Borrowing money and securities: The long and short of margin accounts (Ch. 9)
What is the equity equation for a combined long and short margin account?
Combined equity = (long market value - debit balance) + (credit balance - short market value)
Regulation U
Federal Reserve Board limit on how much credit a bank can allow a customer for the purchase and carrying of margin securities.
Regulation G
Federal Reserve Board regulation of lenders other than commercial banks, brokers, or dealers that provide credit for the purchase of or carrying of securities. This regulation was discontinued by a 1998 amendment.
Where does the money go when securities are sold?
If the stocks are being listed for the first time (primary issue), the proceeds go to the company issuing the securities. If the stocks are already in the market, they are bought and sold among people who own the stock and those who wish to own the stock (secondary issue).
Rehypothecation percentage
In the United States, rehypothecation of collateral by broker-dealers is limited to 140% of the loan amount to a client, under Rule 15c3-3 of the SEC.
Ineligible accounts
Money that a company counts as an asset, but that a lender will not count as collateral. ____ might include accounts receivable that are more than 90 days past due, foreign accounts and illiquid investments. Assets that a lender is likely to accept as collateral include inventory, equipment and accounts receivable that have been due for fewer than 90 days. When a company requests a loan or line of credit, the bank will examine its financial statements and will only accept certain assets as collateral when determining the company's borrowing capacity. These assets make up what the bank calls "tangible net worth." As a condition of the loan, the bank may require the company to meet ongoing financial standards such as not taking on additional debt and not selling any items that have been pledged as collateral. The reason why some assets would be considered ineligible as collateral, is that they might be too difficult for the lender to collect. The asset may also be too illiquid or, in the case of accounts receivable past 90 days, they are unlikely to be paid.
Margin requirement for municipal bonds
Reg T exempts municipal bonds, meaning the Fed makes no ___, but the NYSE generally requires a 15% margin.
Special memorandum account
The amount of extra money an investor is allowed to borrow on a margin account. Suppose an investor buys $20,000 worth of securities on margin and places securities worth 50% of the value of the amount as collateral (in this case, $10,000) as required by Regulation T. If that collateral increases in value to $13,000, the investor has an extra $3,000 in the margin account he/she did not previously have. This $3,000 is placed in the ___. The investor may use it for a loan of up to $3,000 or may use it to buy up to $6,000 more on margin. Developing a ___ is like establishing credit; after one establishes credit (on a credit card, for example), it remains there until that person uses it.
Buying/shorting power
The amount of money available to buy securities on margin using one's excess equity (or special memorandum account). ____ = special memorandum account / Regulation T
Requirements to open a long margin account
The customer is required to deposit Regulation T or $2,000 in a certain account, whichever is greater. The exception to this rule occurs when a customer is purchasing less than $2,000 worth of securities on margin. In this car, the customer pays for the transaction in full. But even if the customer pays in full, the account is still considered a margin account because the customer can make future purchases on margin as soon as he has over $2,000 in equity.
Equity
The investor's portion of a margin account. Specifically, the market value of securities minus the amount borrowed. When an investor initially opens a margin account, the ____ is equal to the margin call. However, the ___ changes as the market value of the securities in the account increases or decreases. When an investor has more equity than the Regulation T requirement, he has excess ____; if an investor has less ___ than the Regulation T, his account is restricted. In a short margin account, the equity increases when the short market value of the securities decreases; when the short market value of the securities increases, the equity decreases. ___ = long market value - debit balance
Long market value
The market value of a security or group of securities as of the close of the most recent trading day or business day.
Short market value
The market value of all of an investor's short positions at the end of a trading day. The short market value is calculated each day to determine whether or not the investor has maintained his/her maintenance margin and therefore whether he/she is subject to a margin call. If an investor shorts securities, he wants the ___ to decrease so the investor can repurchase the securities at a lower price.
Loan value
The maximum amount an individual or company may borrow to buy securities on margin, using securities as collateral. The amount of a loan value is dictated by the Federal Reserve Board in Regulation T.
What is the day trading margin requirement?
The minimum equity requirements on any day in which you trade is $25,000. The required $25,000 must be deposited in the account prior to any day-trading activities and must be maintained at all times.
Margin requirement
The money or securities an investor keeps in a margin account in order to be able to borrow from a brokerage for short sales or other purposes. The___ is kept as collateral until the brokerage calls the margin and the client pays back what is owed. Maintenance equity = Regulation T (usually 50%) OR ___% x long OR short market value
Credit balance (aka credit record, credit register)
The profit from a short sale that is deposited into a margin account. The ___ consists of any maintenance margin the account holder must keep in the account as well as additional funds that may be withdrawn or used to buy more securities. The ___ remains fixed unless the investor removes excess equity, more securities are shorted, or the investor covers some of his short positions. The ___ remains the same as the market price changes. ___ = short market value + margin call
Credit agreement
The section of the margin agreement disclosing the terms of the interest that will be charged on the margin account, including the interest rate charged, the broker-dealer's method of computation, and situations under which the interest rate may change.
Hypothecation agreement
The section of the margin agreement that allows a brokerage firm to use a portion of the customer's margined securities as collateral for margin loans. The brokerage firm is permitted to sell the stock in the event that equity in the account falls below a stipulated level.
Margin requirement when selling short low-priced securities
Under Regulation T, the Federal Reserve Board requires all short sale accounts to have 150% of the value of the short sale at the time the sale is initiated. The 150% consists of the full value of the short sale proceeds (100%), plus an additional margin requirement of 50% of the value of the short sale. For example, if an investor initiates a short sale for 1,000 shares at $10, the value of the short sale is $10,000. The initial margin requirement is the proceeds $10,000 (100%), along with an additional $5,000 (50%), for a total of $15,000.
