If you’re studying for the Series 7, you might find yourself getting stuck on long margin account questions. If so, read on for some tips to help you simplify these tricky questions. Wrap your brain around a few key concepts, and with some practice, you’ll be well on your way to a successful Series 7.

Simplifying Margin Calculations

To get started, you’ll need to recognize some abbreviations for long margin accounting:

  • LMV is long market value, which is the value of the securities that have been purchased in a margin account.
  • DR stands for debit register, which is the money the customer has borrowed from the broker-dealer.
  • EQ is the customer equity, or the customer’s ownership interest in the securities in the account.

You’ll also need to know the master equation for long margin accounting:

LMV − DR = EQ

To make the concept of margin more user friendly, let’s relate long margin accounts to buying a house.  People that buy houses usually borrow money to purchase their home by taking out a mortgage. The difference between the market value of their house and the amount of their mortgage is their home equity (Home Market Value ). While market conditions can cause the value of the house to go up or down, what homeowners owe on their mortgage doesn’t change as a result. What changes in response to market fluctuation is the amount of home equity.

Let’s illustrate this with a $300,000 home purchased with a down payment of $100,000. In this example, the mortgage amount, or the money borrowed, is $200,000 since the buyer put $100,000 down.

Home Value = LMV = $300,000; Mortgage = DR = $200,000; Equity = $100,000

If the home value rises to $350,000, what are the resulting changes? The mortgage amount (DR) remains at $200,000, but the equity increases to $150,000. The equation of LMV – DR = Equity easily calculates the new amount of equity.

Alternatively, if the home value falls to $250,000, the homeowner will have equity of $50,000 because LMV of $250,000 – DR of $200,000 = Equity of $50,000. Remember, only the equity changes as a result of market value movement, not the amount that was borrowed—a key concept to remember for margin accounting.

There’s another useful similarity between margin accounting and home ownership: the concept of a home equity loan. When homeowners experience an increase in the market value of their homes, the bank allows them to borrow against the increased equity that results. This “home equity loan” concept applies to margin accounts in the form of an SMA (special memorandum account). SMA is simply an additional line of credit that is created from market value appreciation, just like a home equity line of credit. A margin account customer can use it to buy stock or take out cash, as long as the account is in good standing.

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Margin Accounting Example Question

We’ll now apply this understanding and use a comprehensive example to work through long margin accounting and SMA.

Question: In a new margin account, an investor purchases 1,000 shares of XYS stock at $60 per share. If the market value of the stock appreciates to $90, and the customer uses the full purchasing power to buy additional stock, what is the resulting debit balance in the account?

Solution: Carefully follow the logic in the steps below to get to the answer.

  • To open this position, the customer must meet the Reg T requirement of 50% of the purchase amount. The account is established as follows: LMV = $60,000; DR = $30,000; EQ = $30,000.
  • The long market value appreciates to $90, so the account is now updated as follows: LMV = $90,000; DR = $30,000; EQ = $60,000. Use the formula LMV – DR = EQ to get to this new equity amount.
  • After a market move, a margin account must be marked to the market. This is a daily process on the part of the BD to determine the status of the account. It identifies whether the account is generating SMA, is in restricted status, or will receive a maintenance call because of insufficient equity.Determining the status of the account requires recalculation of the Reg T requirement and determination of FINRA’s minimum maintenance requirement based on the new market value of the stock. In this question, the new Reg T is 50% of $90,000 (the new market value) or $45,000. The FINRA minimum maintenance is 25% of the new market value of $90,000 or $22,500. Tip: The quick way to find minimum maintenance is to divide the Reg T amount in half (Reg T of $45,000/2 = $22,500).The next step in determining the account status is to compare the amount of equity to these newly calculated benchmarks. One of these three outcomes will result:
    • If the new equity amount is more than the new Reg T amount, the account has excess equity. Excess equity creates SMA. In this example, the equity of $60,000 exceeds the Reg T benchmark of $45,000. The account in our question now has $15,000 of excess equity, which creates $15,000 of SMA and gives the account purchasing power, also known as buying power.
    • If equity is between the Reg T amount ($45,000) and the minimum maintenance requirement ($22,500), the account is restricted. A restricted account is still OK – it just means the customer may be limited on the use of SMA and that, when stock is sold, only 50% of the sales proceeds can be withdrawn. The account in our example is not restricted because the equity of $60,000 exceeds the Reg T requirement of $45,000.
    • If the equity were below the FINRA 25% minimum maintenance requirement of $22,500, the investor would get a maintenance call and would have to promptly deposit cash or securities to bring the equity up to the $22,500 minimum. Obviously, the account in this example is not in jeopardy.
  • From the previous step, we know the account has purchasing power. The SMA of $15,000 has purchasing power of 2 to 1, so the customer can purchase $30,000 of stock.
  • Using SMA to purchase stock increases the debit balance in the account by the full amount of the purchase. This is because the investor borrowed 50% of the purchase amount from the BD and met the 50% equity requirement with the SMA line of credit – all borrowed money. As a result, to find the answer to the question, the new purchase amount of $30,000 must be added to the existing debit balance of $30,000, to arrive at the new debit balance of $60,000.
  • After this purchase the account is as follows:

