equity (EQ) in a short margin position is calculated as

A

Credit balance - Short Market Value

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36
Q

What is the main difference between long and short positions within a margin account?

A

The difference between long and short positions is at the equity of a long position increases when the LMV rises, but the equity of a short position increases when the SMV drops.

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37
Q

For a short margin position account. Industry rules set a minimum maintenance requirement for equity to be at least _% of the SMV.

A

For a short margin position account. Industry rules set a minimum maintenance requirement for equity to be at least 30% of the SMV.

If a client has a shirt account in which SMA exists, she may not withdraw SMA if the withdrawal brings the account below the minimum maintenance requirement of 30%.

Ex:
CR. - SMV. = EQ
$30k. $20k. $10k
$30k. $25k. $5k

Based on the SMV increase to $25k, the min maintenance requirement is $7,500 ($25k x 30%).

Since the EQ is $5k, which is less than the maintenance requirement, the client receives a maintenance call for the $2,500 difference.

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38
Q

For a short margin position, the customers minimum required deposit is the _ of $2,000 or the required reg T deposit.

A

Greater of $2,000 or the required reg T deposit.

Ex: A customers initial transaction in a margin account is a $1,600 short sale of stock. Although the FRB required a 50% reg T deposit ($800), this amount doesn’t meet the industry requirement of the greater of $2,000 or 50% of the transaction. Therefore the customers deposit is $2,0000.

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39
Q

If a customer made a purchase and a short sale in a margin account, it may be necessary to calculate the combined equity of the account.

What are the 2 formulas to do so?

A

LMV + CR - DR - SMV or
(LMV - DR) + (CR - SMV)

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40
Q

What’s the maintenance requirement for a customer who has made a $1 million purchase of 2x Long Gold Index ETF?

A

To calculate the maintenance requirement, the standard long requirement of 25% is multiplied by the leverage factor of 2. Therefore, in this example, the customer must maintain a 50% margin requirement: $1,000,000 x 50% = $500,000.

Special maintenance requirement on leveraged ETFs

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41
Q

What’s the maintenance requirement for a customer who had a $1 million short position of a 3x Inverse Gold Index ETF?

A

To calculate the maintenance requirement, the standard short requirement of 30% is multiplied by the leverage factor of 3. Therefore, in this example, the customer must maintain a 90% margin requirement: $1,000,000 x 90% = $900,000.

Special maintenance requirements on Leveraged ETFs

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42
Q

What is minimum equity requirement for a day trader?

A

$25,000.

This must be deposited into the account before any day trading begins.

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43
Q

is a risk-based margin policy that aligns margin requirements with the overall risk of a portfolio. This type of margin allows for real-time risk management that can offer lower margin requirements than traditional methods, especially for large and sophisticated investors who have diversified portfolios

A

Portfolio-based Margin

The primary principle behind portfolio margin is that securities that are part of the same portfolio often have offsetting risks. This means that a decline in one security may be offset by the gain in another, leading to a lower overall risk for the portfolio. By taking this into account, portfolio margin can result in significantly lower margin requirements than traditional methods which consider each security in isolation.

The calculation of portfolio margin involves sophisticated risk assessment techniques.

Portfolio margin uses an SEC-approved computer modeling system to perform risk analysis and multiple pricing scenarios to measure risk in order calculate the appropriate margin requirements.

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44
Q

True or False. Portfolio margin is not available to small retail clients.

A

True.

Its only allowed for the following entities:

  1. Any broker or dealer that’s registered with the SEC under the Securities Exchange Act of 1934
  2. Any member of a National Futures exchange to the extent that listed index options, unlisted derivatives, ETF options, index warrants or other underlying instruments hedge the members index futures
  3. Any person approved to engage in uncovered options contracts. If a customer intends to trade unlisted derivatives, the customer must maintain Equity of at least 5 million at all times. Prior to offering portfolio margining methodology, a broker-dealer must develop a profile customers were eligible to use it. The broke a dealer must establish an approval process and Implement minimum Equity requirements for customers that are eligible to use portfolio margining
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45
Q

A _ is any customer who executes four or more day trades over in a five-business-day
period.

A

A pattern day trader is any customer who executes four or more day trades over in a five-business-day
period.

If a customer meets the definition of a pattern day trader, but the number of day trades is 6% or less of
total trades for the five-business-day period, the customer is not considered a pattern day trader. On
the other hand, if the broker-dealer knows, or has a reasonable basis to believe, that a customer who is
opening an account or resuming day trading will engage in a pattern of day trading, the firm may
immediately impose special day trading margin requirements.

