Series 7 & Margin Accts

Question 1

What is a margin account?

Answer 1

A margin account is an account in which a customer is going to make some kind of  cash deposit usually like a down payment to buy stock on credit.

Question 2

Contrast a margin acct with a cash account. What are the differences?

Answer 2

cash account the customer pays in full for whatever transaction they deal in.

Question 3

What are LONG MARGIN TRANSACTIONS?

Answer 3

The use of borrowed funds in brokerage accounts to buy securities using the securities as collateral.

Question 4

Who makes the rules about how we purchase things in margin accounts and what we can purchase in a margin account?

Answer 4

The  Federal Reserve Board

Question 5

What role does the Federal Reserve Board play in margin accounts?

Answer 5

It makes the rules about how we purchase things in margin accounts and what we can purchase in a margin account

Question 6

How does the Fed effect securities?

Answer 6

They restrict the kinds of securities that can be purchased in a margin acct.

Question 7

What kinds of securities does the Fed actually concern itself with?

Answer 7

Specifically Common Stock.

Question 8

What is marginable stock?

Answer 8

Not all stock can be purchased on margin or credit. Stock that can be purchased on margin is called Marginable Stock.

Question 9

What does a stock have to be to be called marginable?

Answer 9

Marginable stock is any stock that is listed on an exchange

Question 10

What are the only 2 types of stock that can be purchased on margin?

Answer 10

Stock that is listed on an exchange and NASDAQ stocks

Question 11

What is the first step to opening a margin account?

Answer 11

The First document - New Account form Is required.

Question 12

If the first document is a New Account Form, what is the second document required to open a margin acct.?

Answer 12

2nd document a Margin Agreement or Customer Agreement with several parts.

Part 1 - Credit Agreement - discloses the terms of credit in which a loan will be extended to them. (Similar to getting a loan from a bank).

Part 2 - Hypothecation Agreement - the process of using stock or other securities as collateral for a 
Loan.

Question 13

Opening up a Margin acct., what are the Part 1 and Part 2 agreements?

Answer 13

Credit Agreement and Hypothecation Agreement.

Question 14

Opening up a Margin acct., what is the Credit Agreement?

Answer 14

Discloses the terms of credit in which a loan will be extended to them. (Similar to getting a loan from a bank).

Question 15

Opening up a Margin acct., what is the Hypothecation Agreement?

Answer 15

The process of using stock or other securities as collateral for a 
Loan.

Question 16

What is the stock they are buying in the margin account on credit will serve as?

Answer 16

 the collateral for a loan

Question 17

The hypothecated  Agree,emt is between who and whom?

Answer 17

This agreement between the broker dealer and the customer.

Question 18

What is an optional agreement or form and not always included in a Hypothecation agreement?

Answer 18

A Loan Consent form.

Question 19

What is a loan concent form?

Answer 19

It allows the brokerage to lend the customer’s stock to other customers who need to borrow it to sell stock short. 

Question 20

A Hypothecation agreement may include what particular agreement regarding his stock purchases?

Answer 20

a loan consent form

Question 21

What are the 3 basic areas of a balance sheet?

Answer 21

• assets on the Left 
• liabilities and equity on the right 
  Like any balance sheet  assets must always equal liabilities plus equity 
  that is true of any kind of financial balance sheet.

Question 22

On a balance sheet what are assets equal to?

Answer 22

Liabilities + Equity

Question 23

On a balance sheet, what are liabilities and equity equal to?

Answer 23

Assets

Question 24

• When the customer purchases the stock, it is reflected as 100 shares of XYZ and given a monetary value or $10,000, the whole amount is expressed as a?

Answer 24

asset.

Question 25

Assets, liabilities and equity values are changed by what?

Answer 25

the fluctuation of the Market

Question 26

What is marking to market?

Answer 26

Mark To Market, or Marking to Market, is whenasset values are determined “according to market prices”at the end of each day in order to arrive at the profit or loss status.
• Later these initial values can change with the fluctuation of the Market
○ These values are recalculated daily at the end of the day.
○ These changes in value and their recording are referred to a “Mark to the Market”.
Mark to the market = revaluing the account based on new market values.

Question 27

What does the asset side or a balance sheet correspond to? What does it express or show?

Answer 27

the MV or Market Value

Question 28

What does the right side of the chart or balance sheet show?

Answer 28

shows equity of what you actually own

Question 29

What is a debit balance?

Answer 29

The amount that the customer owes to the brokerage

Question 30

MV - DR = EQ or Market Value (of the stock i.e., the total purchase involved) minus the amount owed (by the customer for the loan to purchase) EQUALS what?

