Every margin question asks two things: how much of the account truly belongs to the customer, and is it enough? Equity answers the first question. The rules below answer the second.
In a margin account, your firm lends the customer part of the purchase price and holds the securities as collateral. Borrowed money can push prices up, and when prices fall, margin calls force sales that push them down further. So the Federal Reserve caps how much a firm may lend against securities. Regulation T (Reg T), the Federal Reserve Board's credit rule, sets the deposit for each new trade.
- Credit agreement: It sets the interest terms: when interest applies, the rate, and how interest is computed.
- Hypothecation agreement: It lets the firm pledge the customer's securities as collateral for the bank loan that funds the customer's borrowing. A margin account cannot open without it.
- Loan consent: This optional loan consent lets the firm lend the securities to others, usually short sellers. A customer who refuses it can still borrow.
Common mistakes
- Letting SMA fall with prices: SMA keeps its high-water mark. In Example 1 it stays at $5,000 after LMN drops to $35.
- Quoting 30% for every short: A $4 short needs 100%, and a $10 short needs $5 a share.
- Requiring $2,000 on a small purchase: A $1,500 purchase needs only $1,500, its full cost.
Bottom line
- Equity is LMV − DR for a long account, CR − SMV for a short account, and LMV + CR − SMV − DR for a combined account.
- Reg T initial margin is 50% for margin stock and 150% in total for a short sale.
- A new margin account needs $2,000 equity, but never more than the purchase cost.
- A Reg T call is due within one payment period, T+3 under T+1 settlement, and only the firm can seek an extension from its examining authority.
Exam shortcut
Write the equity line before reading the choices: LMV − DR, CR − SMV, or both. Then let the stem's verb pick the test. "Buy," "deposit" or "sell short" means Reg T. Use 50% of a purchase, or 150% in total on a short, then check the $2,000 floor.
The full lesson (about 4,141 words, 28 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- D35
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