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46
Q

A _ is defined as the purchase and sale—or the sale and purchase—of the same security on
the same day in a margin account

A

A day trade is defined as the purchase and sale—or the sale and purchase—of the same security on
the same day in a margin account

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47
Q

Portfolio margin uses an SEC-approved computer modeling system to perform risk analysis and
multiple pricing scenarios to measure risk in order to calculate the appropriate margin requirements.

A

Each eligible product will have a different theoretical valuation range,
including the following:

  • Highly capitalized broad-based indices use a potential market increase of 6% and a decrease of 8%.
  • Non-highly capitalized broad-based indices use a potential market increase of 10% and a decrease of
    10%.
  • Equity options, narrow-based index options, and/or security futures use a potential market increase of
    15% and a decrease of 15%.

The goal of portfolio margining is to reduce excess margin calls and to lower the risk of forced position liquidations. The end result is that if positions are hedged appropriately, there’s normally a
reduction in net margin requirements.

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48
Q

Portfolio margin is not available to small retail clients; instead, it’s only
allowed for the following entities:

A
  1. A financial broker or dealer that’s registered with the SEC under the Securities Exchange Act of 1934
  2. A member of a national futures exchange who uses listed index options, unlisted derivatives, ETF options, index warrants or other underlying instruments to hedge their index futures
  3. A person approved to engage in uncovered option contracts. If you want to trade unlisted derivatives, you must maintain equity of at least $5,000,000 at all times. Before offering portfolio margining methodology, a broker-dealer must identify customers who are eligible to use it, establish an approval process, and implement minimum equity requirements for eligible customers.
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49
Q

Mr. Green, a new client, decides to short 100 shares of JRF at $18 per share. What is the initial margin requirement for this trade?

A. $2.50 per share
B. 30% of current market value
C. $1,800
D. $2,000

A

Answer: D

If the initial transaction in a margin account is a short sale, industry rules require a minimum equity deposit of $2,000 or the required Reg. T deposit, whichever is greater. Since $2,000 is greater than $1,800, the required deposit is $2,000. For a purchase, the minimum equity requirement is the lesser of $2,000 or 100% of the purchase price.

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50
Q

A client purchased $50,000 worth of a security in her margin account and deposited the Regulation T minimum. A few days later, the market value of the security was $60,000. What action can the client take in her account?

A She can use the SMA in the account to pay down the debit balance.
B The account is restricted and the client is prohibited from taking any action unless she brings the equity back to the Regulation T minimum.
C. She can buy $10,000 worth of stock or withdraw $5,000 in cash.
D. She can buy $20,000 worth of stock and can take out $5,000 in cash.

A

Answer: C

The Reg T minimum is 50% of the market value of the purchase. At the time of the initial trade, the client’s account had $50,000 in market value and she deposited $25,000 in cash (i.e., equity). This also means the customer borrowed $25,000 (i.e., debit). When the market value of the securities increased to $60,000, the debit stayed at $25,000, but the equity increased to $35,000 ($60,000 LMV - $25,000 Debit). Based on the increase of the market value to $60,000, the Reg T minimum is $30,000, which means that the account has $5,000 of excess equity ($35,000 Equity - $30,000 Reg T minimum). As a result, the client can withdraw the $5,000 in cash or use it to purchase $10,000 of securities.

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51
Q

What is the SRO maintenance requirement on a $1 million purchase of a 2x Long Gold Index ETF?

A

Answer: $500,000

Leveraged ETFs have maintenance requirements in excess of the typical SRO thresholds of 25% on long positions and 30% on short positions. The process for determining the margin requirement on these securities uses the standard SRO maintenance requirement and multiplies by the portfolio leverage factor. In this case, the standard long requirement is 25% which is multiplied by a factor of 2; therefore, the client must maintain a 50% margin. $1,000,000 x 25% = $250,000. $250,000 x 2 = $500,000.

52
Q

The margin disclosure document describes the different types of risk associated with margin accounts and includes the following declarations.

  • You can lose more funds than you deposit.
  • The firm can force the sale of securities in your account.
  • The firm can sell your securities without contacting you.
  • You are not entitled to choose which securities are liquidated in order to meet a margin call.
  • The firm’s house maintenance margin requirements may change without providing you advance written notice.
  • You are not entitled to an extension of time on a margin call.

