Chapter 9- Cash and margin accounts

Question 1

Two types of accounts

Answer 1

Margin accounts

cash accounts

Question 2

Cash account

Answer 2

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

Question 3

Margin account

Answer 3

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

Question 4

3 types of margin accounts

Answer 4

Margin account long- for buying stock
Margin account Short - for selling stocks short
Margin account mixed - long and short positions in the same account

Question 5

What is the “margin” in a margin account

Answer 5

This is the amount that the customer must deposit to do a leveraged trade

Question 6

Reg-T margin requirements

Answer 6

Can borrow a maximum of 50% of the total value

Question 7

Special Memorandum Account (SMA)

Answer 7

is a line of credit extended to the customer by the broker-dealer

Question 8

Reg-T regulates…

Answer 8

credit extensions by broker dealers

Question 9

Reg-T covers

Answer 9

Cash and margin accounts

Do not cover commodities

Question 10

Reg-T settlement

Answer 10

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

Question 11

Reg-T does not apply if…

Answer 11

Less then $1,000 or less of securities were purchased

or

the security is a government security

Question 12

Cash accounts that were “sold out”, (consequence)

Answer 12

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

Question 13

Free-Riding

Answer 13

Buying and selling a stock before you have paid for it (during settlement period)

This is a violation of federal reserve rules.

Question 14

Reg-T Classifications

Answer 14

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)

Question 15

Puts, calls, and margin accounts

Answer 15

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

Question 16

Margin loan funding

Answer 16

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

Question 17

Hypothecation

Answer 17

Occurs when the b/d makes a margin loan to a customer using the securities purchased as collateral

Question 18

Rehypothecation

Answer 18

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

Question 19

Debit Balance

Answer 19

This is the amount that the customer has borrowed from the B/D to purchase securities in a margin account

Question 20

When B/D requests a loan from a bank it can use up to…

Answer 20

140% of the value of the customer’s debit balance in the form of customer securities as collateral for the loan

Question 21

To open a margin account you need…

Answer 21

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

Question 22

Interest charged on debit balances of a margin account…

Answer 22

Fluctuate. They are based on the Broker Loan Rate or Call Loan Rate

Increase the customers debit balance

Question 23

Initial Requirements in margin account long

Answer 23

must deposit 50% or $2,000, whichever is greater

Question 24

Cash or securities requirement for Reg T initial requirements (margin long accounts)

Answer 24

Deposit full cash amount

deposit securities that have 2x the value of the Reg T requirements

Question 25

Initial Requirements for short margin accounts

Answer 25

$2,000 minimum equity, no exceptions

Customers must deposit 50% of the short sale of $2,000, whichever is greater

Question 26

Initial Margin requirement of short sale stocks

Answer 26

$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

Question 27

Customers Net Financial Ownership formula

Answer 27

Current market value - debit balance = Net financial ownership (aka equity)

Question 28

Options when we have excess equity

Answer 28

Withdraw cash
Buy more stock (excess equity has 2x buying power)
SMA - Line of credit (do nothing)

Question 29

Options when we are below Reg-T 50%

Answer 29

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

Question 30

What happens when margin account equity falls below 25%

Answer 30

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

Question 31

Determining the condition of the long margin account

Answer 31

1. look at the market value of the stock
2. Divide by 2 (50% from reg T)
3. Subtract debit balance from step 2
   This will equal the excess equity, if positive, or the amount in restriction, if negitive

Question 32

SMA can be increased by

Answer 32

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)

Question 33

SMA can be decreased by

Answer 33

New Margin purchases
Cash withdrawal

(is not decreased by a decline in market value)

Question 34

SMA, Purchases in restriction and minimum maintenance

Answer 34

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

Question 35

Buying power equals

Answer 35

Either 2x SMA or 2x excess equity

Question 36

Rules for sales in a long margin account in restriction

Answer 36

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

Question 37

Rules for buying in a long margin account in restriction

Answer 37

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

Question 38

Customer Wishes to replace one security with another

Answer 38

Must be done dollar for dollar, not share for share

AKA same day substitution

Question 39

Customer Wants to replace a security with cash on a restricted account

Answer 39

The customer must deposit cash equal to 50% of the securities being withdrawn

Question 40

Minimum Maintenance Requirement Formula

Answer 40

Current Market Value * .25 = Minimum Equity

Question 41

Maintenance Margin Calls

Answer 41

Due on demand
If not satisfied liquidation your your account can occur

Question 42

Liquidating from a margin call

Answer 42

The firm must liquidate 4x the value of the call

Question 43

Determining Minimum maintenance threshold

Answer 43

Debit balance * .75

Question 44

Minimum Maintenance on a Short Margin account

Answer 44

30% of the current market value

Question 45

Debit Balance in a short account

Answer 45

There is never a debit balance since we owe shares and not money in a short account

Question 46

Interest on short accounts

Answer 46

No interest is paid or due on a short account

Question 47

Formula for determining equity on a short margin account

Answer 47

Proceeds from short sale
+ Reg T requirements
———————————-
Credit Balance
- Current market value short
——————————————
Equity

Question 48

Determining when you get a minimum maintenance call on a short margin account

Answer 48

Credit balance / 1.30

Question 49

Calculating Mixed margin account formula

Answer 49

Market value long - debit balance + credit balance - Short market value = equity

Question 50

Purchasing stock on a when issued basis requires a deposit of cash equal to…

Answer 50

25% of the issue or $2,000 whichever is greater (true for margin or cash accounts)

Question 51

Margin Accounts for fiduciaries require

Answer 51

Written authorization

Question 52

Margin accounts for minors…

Answer 52

are prohibited