What happens if a client fails to meet a margin call?
Your brokerage firm can close out any open positions in order to bring the account back up to the minimum value. Your brokerage firm can do this without your approval and can choose which position(s) to liquidate. In addition, your brokerage firm can charge you a commission for the transaction(s). You are responsible for any losses sustained during this process, and your brokerage firm may liquidate enough shares/contracts to exceed the initial margin requirement.
Leveraged ETFs
a fund that uses financial derivatives and debt to amplify the returns of an underlying index. ____ are available for most indexes, such as the Nasdaq 100 and the Dow Jones Industrial Average. ____ are typically used by traders who wish to speculate on an index, or to take advantage of the index's short-term momentum. Due to the high-risk, high-cost structure of ____, they are rarely used as long-term investments. In many cases, traders hold positions in ____ for just a few days or less.
Short margin account
a margin account whereby an investor borrows securities to immediately sell in the market. Hopefully, for this bearish customer, the price of the security will decrease so the investor can purchase the shares in the market at a lower price and then return them to the lender for a profit. The ___ formula is as follows: short market value + equity = credit balance
Long margin account
a margin account whereby the customer buys securities by coming up with a certain percentage of the purchase price of the securities and borrowing the balance from the broker-dealer. These optimistic investors are hoping for a bull market, because they want to see the securities sometime later for a profit. The ___ formula is as follows: long market value - debit balance = equity
Portfolio margin
a risk-based margin policy available to qualifying US investors. The goal of ___ is to align margin requirements with the overall risk of the portfolio. ___ usually results in significantly lower margin requirements on hedged positions than under traditional rules. While margin requirements of Regulation T generally limit leverage on equity to 2:1, with ___, leverage of 6:1 or more is possible.
Margin requirement for long accounts
25% of the current market value
Margin requirement for short accounts
30% of the current market value
Margin requirement for U.S. government securities
4% to 6%, on a sliding scale - the higher the years to maturity, the higher the percentage of market value that must be in cash
Margin account
A brokerage account in which the brokerage lends money to the account holder, which the account holder then uses to buy securities. That is, a ____ is one in which an investor makes investments with borrowed money. This opens up investment opportunities that an investor might not otherwise be able to afford. More importantly, however, a ____ increases both gains and losses for the investor. Regulation T and other regulations require ____ to have money or securities kept as collateral. FINRA and the NYSE requires a minimum deposit of $2,000 to open a ____ or ask customers to pay for the securities in full.
Restricted account
A margin account without enough equity to meet the initial margin requirement that is restricted from any purchases of additional stocks on margin until the requirement is fulfilled. ___ = margin requirement - equity
Loan consent form
A part of a margin agreement between a brokerage firm and a client that permits the brokerage firm to lend securities owned by the client.
Regulation X
A rule issued by the Board of Governors of the Federal Reserve System (FRS) that governs credit limits granted to foreign persons or organizations for purchases of American Treasuries. Borrowers who are subject to ____ must also prove that the credit they obtain conforms to the limits under Federal Reserve Regulations T (relating to brokers and dealers) and U (banks and lenders).
Exchange-traded Fund (ETF)
A security that represents all the stocks on a given exchange. For example, an ___ may track the Standard and Poor's 500. The organization issuing the exchange-trade fund owns each of the stocks traded on the S&P 500 in approximate ratio to their market capitalization. ETF shares can be bought, sold, short-sold, traded on margin, and generally function as if they were stocks. Investors use ___ as a way to easily diversify their portfolios at relatively low cost.
Margin agreement
An agreement between a brokerage and a client governing a margin account. The ___ enables the client to borrow from the brokerage in order to buy securities. The agreement details what collateral must be placed on the account and the other duties each party must fulfill. It also includes three main sections: the credit agreement, the hypothecation agreement, and the loan consent form. The client must sign the ____ before the margin account is created.
Day trader
An investor who makes many trades throughout a trading day, buying and selling securities in order to profit from short-term changes in prices. For example, a ___ may buy Stock A at $15 per share because he/she believes it will be $25 a few minutes or hours later. The activities in which ____ engage are high risk because there is no guarantee that the price will move in the desired direction. However, ____ provide a great deal of liquidity to the market. The initial margin requirement for opening a ____ account is $25,000.
Margin call (aka maintenance call, Fed call)
An order by a brokerage for an account holder to deposit more cash or securities into a margin account when the value of the cash and securities currently in it falls below some defined percentage. This is done to protect the margin loans brokerages make to clients. ___ = the current market value of the securities x Reg T (50%) For short margin accounts, ___ equals the following: ____ = maintenance equity - equity Maintenance equity = Regulation T (usually 50%) OR margin requirement % x short market value
Requirements to open a short margin account
Because of the increased risk, the customer is always required to deposit Regulation T or $2,000 in a certain account, whichever is greater.
Regulation T
the Federal Reserve Board rule that governs how much you can borrow through your margin account to cover the purchase price of a security. It requires customers to deposit at least 50 percent of the current market value of the securities purchased on margin, and the balance is borrowed from the broker-dealer. The rule also identifies which securities can be purchased on margin and which can't. That is, exchange-listed securities, most NASDAQ stocks, and non-NASDAQ over-the-counter (OTC) securities approved by the Federal Reserve Board.
Debit balance (aka debit record or debit register)
the amount of money that a customer owes a brokerage firm after purchasing securities on margin. It may be increased by interest charges imposed by the broker-dealer for purchasing securities on margin. The ___ remains the same as the market price changes. ___ = long market value - margin call
