If you are taking The SIE exam, the Series 7 series 24 or series 99 exam, here are the must know facts about margin accounts to ensure you pass your exam.
The Federal Reserve Board sets the amount that must be deposited when customers purchase securities using borrowed funds. This is known as the initial margin requirement. The initial margin requirement has been equal to 50 percent of the purchase price for many years. For example, if a customer wanted to purchase $50,000 worth of stock on margin, the customer would be required to deposit $25,000 and the broker dealer could loan the customer the rest. Alternatively, if the customer wanted sell stock short in the hope that the securities would fall in value, the customer would be required to deposit 50 percent of the price of the stock sold short. For example, if the customer sold a stock short with a market value of $60,000, the customer would be required to deposit, $30,000 to hold the position. Once a position has been established in a margin account, customers are required to maintain a minimum level of equity. The minimum equity requirement is set by the NYSE and FINRA in both new and established margin accounts.
Customers who want to establish a new margin account must have at least $2,500 in equity prior to the broker dealer loaning the customer any funds. Customers who have established margin accounts and who purchase securities on margin are required to maintain equity equal to 25 percent of the long market value. Going back to our customer who purchased $50,000 worth of stock on margin, the minimum equity requirement at the $50,000 level would be $12,500. Alternatively, customers who have sold stock short, would be subject to a minimum equity requirement of 30 percent of the short market value. The investor who sold $60,000 worth of stock short would be subject to a minimum equity requirement of $18,000. Investors whose equity falls below the minimum level will be required to deposit additional money to restore the account to at least the minimum level. This is known as a margin call. When the equity in an account is below the initial requirement of 50 percent and above the minimum equity requirement, the account is said to be a restricted margin account. The term restricted only refers to the relationship of the equity to the market value. No limitations are placed on the account and the investor is free to increase his /her positions at will by depositing 50 percent of the price of the new securities.
To calculate how low the value of a stock or portfolio can fall to be at the minimum equity for investors who establish long margin accounts use the following formula
Debit Balance / .75
Our investor above who purchased $50,000 worth of stock and deposited the $25,000 margin requirement, therefore had a loan or debit balance of $25,000. Using the above formula, we get $25,000 / . 75 = $33,333. That is to say that the account can fall in value to $33,000 and the investor will be at the minimum margin requirement. The customer will not get a call at this level. Should the stock fall $1 more the investor will be required to deposit more money.
To calculate how high the price of a stock or portfolio can rise to be at the minimum equity for investors who have established short positions use the following formula:
Credit Balance / 1.3
Going back to our investor above who sold $60,000 worth of stock short, the investor was required to deposit $30,000 to hold the position. The result of the the short sale and the required deposit created a credit balance of $90.000. Using the formula above the we get $90,000 / 1.3 = $69,230. The value of the short stock can rise to this level and the investor will not be subject to a call. If the stock increases by $1 more the investor will be required to deposit more money to hold the short position.
Special rules apply for customers who sell low priced stock short. A customer who sells a stock short worth $5 or less is subject to a margin are requirement of the greater of $2.50 per share or 100 percent of the value of the stock sold short. For example, a customer who sold 1,000 shares of stock short at $3 per share would be required to deposit $3,000.
Take note A customer can never be required to pay more than 100 percent of the stock price when purchasing a stock on margin. A customer who purchased 1,000 shares of stock at $2 in a new margin account would be required to deposit $2,000. As the minimum equity is $2,500 prior to any loan being made by the customer.
If you master the above concepts you will be sure to pass your SIE, Series 7 or series 99 exams. Be sure your are ready to pass with all of our exam prep products with our Greenlight money back pass guarantee