Customers can pay for security trades in full with cash or in part, on margin. A customer who trades in a cash account must pay for the full purchase price of the security by the settlement date.
Cash accounts are the most basic type of investment account. Just about anyone who is eligible to open an investment account can open a cash account.
"Margin" refers to the minimum amount of cash or marginable securities that a customer must deposit to buy securities. These accounts allow the customer to borrow part of the security's purchase price from a broker-dealer to pay for trades.
For less money than buying the securities outright, a customer who opens a margin account can invest when he or she may not have the full cash amount available. Also, a customer with marginable securities can borrow money against them up to certain limits as long as they are fully paid for. However, customers who open margin accounts must meet certain minimal financial requirements.
Under Regulation T, the Federal Reserve Board sets the minimum amount a customer must deposit when purchasing securities on margin or selling securities short. This initial margin requirement is called Regulation T and is equal to a minimum of 50% of the market value for marginable securities and 100% for non-marginable securities.
Regulation T also identifies which securities can be bought on margin, including the following:
- Stocks and bonds listed on an exchange
- Stocks quoted on the Nasdaq National Market
- Certain OTC securities
- Warrants for listed securities (with certain non-listed exceptions)
Exam Tips and Tricks
Non-eligible securities include the following:
- Certain common and preferred OTC stocks
- New Issues
- Insurance contracts
Exam Tips and Tricks
Remember that the Securities Act of 1934 gave the Federal Reserve Board the authority to regulate credit extended for securities purchases. The Fed established Regulation T to specify the equity requirements for margin transactions and the types of securities that may be purchased on margin. (Note: Mutual funds cannot be purchased on margin because they are technically considered new issues and are not marginable securities.) While the Fed established rules of credit, the SEC actually enforces these rules.
Margin accounts may not be opened for the following types of accounts:
- Corporate retirement accounts
- UGMA and UTMA custodial accounts
- Keogh plans
- Tax-sheltered annuities (TSAs)
The following documentation is required before a margin account can be established:
- Credit Agreement - explains the terms under which credit is granted
- Hypothecation Agreement - gives the firm permission to pledge securities held on margin
- Loan Consent Agreement - allows the firm to loan securities held on margin to other brokers
For a quick primer on margin accounts, the Margin Trading tutorial is very useful.
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