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Series 7 Margin Accounts: What Makes Them So Confusing

Aside from Options, Series 7 Margin Accounts are one of the most requested topics that we get. Whether it’s because few of the students we tutor clients have an actual margin account, or that they just don’t understand them, it can be a vexing subject. Either way, below we discuss some places to channel your attention for this difficult subject.

 

Series 7 Margin Accounts: Where to Start

As with most topics, let’s start with the basics. First, you should understand what we mean when we say “margin”. Many of our students assume “margin” means debt, when in fact margin is the money deposited into a brokerage account that then gets used as collateral in order to take on debt. We deposit margin with a broker in order to borrow additional funds from that broker – presumably to invest in a stock in which we have very high conviction.

Next, be sure to know the rules associated with the margin section. You don’t need to know every single one, but those related to Regulation T are a must! Regulation T, and the rules/requirements around it, is something that you will hear over and over again in this section. Get to know the key elements which include Initial Margin Requirements, Minimum Maintenance Requirements, when payment is due, and many, many more. Fun right!?

 

Know the Formulas

The Series 7 Margin Accounts section has many formulas. You should try to focus on the basics here too. Some key formulas include:

 

Equity:

Long Margin Account:

Equity = Long Market Value (LMV) – Debit Balance

 

Short Margin Account:

Equity = Credit Balance – Short Market Value (SMV)

 

Combined Margin Account (Long and Short Margin Account):

Equity = Equity of Long Positions + Equity of Short Positions

Or

Equity = (LMV – Debit Balance) + (Credit – SMV)

 

Minimum Maintenance Margin for a Long Margin Account:

LMV x 25% = Minimum Equity Required in Long Account

 

Minimum Maintenance Margin for a Short Margin Account:

SMV x 30% = Minimum Equity Required in Short Account

 

Rehypothecation Pledge:

140% x Debit Balance = Rehypothecation Pledge (e.g., collateral pledged by the broker to a bank)

 

There is a big difference between memorizing formulas and applying them however. After you’ve memorized the above “core” formulas, review some practice problems. Margin is an important topic on the exam but may show up less frequently than Options. If you can get a relatively good handle on the core issues from the Margin section then it will leave you with plenty of time to tackle larger sections (e.g., Options and Suitability).

 

Be Able to Apply the Formulas and Rules

Ok, so you understand margin, and you’ve memorized the formulas. Can you apply what you’ve learned? Proceed with some practice questions to make sure that you can put your knowledge into action. At a minimum, focus on questions that test your ability to calculate Regulation T Margin requirements. These are typically the easiest questions you might get around margin.

 

Equity Example

The amount of initial margin that will be extended to an investor whether in a long or a short account is 50%. When tested, you will need to know that if an investor plans to invest a total of $10,000 into the XYZ Company (on margin), then the investor has to put up at least $5,000 (50% x $10,000 = $5,000) at the outset of the trade.

If you want to take it up a notch, practice your ability to calculate Equity. This will be the next easiest Margin calculation.

Imagine you own two stocks, 100 shares of XYZ currently trading at $75 and 100 shares of ABC currently trading at $40. If you have a debit balance of $3,000, what is your Equity?

Answer:

Long Equity = LMV – Debit = [(100 x $75) + (100 x $40)] – $3,000 = $11,500 – $3,000 = $8,500

 

Minimum Maintenance Example

Regulation T also outlines the “Minimum Maintenance” requirements. Minimum Maintenance margin required in a long margin account is 25%. For a short account, you need 30%. The minimum maintenance is the minimum level of equity a margin account must have before it receives a “Margin Call.” This one is a little more involved since you will need to calculate the Minimum Maintenance (e.g., for a Long Account it will be 25% x LMV) and then compare it to the Equity of the long account. Therefore you will also need to calculate Equity (e.g., LMV – Debit = Equity). You compare the two numbers, and voila!

Example: Janice’s margin account has a long market value of $12,000 and a debit balance of $10,000. Will she receive a margin call, and if so, for how much?

Step 1: Calculate the Minimum Maintenance Requirement for a long account:

LMV x 25% = MM

$12,000 x 25% = $3,000

Step 2: Calculate Equity.

Equity = LMV – Debit

$12,000 – $10,000 = $2,000

Step 3: Compare the Minimum Maintenance Requirement to the equity to determine if she has enough to meet the 25% minimum.

$2,000 < $3,000 ==> Since there is less equity than the Minimum Maintenance requirement, there will be a margin call. It will be for $1,000 ($2,000 – $3,000 = -$1,000 short).

 

Wrapping Up

There is a lot more that you can cover in the Series 7 Margin Accounts section. However, the above is a great place to start. Although we didn’t cover it in detail, make sure you can handle the short margin accounts too. If you need a Series 7 tutor to help you, feel free to contact us. We also offer some tips and tricks around the Series 7 in our guide here. We wish you luck!

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