Chapter 9- Cash and margin accounts Flashcards
Two types of accounts
Margin accounts
cash accounts
Cash account
Requires customers to pay cash in full for all purchases made from this account
Customer’s signatures are not required when opening a cash account
Margin account
Allows customers to purchase securities worth twice the amount they have deposited by allowing the investor to borrow money from the broker-dealer or borrowing securities from the broker dealer to sell the stock short
3 types of margin accounts
Margin account long- for buying stock
Margin account Short - for selling stocks short
Margin account mixed - long and short positions in the same account
What is the “margin” in a margin account
This is the amount that the customer must deposit to do a leveraged trade
Reg-T margin requirements
Can borrow a maximum of 50% of the total value
Special Memorandum Account (SMA)
is a line of credit extended to the customer by the broker-dealer
Reg-T regulates…
credit extensions by broker dealers
Reg-T covers
Cash and margin accounts
Do not cover commodities
Reg-T settlement
if a customer purchases a security payment must be received by the 4th business day after the trade date
If not the B/D must obtain an extension from the regulatory authorities
or
cancel or liquidate the unsettled portion of the transaction
Reg-T does not apply if…
Less then $1,000 or less of securities were purchased
or
the security is a government security
Cash accounts that were “sold out”, (consequence)
If a cash account was sold out for failure to pay that account must be frozen for 90 days
If they want to make a trade during that frozen period they must have cash sufficient to cover the total cost of the trade deposited before the trade is made
Free-Riding
Buying and selling a stock before you have paid for it (during settlement period)
This is a violation of federal reserve rules.
Reg-T Classifications
Registered - sold on exchanges
OTC- Securities that are not sold on exchange but can be purchased on margin
Exempt - Securities that are issued by government or municipalities
Unregistered - New issues, open end investment companies and other securities accompanied by an offering circular or prospectus (these have no loan value)
Puts, calls, and margin accounts
Put and call options can be purchased in a margin account but can not be purchased on margin. 100% of the premium payment is required
Margin loan funding
Funding is often from a bank where the b/d puts up the securities as collateral to a bank to obtain a loan. This is why they must be in street name
Hypothecation
Occurs when the b/d makes a margin loan to a customer using the securities purchased as collateral
Rehypothecation
When the b/d pledges the securities as collateral to a bank for the loan to fund the customers margin purchase
If there are fully paid for securities in a customers margin account those securities can not be rehypothecated since the customer owns them fully
Debit Balance
This is the amount that the customer has borrowed from the B/D to purchase securities in a margin account
When B/D requests a loan from a bank it can use up to…
140% of the value of the customer’s debit balance in the form of customer securities as collateral for the loan
To open a margin account you need…
New account report form
Margin agreement (aka customer or hypothecation agreement)
(some B/D have a single form for this now)
Customer Loan consent agreement
Credit agreement
If RR has discretionary authority on the account and customer wants to add margin capabilities they must sign a margin agreement and the RR must get supervisory approval
Interest charged on debit balances of a margin account…
Fluctuate. They are based on the Broker Loan Rate or Call Loan Rate
Increase the customers debit balance
Initial Requirements in margin account long
must deposit 50% or $2,000, whichever is greater
Cash or securities requirement for Reg T initial requirements (margin long accounts)
Deposit full cash amount
deposit securities that have 2x the value of the Reg T requirements
Initial Requirements for short margin accounts
$2,000 minimum equity, no exceptions
Customers must deposit 50% of the short sale of $2,000, whichever is greater
Initial Margin requirement of short sale stocks
$0- 2.50 = 2.50/share
$2.50-5.00 = 100% of the market value
$5.00- 10.00 = $5.00 / share
$10.00 and up = 50% of market value
If this amount is less than $2,000 then the customer still needs to put in the $2,000 minimum
Customers Net Financial Ownership formula
Current market value - debit balance = Net financial ownership (aka equity)
Options when we have excess equity
Withdraw cash
Buy more stock (excess equity has 2x buying power)
SMA - Line of credit (do nothing)
Options when we are below Reg-T 50%
Must abide by Federal retention rules
50% of any sale can be given to owner
50% of any sale must be retained to pay down debit
What happens when margin account equity falls below 25%
Maintenance call (margin call) - requires customer to deposit cash or securities to be back at or above 25% equity
Due on demand and if the not done the B/D can sell off stock to make the account achieve that balance
NYSE and FINRA set 25% rule. Firms can have a higher minimum maintenance requirement if they choose
Determining the condition of the long margin account
- look at the market value of the stock
- Divide by 2 (50% from reg T)
- Subtract debit balance from step 2
This will equal the excess equity, if positive, or the amount in restriction, if negitive
SMA can be increased by
Appreciation of value of securities
Cash deposits that were not required
Cash dividends on stock in the account
Long sale of securities (increased by 50% of sale proceeds)
SMA can be decreased by
New Margin purchases
Cash withdrawal
(is not decreased by a decline in market value)
SMA, Purchases in restriction and minimum maintenance
If an account has an SMA balance but goes into restriction they can still use the SMA to make new purchases as long as those new purchases do not put the account into minimum maintenance
Buying power equals
Either 2x SMA or 2x excess equity
Rules for sales in a long margin account in restriction
Customer is allowed to withdraw 50% of sale proceeds or SMA can be credited that 50%
If they sells more then they buy on the same day they are allowed to withdraw 50% of the difference from the buy and sell
Rules for buying in a long margin account in restriction
You can still buy in your account but you have to put up the 50% for the purchase
If a customer buys more then they sell on the same day they are required to deposit the Reg T% of the difference
Customer Wishes to replace one security with another
Must be done dollar for dollar, not share for share
AKA same day substitution
Customer Wants to replace a security with cash on a restricted account
The customer must deposit cash equal to 50% of the securities being withdrawn
Minimum Maintenance Requirement Formula
Current Market Value * .25 = Minimum Equity
Maintenance Margin Calls
Due on demand
If not satisfied liquidation your your account can occur
Liquidating from a margin call
The firm must liquidate 4x the value of the call
Determining Minimum maintenance threshold
Debit balance * .75
Minimum Maintenance on a Short Margin account
30% of the current market value
Debit Balance in a short account
There is never a debit balance since we owe shares and not money in a short account
Interest on short accounts
No interest is paid or due on a short account
Formula for determining equity on a short margin account
Proceeds from short sale
+ Reg T requirements
———————————-
Credit Balance
- Current market value short
——————————————
Equity
Determining when you get a minimum maintenance call on a short margin account
Credit balance / 1.30
Calculating Mixed margin account formula
Market value long - debit balance + credit balance - Short market value = equity
Purchasing stock on a when issued basis requires a deposit of cash equal to…
25% of the issue or $2,000 whichever is greater (true for margin or cash accounts)
Margin Accounts for fiduciaries require
Written authorization
Margin accounts for minors…
are prohibited
