Investment Strategies - Leverage as a Strategy

Leverage as a Strategy
Leverage is, quite simply, the purchase of shares on credit. A margin account in a brokerage firm is where this would be accomplished. Because firms have a margin desk that performs calculations relating to the investor's availability of credit or deposit requirements, the planner need only have a working knowledge of margin analysis. The exam may contain a question or two on this topic.

Benefits of Margin
Benefits of margin include the ability to purchase more shares with a lower initial cash outlay. Broker/dealers benefit by generating interest income from the margin loans and by receiving larger commissions, as margin clients often trade larger positions with less money down.

Establishing a Margin Account
To establish a margin account, the client needs to sign a margin agreement, which has three parts. The Credit Agreement discloses loan terms from the broker/dealer. The Hypothecation Agreement allows the broker/dealer to pledge the clients' margin securities as collateral to the bank which, in turn, lends money to the broker/dealer based upon the securities' value. Margin accounts are set up in street name with the broker/dealer as the nominal owner and the client as the beneficial owner. Finally, the Loan Consent Form allows the firm to lend clients' margin securities to other clients or broker/dealers, often for short selling. Customers must sign the former two agreements; the Loan Consent form is optional.

Regulation T: The Securities Act of 1934 empowered the Federal Reserve Board (FRB) to regulate the extension of credit in the securities industry. Regulation T requires clients to deposit at least 50% of the market value of a margin transaction within five (5) business days. If the first purchase is less than $2,000, the customer must put up the full purchase price; if it is between $2,000 and $4,000, s/he must put up $2,000; if the amount exceeds $4,000, the initial deposit is 50%. Regulation T also determines which securities are eligible for a margin purchase. They are exchange-listed bonds and equities, NASDAQ stocks and non-Nasdaq OTC shares that the FRB approves. Mutual funds and new issues may not be purchased on margin, but can be used as collateral after thirty (30) days.

Margin Accounting:
Long Margin Accounting- the formula for determining the amount of equity in an margin account reads as follows:

LMV-DR=EQ


Where LMV = long market value or the current value of the stock position; DR=debit register or the amount of money that the client borrowed; EQ = equity, or that percentage of the securities in the account that the client actually owns.

The debit register is analogous to a home mortgage. It may not change, but the market value may increase or decrease which, in turn, impacts the amount of equity. Payments toward the reduction of the debit balance do not affect the value of the account, but increase the equity. The margin balance sheet reads as follows:


LMV

DR







EQ

Initial margin is 50% of LMV; maintenance margin is 25% of LMV. The account is marked to market daily to determine if the account is meeting the maintenance requirement of the NASD/NYSE.

LMV DR
60000 30000
50000
36000
EQ
Reg. T 25000 1800 30000
Min. Maint 12500 900 20000
600

Short Selling Strategies


Related Articles
  1. Markets

    Intermediate Guide To E-Mini Futures Contracts - Margin

    Margin is essentially a loan that a brokerage firm extends to a client (the trader or investor) that is used for the purchase of trading instruments. Margin trading allows traders and investors ...
  2. Active Trading Fundamentals

    Explaining Initial Margin

    Initial margin is the percentage of a stock’s price an investor must have in his account to buy that stock on margin.
  3. Term

    Understanding the Maintenance Margin

    A maintenance margin is the minimum amount of equity that must be kept in a margin account.
  4. Trading Strategies

    Margin Investing Gets A Bad Rap, But For The Thrill-Seeker, It's Worth It

    Investing on margin can be profitable but it's a risky play that needs care.
  5. Stock Analysis

    Margins Matter (MCD, WEN, BKC)

    Just how important are margins on your stocks' prices?
  6. Options & Futures

    Spreading The Word About Portfolio Margin

    An underused opportunity provided in an SEC rule can enhance returns and lower risk for spread traders.
  7. Professionals

    How To Calculate Margin On The Series 3 Exam

    Learn what you need to know about margin to pass your Series 3 exam.
  8. Active Trading Fundamentals

    Introduction to Margin Accounts

    Find out what your broker is doing with your securities when you invest on margin.
  9. Investing Basics

    Margin

    Find out exactly what margin is and why it's important.
  10. Pattern Day Traders

    If a day trader makes four or more day trades in a rolling five business day period, the account will be labeled immediately as a pattern day trade account. Certain limitations will then be applied ...
RELATED TERMS
  1. Buying On Margin

    The purchase of an asset by paying the margin and borrowing the ...
  2. Margin Loan Availability

    1. The dollar amount in an existing margin account that is currently ...
  3. Minimum Margin

    The initial amount required to be deposited in a margin account ...
  4. Margin Debt

    1. The dollar value of securities purchased on margin within ...
  5. Option Margin

    The cash or securities an investor must deposit in his account ...
  6. Cross Margining

    An offsetting position where market participants are able to ...
RELATED FAQS
  1. How much can I borrow with a margin account?

    Understand the basics of margin accounts and buying on margin, including what amount investors can typically borrow for purchases ... Read Answer >>
  2. How is buying on margin regulated by the Securities and Exchange Commission (SEC)?

    Learn how FINRA and the Federal Reserve regulate margin account trading, and understand how pattern day trading can impact ... Read Answer >>
  3. Why does the Federal Reserve Board regulate which stocks can be bought on margin?

    Find out why the Federal Reserve Board began regulating margin stock purchases in 1934 and why margin requirements do not ... Read Answer >>
  4. What does it mean when I get a maintenance margin call?

    Understand how maintenance margin calls work, and learn about how margin requirements are different for trading stock versus ... Read Answer >>
  5. How are margin calls regulated by the SEC?

    Learn how FINRA and the Federal Reserve Board regulate trading in margin accounts, and see how brokers can liquidate positions ... Read Answer >>
  6. What is the difference between initial margin and maintenance margin?

    Learn the difference between an initial margin requirement and a maintenance margin requirement and how these affect an investor's ... Read Answer >>
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center