Answer 30

= the EQUITY in the margin account.

Question 31

What allows us to see the relationship between the MV, the DR (debit balance) and the Equity in the account?

Answer 31

The structure of the balance sheet

Question 32

What allows us to see the relationship between the MV, the DR (debit balance) and the Equity in the account?

Answer 32

The structure of the balance sheet
• The value of what the customer owns in the account
market value - debit balance = equity

Question 33

What are 2 additional rules that apply to Margin accounts?

Answer 33

Federal Reserve Board Regulation T: 50% equity

NYSE/NASD Minimum Initial Equity requirement: $2,000, but not more than 100% MV

Question 34

What is the caveat to the NYSE/NASD Minimum Initial Equity requirement and the
Federal Reserve Board Regulation T: 50% equity?

Answer 34

The investor is not required todeposit more than the value of the stockbeing purchased.

Question 35

Supposea customerwants to purchase $3,000 of stock in an empty marginaccount. What must the customer deposit?

Answer 35

• Under RegulationT50 %or $1,500
  
  • TheNASD in the New York Stock Exchangerequirement says
    ▪ that you have to put upat least$2,000and
    ▪ we always have toput up whichever of these tworequirementsisthe greater of the two.
    ▪ In this case, the requirement is goingto be$2,000

Question 36

Another Margin acct. case
Thecustomer which is topurchase $1,500 worthof stock in a new account .
- What is the initial Margin requirement?

Answer 36

• We have tocome up with the greater amount.
  ▪ Reg Twould say that you have to put up $750.
  § 50% of the amount of the stock you’re buying.
  ▪ The NYSC and NASD requirement is
  § normally $2,000
  ▪ Doesthat apply in this situation?
  § Thatdoesn’t really seem fair because
  □ whyshould you have to put up $2,000
  □ when the stock you’re buying isreally only worth $1,500?
  □ If youdid this in a cash account, you wouldonly have to put up $1,500.
  § Infactin this situation the initialequity is only $1,500.
  § because you have to put up no more than100% of the value of thestock you’re purchasing.

Question 37

What is the NYSE/NASD Minimum Initial Equity requirement and the
Federal Reserve Board Regulation T: 50% equity designed to eliminate?

Answer 37

small margin accounts from theindustry.
□ Small margin accountsare really not appropriate.
® Marginaccounts do involve somerisk.
® We don’t want investors who canonly afford to invest a small amount ofmoney to get involved in a riskytransaction like a margin account.
This minimum rule discouragessmall margin accounts.

Question 38

Why was it important to eliminate small margin accts.?

Answer 38

□ Small margin accountsare really not appropriate.
® Marginaccounts do involve somerisk.
® We don’t want investors who canonly afford to invest a small amount ofmoney to get involved in a riskytransaction like a margin account.
® This minimum rule discouragessmall margin accounts.

Question 39

What happens as the MV changes and the value of the account ebbs and flow?
What happens when the stock appreciates? What figure on the balance sheet must change in order to reflect the actual amount(s) of the balance sheet?

Answer 39

Rememberthecustomer

- bought initially $10,000 worthof stock 
- 100 shares at $100 a share. 
- He had to put up 50% whichis the Reg T requirement. 
- That'swhatthe customer added to the account.

The broker dealerused50% or$5,000 of their own moneyto help the customer purchase the stock.
- Suppose that XYZ then increases to $120 per share?
- The total now for the 100 sharesare worth $12,000 so theaccount value is now $12,000.
- We have a problem.
▪ Notice that the left side and theright side are no longer in balance.
▪ We have to make some other adjustment.
▪ Ifwe change one entry we have to changeanother entry to keep the two sides in balance.
§ Those changes can’t be justarbitrary. They have to fit what’sactuallygoing on.
We’re going tochange either the Debit Balance number or the Equity value number.
▪ Which one wouldreally be changed?
▪ The Debit Balance number represents the amount that youowe to the brokerage.
§ If yourstock goes up in value, does that meanthat you owe more money to the brokerage?
§ The answer to that is No!
□ Youborrowed$5,000originally
□ and that isstill what you owe to the brokerage.
□ An increase in the value of your stockdoes not increase your debt to thebrokerage.
So it must be the Equity figurethat is going to change.

Question 40

When the value of a stock goes up, what element of a balance sheet must change (to reflect the actual value of the account)?

