Now that you have the background to understand how margin accounts work, it is time to focus on buying power for normal equities.
Long Market Value
The long market value of a margin account is the total market value of all securities currently held, as of the close of the previous business day.
Let's say your new client just opened a margin account and now wants to buy 100 shares of UVW at $40 per share. It would cost $4,000, but, assuming the margin requirement is 50%, your client would have to infuse $2,000 in cash. The difference, which is known as the loan value, would be loaned - with interest - by the broker-dealer. Once the cash is deposited and the trade is made, the account is said to have a long market value of $4,000, comprised of $2,000 on loan from the broker, or debit balance, and $2,000 equity, or credit balance. The equity will always be the difference of the market value less the debit:
$ 4000 long market value
$ (2000) debit balance
$ 2000 credit balance
Broker-dealers are in the business of trading and, perhaps, advising on trades - not lending money. Banks do that, and the brokerage frequently will rehypothecate the shares to a bank to secure the actual loan. The bank can require a pledge of up to 140% of the debit balance, which would drive down the amount of equity in the margin account.
The Series 7 exam will probably not deal with this kind of scenario, so let's just assume in our example that the brokerage's bank requires hypothecation of just 100% of the debit balance, leaving equity in the account unaffected. Let's also hold interest at 0% just to keep the math clear.
Stock Price Changes and Margin Requirements
InvestingDebit is an accounting term used to refer to the left side of an accounting journal entry. Each debit must be offset by an equal credit entry.
Financial AdvisorInvesting on margin can be profitable but it's a risky play that needs care.
InvestingWhen 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 ...
Financial AdvisorA maintenance margin is the minimum amount of equity that must be kept in a margin account.
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InvestingA brokerage account is a contractual arrangement between an investor and a licensed securities broker or brokerage.
InvestingInitial margin is the percentage of a stock’s price an investor must have in his account to buy that stock on margin.
Personal FinanceAn account balance represents the total amount of money in a financial account at any given moment.