The firm definitely needs to provide advance written notice if the method of calculating interest charges is changed.

A

Note

53
Q

A customer’s margin account has a current market value of $10,000, a debit balance of $8,000, and SMA of $1,000. The customer could meet a maintenance call with:

A

Answer: $500 Cash

A long margin account must maintain equity equal to 25% of the market value. The account is $500 below the minimum ($2,500 required minus $2,000 equity). Using SMA will increase the debit balance and, therefore, may not be used to meet a maintenance call.

54
Q

“You don’t lose it till you use it”

Refers to

A

SMA

55
Q

True or False. SMA is a line-of-credit. There is no actual cash in the account. Its buying power is 2x the equity in the account. If you withdraw funds from SMA, your debt (loan) increases and your equity decreases

A

True

56
Q

When an investor shorts a stock, they borrow the shares from the brokerage to sell in the market with the expectation that they can buy them back at a lower price in the future. The proceeds from the short sale are credited to the investor’s margin account, creating a

A

Credit balance

57
Q

What are the two components that make up the credit balance in a short margin position?

A

Total proceeds generated by the short sale + the margin requirement on the value of the sale. (50%)

*Ex: an investor sells short 1,000 shares of ABC at $20 which generates profit of $20,000. The customer must deposit margin of $10,000 ($20,000 x 50%).

After making the deposit, the credit balance is $30,000 ($20,000 of short sale proceeds + margin deposit of $10,000).

The account will be established as follows:

CR. - SMV. = EQ
$30,000. $20,000. $10,000

58
Q

is when an investor borrows money from their broker to buy more stocks than they could afford with just their own money. The investor is betting the stock price will go up. If it does, they can sell the stock, repay the loan, and keep the profit. However, if the stock price goes down, the investor will still owe the loan amount to the broker.

A

A long margin position

59
Q

is when an investor borrows stocks from their broker and sells them, hoping the price will go down. If the price goes down, they buy the stock back at the lower price, return the shares to the broker, and keep the difference. However, if the stock price rises, the investor will have to buy back the stock at a higher price and lose money.

A

A short margin position

60
Q

is a demand from a brokerage for an investor to add money to their margin account to meet the minimum account balance requirement. If the investor can’t meet the margin call, the broker may sell their securities to cover the shortfall.

A

What is a margin call?

61
Q

is the minimum amount of equity that must be maintained in a margin account. It is usually expressed as a percentage of the total value of the securities in the account.

A

What is a maintenance margin?

62
Q

What is initial margin requirement?

A

Answer: The initial margin requirement is the percentage of the total purchase price of a security that the investor must have in their account at the time of purchase. The Federal Reserve’s Regulation T sets this requirement at 50%.

63
Q

is an investor who executes four or more “day trades” within five business days in a margin account, provided the number of day trades is more than six percent of the total trades in the account during that period. Pattern day traders are subject to special rules and requirements.

A

What is a pattern day trader according to FINRA rules?

64
Q

What does it mean to have a debit balance in a margin account?

A

A debit balance in a margin account represents the amount you owe to your broker for loans used to purchase securities.

65
Q

What is a credit balance in a margin account?

A

Answer: A credit balance in a margin account refers to the amount of money or value of securities an investor has after all debts have been paid. In the context of a short sale, it’s the amount of money received from selling borrowed shares.

66
Q

What is a restricted margin account?

A

A restricted margin account is one where the account’s equity is less than the maintenance margin requirement, but more than the minimum amount at which a margin call would be issued. The investor can still trade, but must follow certain rules and restrictions.

67
Q

What is marked to market in relation to a margin account?

A

Marked to market refers to the daily settling of gains and losses in a margin account due to changes in the market value of the securities. If the market value decreases significantly, it may trigger a margin call.

68
Q

What is day trading margin?

A

Answer: Day trading margin is the amount an investor must maintain in their account to engage in day trading. According to FINRA rules, the minimum equity requirement for a pattern day trader is $25,000. If the account falls below this amount, the trader won’t be able to day trade until the minimum equity level is restored.

69
Q

What is Short Market Value (SMV) in a margin account?

A

Answer: SMV refers to the total market value of all short positions in a margin account. It fluctuates with changes in the market price of the shorted securities.

70
Q

What happens when the SMV increases in a margin account?

A

Answer: When the SMV increases, it means the market price of the shorted securities has risen. This is unfavorable for the investor holding the short position, as it would cost more to buy back the shares to cover the short position.

