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SERIES 7 TOPOFF -- SANDBOX > Margin Accounts > Flashcards

Margin Accounts Flashcards

This deck focuses on margin accounts, including both long and short margin accounting.

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.

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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.

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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.

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4
Q

What is hypothecation?

A

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

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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.

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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.

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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.

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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.

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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.

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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.

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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.

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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

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13
Q

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

A

30 days after the SEC declares effectiveness.

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14
Q

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

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)
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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)
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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.

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17
Q

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

A

Long Market Value

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18
Q

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

A

The Debit Balance

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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.

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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.

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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
  • SMA Value $0
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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.

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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.

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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.

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25
When does an account become restricted?
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
What are the special margin rules for buying securities in a restricted margin account?
None ## Footnote There are no special rules - only the normal Reg T of 50% of new purchases.
27
Can a restricted account still have SMA?
Yes ## Footnote 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
If an account is under Reg T (Restricted), how are the proceeds from sales handled?
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
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 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
How many days are allowed to satisfy a margin call?
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
What type of balance is created when a stock is shorted?
A Credit Balance ## Footnote 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
What is the method to determine the equity in a short account?
Total credit in the account minus short market value equals account equity.
33
Which equity level triggers a margin call in a short margin account?
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
A margin account is set up with an initial short sale of $20,000 of stock. What is the initial margin?
$10,000 ## Footnote Reg T covers initial margin only and is always 50% - for both long and short accounts.
35
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?
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
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?
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
A fully margined initial sale of $20k of stock declines to $15K. What is the current market value, equity, credit, and SMA?
"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
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
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
Which **regulatory body** sets margin rules?
The Federal Reserve ## Footnote 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
What is another name for the **body of margin rules**?
Regulation T ## Footnote This is because in the Act of 1934, margin rules are covered in section "T."
41
# Define: **buying on margin**
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
# Define: **initial margin requirement**
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
# Define: **long market value**
The current market value of long securities in a margin account.
44
# Define: **margin rate**
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
# Define: **Regulation T**
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
A pattern day trader effects 4 or more day trades within a
5 business day period
47
Authorizes the regulation of credit to the Federal Reserve Board
Securities Act of 1934
48
Number of days mutual fund shares must be held before they can be used as collateral in a margin account
30 days
49
Agreement that gives a broker-dealer permission to pledge customer margin securities as collateral for bank loans
Hypothecation Agreement
50
How customer securities must be registered in a margin account
Street name
51
The form required for a broker-dealer to loan customer margin securities to other customers for short sales
Loan Agreement
52
The regulation that grants authority to regulate the extension of credit in the securities industry
Reg T (Securities Act of 1934)
53
Minimum deposit required in margin accounts within 5 business days by Reg T
50% of the market value of the transaction
54
Type of securities that cannot be purchased on margin, but can be used as collateral after 30 days
Mutual funds
55
Minimum initial deposit required by FINRA Rules
$2,000
56
The deposit required to purchase shares with a value of $2,500 in a margin account
$2,000
57
The deposit required to purchase shares with a value of $6,000 in a margin account
$3,000
58
The deposit required to purchase shares with a value of $1,500 in a margin account
$1,500
59
The deposit required to sell short shares with a value of $2,500 in a margin account
$2,000
60
The Reg T deposit required to sell short shares with a value of $6,000 in a margin account
$3,000
61
The deposit required to sell short shares with a value of $1,500 in a margin account
$2,000
62
The recalculation made daily to check the amount of equity in a margin account
Mark to the market
63
The impact on the equity in a long margin account when the market value of the securities increases
Equity increases
64
The impact on the debit balance in a long margin account when the market value of the securities increases
No change
65
The minimum maintenance requirement in a long margin account
25% of the long market value
66
The minimum maintenance requirement in a short margin account
30% of the short market value
67
An account that has equity of less than Reg T but more than minimum maintenance
Restricted
68
Created when equity is greater than the Reg T amount
SMA
69
Buying power of SMA
$2 of buying power for every $1 of SMA
70
Formula for determining the market value of maintenance in a long margin account
Debit balance/.75
71
Use of cash dividends when not removed from a margin account within 30 days
Reduce the debit balance
72
Requirement that 50% of sales proceeds must be used to reduce the debit balance when securities are sold in a restricted account
Retention requirement
73
The credit to SMA when securities are sold
50% of the sales proceeds
74
In a short margin account, the impact on equity when the short market value of securities increases
Equity decreases
75
The equation for determining the amount of equity in a short margin account
CR - SMV = EQ
76
The equation for determining the amount of equity in a long margin account
LMV - DR = EQ
77
The point at which a maintenance call is triggered in a short account
Equity below 30% of SMV
78
The equation for determining the short market value at maintenance
CR / 1.30%
79
A margin account with both long and short positions
Combined account
80
The basic equation for determining equity in a combined account
LMV + CR - DR- SMV = Combined Equity
81
The impact on SMA in a short account when the market value of the securities rises
No change
82
The impact on SMA in a long account when the market value of securities falls
No change
83
The impact on SMA in a short account when the market value of securities falls
Increases if the new excess equity is greater than the old SMA
84
The impact on SMA in a long account when the market value of securities rises
Increases if the new excess equity is greater than the old SMA
85
What SMA in a margin account creates
Buying power
86
A line of credit that a customer can use to borrow from or purchase securities in a margin account
SMA
87
The two agreements that are required for an investor to open a margin account
Hypothecation Agreement and Credit Agreement (Loan consent is optional)
88
The three components of a margin agreement
Hypothecation agreement, credit agreement, loan consent form
89
Two categories of securities that are exempt from Reg T margin requirements
U.S. Government securities, Municipal securities
90
The impact to SMA in a long account when a non-required cash deposit of $1,000 is made
SMA will increase $1,000
91
When a maintenance call must be met
Promptly
92
Minimum equity to open a day trading account
$25,000
93
Under Reg T, payment must be made by
S + 2
94
Impact on a long margin account debit balance when $10,000 of SMA is used to buy stock
Debit balance increases $20,000 (Buying power of SMA is 2:1)
95
Impact on credit balance in a short account when SMV of securities rises
No change to credit balance, but equity falls
96
The \_\_\_\_\_\_\_\_ margin is the required proportion of your equity to the total value of the stock purchased on margin.
maintenance margin ## Footnote 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
Which entity establishes the maximum percentage of a security's value that may be financed through a margin loan?
U.S. Federal Reserve
98
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?
$500 ## Footnote 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
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
25% ## Footnote In a long margin account, if the customer's equity falls below 25% of the market value, they will get a margin call.
100
In a short margin account, a customer will receive a margin call if their equity falls below what percentage of the short market value?
30%
101
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?
$46,667 ## Footnote 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
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?
$115,384 ## Footnote 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
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?
$1,000 ## Footnote 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
In a margin account, the long market value minus the debit balance equals the
investor's equity
105
In a short margin account, the short market value plus the investor's equity equals the
Credit balance ## Footnote 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
After how many days can mutual fund shares be used as collateral?
30 days ## Footnote 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
# Define: **credit agreement**
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
# Define: **hypothecation agreement**
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
# Define: **loan consent agreement**
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
# Define: **maximum loan value**
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
# Define: **restricted account**
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
When is an **account designated** a "pattern day trader?"
When there are four or more day trades (buy and sell same day) made within a five-day period - also called a "round trip."

SERIES 7 TOPOFF -- SANDBOX (8 decks)

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