Answer 40

If the market value of the stockgoes up, that in itself doesn’t changethe debit balance or what you owe to thebroker-dealer.
It’s the equity that will increase inthat situation.

Question 41

If the market value of the stockgoes up whatwould Reg T require as a deposit if wewere to purchase the stock in the marketat this point?

Answer 41

▪ Remember that’s goingtobe50%of the MV $12,000times50% ($12,000 x 50% = $6,000.00
§ will give us$6,000as the current Reg T equityRequirement.
- Compare that to theequity actually in the account which is$7,000
▪ the account equityis$1,000 more than is required
▪ so thisamount is called Excess Equity.

Question 42

What is Excess Equity?

Answer 42

It’simportant to understandwhat excess equity is.
- Sometimes people are under themisconception that it represents a cashbalance.
▪ Money that you can simply drawout of the account. That it’s your money.
▪ That is really not the case.
- Agood way to think about a margin accountis to use the analogy of someonepurchasing a home.
▪ Say youpurchase a home for$100,000and you putdown a$20,000 down payment.
▪ of coursethat would be your equity what you havein your home.
§ The mortgage companyor the bank would loan you theother$80,000and you would use that topurchase the house.
□ You would havea$100,000asset,
□ but an$80,000 liability
□ and you only have$20,000inthe house.
▪ If the value of yourhouse rose to say $120,000 would your mortgage increase?
§ You wouldn’t owe more money to thebank than you did before, and
§ your equity inyour house would increase.
§ Does thatmean that there is a pile of cashin your house that you can spend.
§ No. itmeans is that
□ your house now has more equity.

Question 43

How do you get access to the increased equity in cash from the gains in the Market in a Margin acct?

Answer 43

• That is only one way to get accessto that equity/cash/money.
  ▪ Anyonewho has a home that has increasedinvalue may know that,
  ▪ another way to getaccess to that equity in your home wouldbe to take out a 2nd mortgage or a home equity loan. 55:07
  ▪ That isexactly what you can do with a marginaccount.
  § Your stock has gone up in value but, (that’s only stock, not actual money or just instrument that has a fluctuating value in a Market)
  □ There’s only stock in your account.
  □ There is no cash there.
  □ How can youget at that increase in the value of thestock (equity)?
  § You can take out a loan againstthe stock which now has a largercollateral value.

Question 44

How do you borrow the excess equity in a marginacct.?

Answer 44

• The market value of our accountis $12,000
  ▪ $12,000 worthofcan serve as collateral for how large a loan? ▪ A $6,000 loan.
  ▪ Remember that the broker-dealer canlend you up to ½ the value of thestock.
  § The broker-dealer has alreadyloaned the customer (and the customer hasalready borrowed$5,000.
  § that was theoriginal debit.
  § So,the broker dealer can lend thecustomer another $1,000
  □ the differencebetween what the collateral (profit in the Market) and what you have actually borrowed.
  My notes: Looks like you can borrow another 50% of the increased profit you made. Rule seems to be you can borrow, or have the broker-dealer cover the other half of what you want to borrow. $500 of the $1,000you need.
  You can take this loan out in cash if you wanted to do so!

Question 45

What are the not necessarily wanted consequences of borrowing on a loan from a margin acct. to take some of the investment profits that have been made?

Answer 45

§ You’ve justtaken out another smaller loan,
§ the loanis going to increase the customer’sDR/DB/ debit balance to$6,000 it is a loan not cashsitting in the account. (My Note: Similar to borrowing on an insurance policy).
▪ The result is, theaccount equity would be reduced to$6,000(to keep the statement in balance).
§ Notice when we tookcash out of the account, it wasn’t like taking cash out of asavings account.
□ You’re really taking out another loan from thebroker-dealer. “That’s great right”. Youhave the cash and you can dowhatever you want with it.
□ But since itwas a loan,
® your overall debt will goup.
® The stock didn’t change in value so theonly other thing that could change to keep our balance sheet in balanceis the amount of equity.
® Remember, you drew out a loan against some of thatequity and so now your equityhasdecreased in the account.

Question 46

How does taking cash out of a margin account affect the account balance?

Answer 46

Whenever you take cash out of a marginaccount, the debit balance will go up (you will owe the brokerage more money).

Question 47

What happens in a margin account if you put cash into the account?

Answer 47

the debitbalance will go down. § Think about cashcoming into the account as being used topay down your loan.
Yourdebit will decrease.

Question 48

What is the “Buying Power” in a margin account?

