Series 7

Customer Accounts - Margin Account Calculations

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.

Example:
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

Hypothecation Process
Through the process of hypothecation, the securities become collateral for that loan, and if the account goes into default, the brokerage can sell them to pay back the obligation. To make this easier, securities in margin accounts are nominally the property of the brokerage and are traded in street name, that is, in the brokerage's name.

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.



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