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. Investing

    Buying on Margin

    When an investor buys on margin, he or she pays a portion of the stock price – called the margin -- and borrows the rest from a stockbroker. The purchased stocks then serve as collateral for ...
  2. Investing

    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. Financial Advisor

    Understanding the Maintenance Margin

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

    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. Trading

    A Guide To Day Trading On Margin

    Buying on margin is a good option if you don't have the cash to day trade.
  6. Investing

    How To Calculate Margin On The Series 3 Exam

    Learn what you need to know about margin to pass your Series 3 exam.
  7. Managing Wealth

    What’s a Good Profit Margin for a New Business?

    Surprisingly, the younger your company is, the better its numbers may look.
  8. Investing

    The Advantages Of SPAN Margin

    Find out how it provides futures and commodity option strategists with more bang for their margin buck!
  9. Financial Advisor

    Margin

    Find out exactly what margin is and why it's important.
Frequently Asked Questions
  1. Depreciation Can Shield Taxes, Bolster Cash Flow

    Depreciation can be used as a tax-deductible expense to reduce tax costs, bolstering cash flow
  2. What schools did Warren Buffett attend on his way to getting his science and economics degrees?

    Learn how Warren Buffett became so successful through his attendance at multiple prestigious schools and his real-world experiences.
  3. How many attempts at each CFA exam is a candidate permitted?

    The CFA Institute allows an individual an unlimited amount of attempts at each examination.Although you can attempt the examination ...
  4. What's the average salary of a market research analyst?

    Learn about average stock market analyst salaries in the U.S. and different factors that affect salaries and overall levels ...
Trading Center