Answer 48

The amount of additional stock the amount of additional stock the customer can buy on margin.
The formula is:
Buying Power = Excess Equity / (divided by) Reg T
Ex: Account w/ $1,000 excess equity:

$1,000 / 50% = $2,000

		§ Our example this will be$1,000dividedby 50%whichequals $2,000worthof buying power. 
			□ That does make sensebecause 
				® if I buy$2,000,worth of stockon margin in general, 
				® how much do I haveto put up under RegulationT? 50%of the value which would be $1,000

Question 49

Why is it important to know the buying power of a margin account (if the account has appreciated in value)?

Answer 49

• The buying power issomething that we want to know about inthe account.
  ▪ We could withdraw$1,000incash OR we could buy$2,000worth ofstock.

Question 50

Howcould the use of buying poweraffect a margin account?

Answer 50

• The difference of$1,000is excess equity but.$1,000 excess equity means that we have$2,000 of buying power.
  
  • What does it mean tohave$2,000of buying power?
    It means that we could buy another$2,000worth of stock in our account, without having to deposit any additionalmoney.

Question 51

What are the consequences ofthe market value of the stock falling?

Answer 51

▪ When the market valuegoes down, the equity goes down as well.
§ The debit balance is staying constant inthese situations.

Question 52

In a margin acct, when the value of the investor’s MV goes up, what has to change in order to keep the account numerically balanced?

Answer 52

the EQ (equity) has to go up. The DR (money owed to the broker-dealer does not. (Rather logical since your profit goes up not the debt you owe to the BD)>

Question 53

If you had $1,000 of excess equity in your margin acct, how much additional stock could you purchase?

Answer 53

$2,000

Formula: excess equity / Reg T requirement 50% =

Question 54

In a margin acct., what happens to the balance sheet when the stock loses market value (MV)?

Answer 54

When the MV goes down, the DR (debt) remains the same but the equity goes down (by the amount of the loss).

Question 55

What is a restricted account?

Answer 55

A margin account in which the equity is less than the current Reg T requirement is called a restricted account.

Question 56

If your margin acct. is restricted, do you have to add funds to the account to bring the Reg T requirement up to 50%?

Answer 56

No, you don’t have to bring the acct. up to 50%.

Question 57

Can you purchase additional stock when a margin acct. is restricted?

Answer 57

Yes. You just have to cover the Reg T requirement for the new stock.

Question 58

How does a restriction on a margin account effect the investor?

Answer 58

It really doesn’t effect them much at all. Really the restriction is just a restriction on the broker-dealer. They can’t loan you additional money on the current collateral in the account because in theory the loan is already too big.

Question 59

What happens to a margin acct. that is restricted and continues to lose market value? Does Reg T step in at any point?

Answer 59

No. Once you meet the initial Reg T requirement, upon the new purchase of that stock, you are not required to meet a Reg T requirement ever again, even if the stock would sink all the way down to zero.

Question 60

If the market value of a margin account continues to lose value, what happens to the debt (DR) in the account

Answer 60

It remains unchanged. The debt is always owed to the BD who contributed 50% on behalf of the investor.

Question 61

What rule is in place by the NYSE/NASD that triggers when a stock continues to lose value in a margin acct.:

Answer 61

The NYSE/NASD maintenance requirement.

You must maintain equity in your account of at least  25% percent of the market value (MV).

Question 62

What rule is imposed it says that you must maintain equity in your account of at least  25% percent of the market value (MV).

Answer 62

The NYSE/NASD Maintenance Requirement

Question 63

What rule is imposed it says that you must maintain equity in your account of at least  25% percent of the market value (MV).

Answer 63

The NYSE/NASD Maintenance Requirement

EQ > 25% x MV

Question 64

What is a maintenance call?

Answer 64

If the equity falls below 25% (the NYSE/NASD Maintenance Requirement)

Question 65

What happens if the investor doesn’t maintain the equity level at 25%, and does not respond to the maintenance call promptly?

Answer 65

The brokerage can sell the stock (to protect their loan) which was collateral for the loan according to the original agreement.

Question 66

determining when a maintenance call would be declared on an account

Answer 66

Multiply the DR (debt on the balance sheet) by 4/3 = the threshold that if breached will trigger a maintenance requirement call.
Instant Learn: DR X 4/3
If the MV falls below this number, any further loss will trigger a maintenance call.

Question 67

Special Memorandum Account (SMA)

Answer 67

Allows you to Note a past positive gain that at that time you didn’t want to withdraw (say $2,000 made in the past but later lost in MV) and allows you to withdraw the funds, even though the account may now be in restriction.