Combined margin and more
Some clients hold combined margin accounts, with both long and short positions in the same account. Combined margin math simply combines the long equation and the short equation at the same time: and combine into .
Additional margin considerations
Excess equity
When the customer equity, , in a margin account is above the minimum equity requirement governed by Regulation T, given the current market values, that is what creates excess equity. In both long and short, you need to figure out what the Reg T required equity is, given the new LMV or SMV, and compare it to the equity that the client actually has using the LMV or SMV along with the DR or CR originally calculated when the margin account was set up.
Example: Long excess equity
The client purchased of securities and deposited the required Reg T deposit, so there is no excess equity yet. If instead they deposited , the value is still , the required equity is still , but they have , which means they have excess of . The same idea happens with the original deposit if the account grows instead: say the account grows to a value of . The stays at because that’s what was borrowed, so equity is . With a of , the required equity is , but we have - again, excess.
Example: Short excess equity
A client short sells and makes the required deposit. This has a of , required equity deposit of , is therefore , and , so everything is balanced, no excess equity. If instead they had deposited , they have a of , so with a of , in equity against a required equity of only - that’s of excess equity. If instead they made the required deposit, and the market price of the security fell so the dropped to : the is still ( short value + Reg T deposit), so in equity. The required equity on a is only , so that’s of excess equity.
Special memorandum account (SMA)
Effectively, a credit account is created with excess equity in a margin account. It can be taken as cash, or can be used to buy additional securities, or short additional securities.
The exam focuses these calculations on long accounts, so this section does too; short accounts work the same way in reverse. Cash withdrawn from SMA isn’t cash sitting in the account, since nothing was sold to raise it: it is a loan from the broker-dealer, so every dollar withdrawn from SMA increases the by $1. That is how the account stays in balance.
SMA is created from excess equity and is marked to the market each day. It works like a high-water mark: it locks in the credit the broker-dealer is willing to lend, so it does not fall when the market moves against the account. It simply stops rising until excess equity climbs above it again, and it only goes down when the customer uses it, by withdrawing cash or buying securities.
Example: SMA withdrawal in a long account
A client buys $50,000 of securities and makes the required $25,000 deposit, so equity is $25,000 and the is $25,000. The value grows to $60,000: equity is now $60,000 - $25,000 = $35,000. The Reg T requirement on a $60,000 is $30,000, so there is $5,000 of excess equity, credited to SMA. If the client withdraws all $5,000, the stays at $60,000, since the market hasn’t changed, and the rises from $25,000 to $30,000. Equity is now $30,000, exactly 50% of the $60,000 , because all of the SMA was withdrawn.
Similarly, in a short account, if there is SMA, if withdrawn as cash, it decreases the CR dollar for dollar. If there was $10,000 in SMA, and the customer withdrew $5,000 of it, the effect of that loan is a reduction in the credit register, as opposed to an increase in the debit register of a long margin account.
For every $1 rise in LMV in a long account, the SMA increases by $0.50: the debit balance doesn’t change, so equity rises $1 while the 50% Reg T requirement rises $0.50. For every $1 fall in SMV in a short account, the SMA increases by $1.50: the credit balance doesn’t change, so equity rises $1 and the 50% Reg T requirement falls $0.50. These rates hold only once equity is at or above the Reg T requirement: in a restricted account, a gain first makes up the shortfall, and SMA is created only by the part that lifts equity past 50%.
Buying power
Buying power is how much more the customer can buy on margin with the current account. A customer who wants $50,000 of securities must deposit the $25,000 Reg T requirement, which creates no additional buying power. Depositing $30,000 instead creates $5,000 of excess equity, and so $10,000 of buying power: $30,000 could have bought $60,000 of securities on margin, but only $50,000 was bought, so the broker-dealer is willing to lend $10,000 more to invest.
In simplest terms, remember cash is twice its value in buying power, because of the 50% Reg T value, but fully paid securities only have equal buying power, because they are worth 50% in cash, due to Reg T again, and that 50% in cash, would therefore buy twice as much, or 100% of the fully paid securities. Cash doubles, fully paid securities are just equal value.
As SMA can be withdrawn in cash or buying power, it is effectively a line of credit; buying power is twice the value of the SMA.
Restricted accounts
Accounts become restricted when the customer’s equity in the account falls below 50%. This is not a maintenance call, that is when it falls below 25% for long, or 30% for short account, this is simply when it is below 50% equity. When an account is restricted, there are rules on any transactions in the account. You can still do closing transactions, but 50% of any proceeds must be used to reduce the debit or credit balance. Transferring funds from the SMA will not remove a restriction, as SMA is effectively a line of credit. To remove restrictions, the LMV or SMV must move into the territory where the customer generates equity (up high enough for LMV, down low enough for SMV), or the customer must deposit more cash, or fully paid securities into the account, increasing their equity portion to above 50%. Selling securities and putting all of the proceeds toward the debit balance works too: equity stays the same while the LMV falls, so the equity percentage rises.