71
Q

Question: What happens when the LMV decreases in a margin account?

A

Answer: When the LMV decreases, it means the market price of the securities has fallen. This reduces the investor’s equity in the margin account and increases the risk of a margin call.

72
Q

What is the relationship between SMA and buying power in a margin account?

A

Answer: SMA directly affects the buying power in a margin account. Buying power refers to the maximum value of securities that an investor can purchase without depositing more money. In a margin account, buying power is typically twice the sum of the investor’s equity and the SMA.

73
Q

Sales tax is an example of a _____________________ tax.

A

Sales tax is an example of a regressive or flat tax.

74
Q

When dealing with institutional client suitability, what are two important considerations?

A

The client’s ability to evaluate independently the risk and the extent to which they are exercising that ability.

75
Q

What is the formula for calculating an individual’s personal discretionary income?

A

Income - Expenses = Discretionary Income

76
Q

How long must new issues be held before they may be used as collateral?

A

30 days

77
Q

Securities that are acceptable as collateral have a loan value that equals ____%.

A

Securities that are acceptable as collateral have a loan value that equals 50%.

78
Q

How long can a short stock position be maintained?

A

Unlimited, provided the account maintains the minimum required equity.

79
Q

What is the formula for finding equity in a combined margin account?

A

(LMV + Credit Balance - Debit Balance - SMV)

80
Q

Define Regulation T.

A

The percentage a customer must deposit when purchasing securities or selling short

81
Q

How is buying power calculated?

A

SMA divided by Reg T of 50% (just remember SMA x 2)

82
Q

Calculate SMA using the following balances: LMV $40,000, Debit $10,000 and Equity $30,000

A

Equity - 50% of the LMV = Excess Equity ($30,000 - $20,000 = $10,000)

83
Q

True or False: Firms may establish their own in-house rules relating to payment dates and minimum requirements.

A

True. However, the requirements must be at least as stringent as those established by the regulators.

84
Q

The ________________ Agreement describes the customer’s pledging of securities as collateral to the BD.

A

The Hypothecation Agreement describes the customer’s pledging of securities as collateral to the BD.

85
Q

On margin, Ben buys 100 shares of ABN at 50 and sells 1 ABN Oct 55 call at 3. What is Ben’s required cash deposit?

A

$2,200, which is 50% of the stock position minus the $300 premium received on the sale of the call

86
Q

May new issues (e.g., IPOs or mutual fund shares) be purchased on margin?

A

No

87
Q

What may a BD lend to a customer in a margin account?

A

The complement of the Reg T margin call. In other words, 50%.

88
Q

What is the Reg T margin requirement for short sales?

A

50%

Remember this 50% comes from the initial sale proceeds.
So if the Short sale produced $10,000 then this becomes $15,000. ($10,000 ✗ 50%)

89
Q

Existing account: LMV $40,000, Debit $25,000, Equity $15,000. How is SMA affected by receiving a $5,000 cash dividend?

A

SMA would be credited with $5,000 (100% of the deposit).

90
Q

What amount of fully paid securities must be deposited to meet a margin requirement?

A

Securities with a loan value equal to the margin call (in other words, two times the margin call)

91
Q

Existing account: LMV $40,000, Debit $10,000, Equity $30,000, SMA $10,000. SMA is used for a $20,000 purchase. Result?

A

LMV $60,000 - Debit $30,000 = Equity $30,000 and SMA is $0

92
Q

The credit balance is made up of what two components?

A

Short sales proceeds plus the Reg. T requirement

93
Q

What stocks does the FRB deem to be marginable?

A

Those stocks listed on major exchanges and on Nasdaq

94
Q

On margin, Emma shorts 100 shares of DEF at 68 and sells 1 DEF Oct 60 put at 4. What is Emma’s required cash deposit?

A

$3,000, which is 50% of the short position minus the premium received on the sale of the put

95
Q

True or False: Short against the box is considered being long and short the same position at the same time.

A

True

96
Q

True or False: Market declines will reduce SMA.

A

False. The only way to lose SMA is to use SMA.

97
Q

If an investor writes a covered call, is there a margin requirement on the option position?

A

No, the long stock position covers the sale of the call.

98
Q

What is the margin requirement when buying options?

A

100% of the premium

99
Q

By how much is the following account restricted? LMV $40,000, Debit $25,000, Equity $15,000

A

Restricted by $5,000. The equity should be $20,000 (50% of $40,000), but there is only $15,000.

100
Q

The _____________________ has the authority to regulate margin requirements.

A

The Federal Reserve Board (FRB) has the authority to regulate margin requirements.

101
Q

Calculate the combined equity in the following account: LMV $24,000, Debit $10,000, Credit $18,000, SMV $9,000

A

(24,000 + 18,000 - 10,000 - 9,000) = $23,000

102
Q

How is the account affected if SMA is withdrawn?

A

Debit balance increases and equity decreases.

103
Q

What is a customer using when she borrows funds to increase the size of her position?

A

Leverage

104
Q

How would a $2,000 cash dividend or voluntary cash deposit affect a margin account’s balances?

A

LMV is unchanged, Debit is reduced by $2,000, Equity is increased by $2,000, and SMA is increased by $2,000.

105
Q

In a margin account, customers pay interest on the ________ balance.

A

In a margin account, customers pay interest on the debit balance.

106
Q

What is the maximum amount of securities that a BD may rehypothecate to a bank?

A

140% of the debit balance

107
Q

True or False: Customers are required to sign the Loan Consent Agreement.

A

False. Signing the agreement is optional.

108
Q

The minimum equity requirement for the initial short sale in a margin account is $_______ .

A

The minimum equity requirement for the initial short sale in a margin account is $2,000.

109
Q

When a customer buys on margin, how much cash may a BD borrow from a bank?

A

100% of the debit balance

110
Q

What is the margin requirement for a short against the box position?

A

5% of the long position

111
Q

How will the sale of securities from an account affect the account balances?

A

LMV and Debit decrease by the sales proceeds, Equity stays the same, and SMA increases by 50% of the sales proceeds.

112
Q

A client buys stock on margin and makes no cash deposit because he uses SMA. How are the account balances affected?

A

LMV and Debit both increase by the full purchase price; no change is made to equity.

113
Q

What document allows a BD to lend customer securities to someone wishing to sell them short?

A

Loan Consent Agreement

114
Q

The formula for determining equity in a long margin account is: ____________ - __________ = Equity

A

The formula for determining equity in a long margin account is: Long Market Value (LMV) - Debit Balance = Equity

115
Q

On margin, Henry sells short 100 shares of DEF at 68 and sells 1 DEF Oct 60 put at 4. What is the margin requirement?

A

$3,400, which is 50% of the short position. Since this is a covered position, there is no requirement on the short put.

116
Q

The industry minimum maintenance requirement for a long account is ____%.

A

The industry minimum maintenance requirement for a long account is 25%. (Equity must be at least 25% of LMV.)

117
Q

What is the rate of interest that a bank charges a BD on margin loans?

A

Call rate

118
Q

The industry minimum maintenance requirement for a short account is ____%.

A

The industry minimum maintenance requirement for a short account is 30%. (Equity must be at least 30% of SMV.)

119
Q

Existing account: LMV $40,000, Debit $10,000, Equity $30,000, SMA $10,000. If SMA is withdrawn, what are the balances?

A

LMV $40,000 - Debit $20,000 = Equity $20,000 and SMA is $0

120
Q

Existing account: LMV $40,000, Debit $25,000, Equity $15,000. If $5,000 is sold from the account, how is SMA affected?

A

SMA would be credited with $2,500 (50% of the sales proceeds).

121
Q

A long margin account’s minimum initial equity requirement is _____ % of the purchase or $_____ , whichever is less.

A

A long margin account’s minimum initial equity requirement is 100% of the purchase or $2,000, whichever is less.

122
Q

____________ governs the extension of credit by BDs.

A

Regulation T governs the extension of credit by BDs.

123
Q

To meet a $20,000 Reg. T call, a customer could deposit cash of $________ or fully paid securities of $________.

A

To meet a $20,000 Reg. T call, a customer could deposit cash of $20,000 or fully paid securities of $40,000.

124
Q

The formula for determining equity in a short margin account is: ____________ - ____________ = Equity

A

The formula for determining equity in a short margin account is: Credit Balance - Short Market Value (SMV) = Equity

125
Q

Hypothecation is synonymous with what term?

A

Pledge

126
Q

On margin, an investor buys 100 shares of ABN at 50 and sells 1 ABN Oct 55 call at 3. What is the margin requirement?

A

$2,500, which is 50% of the stock position. Since this is a covered position, there’s no requirement on the short call

127
Q

If a client’s equity falls below 25%, the maintenance call must be met __________.

A

If a client’s equity falls below 25%, the maintenance call must be met promptly.