LMV = $120,000 ($90,000 + new stock of $30,000); DR = $60,000 (existing balance of $30,000 plus the $30,000 purchase); EQ = $60,000

As you’ve seen, this example includes many steps, but none of them on their own are difficult. Just be deliberate about dealing with all of the steps in the question. A common mistake is the failure to re-calculate the benchmarks after a change in the value of the stock. The new Reg T and FINRA minimum maintenance are critical in answering nearly any question that involves market value fluctuation.

Some Additional Long Margin Accounting Points

Besides the accounting concepts we just reviewed, listed below are some additional long margin accounting points you should learn:

  • Reg T of 50% applies on a new margin account purchase, unless the amount of the purchase is small. Then, the FINRA $2,000 rule applies instead, which means the customer must deposit a minimum of $2,000 or pay in full for the transaction if the stock purchase amount is less than $2,000. For example:
    • If a customer purchases $10,000 of stock on margin, the equity requirement is $5,000. To set this up: LMV = $10,000; DR = $5,000; EQ = $5,000.
    • If a customer purchases $3,000 of stock on margin, the equity requirement is $2,000. To set this up: LMV = $3,000; DR = $1,000; EQ = $2,000.
    • If a customer purchases $1,800 of stock on margin, the equity requirement is $1,800. To set this up: LMV = $1,800; DR = $0; EQ = $1,800.
  • The amount of SMA is determined by comparing the excess equity to the existing SMA balance. The greater of the two amounts is the new SMA balance.
  • Once SMA is created, it is not reduced by falling market value. It is only reduced when it is used, and it can be used to buy stock ($1 of SMA buys $2 of stock) or withdraw cash ($1 of SMA is $1 of cash).
  • Any use of SMA increases the DR of the account.
    • SMA of $10,000 can purchase $20,000 of stock. In this example, the LMV increases by $20,000, and the debit balance also increases by $20,000. There is no change to the equity.
    • SMA of $10,000 can be withdrawn as $10,000 in cash. In this example, the LMV does not change, but the debit balance increases by $10,000, which means the equity will fall by $10,000.
  • A restricted account means that the use of SMA may be limited. SMA cannot be used if it causes the equity to fall below the FINRA minimum maintenance of 25% of the account’s LMV.
  • To find how far the market value of the securities in the account can fall before the customer gets a maintenance call, use the formula DR/0.75. This is called the market value of maintenance formula. Don’t confuse this with minimum maintenance, which is the minimum equity required by FINRA (25% of the LMV).

Practice Diligently

The next step on the way to margin mastery is practice. Work margin accounting questions slowly and thoroughly following the steps above. You’ll find they get easier each time. Remember that margin account questions do not make up a large percentage of the Series 7 Exam. Of the total 125 questions, you’re likely to see no more than 5-7 on this topic, and most will be on long margin accounts with only 1 or 2 on short margin accounting. So, while you want to get your margin questions right, prioritize study time for topics like options, suitability, municipal securities, client accounts, and taxation. Each of these topics is usually worth more than 10 questions, so it can be far more damaging if you under-prepare for these than for margin questions.

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Written by Marcia Larson
Marcia Larson is Vice President, Faculty, at Knopman Marks Financial Training, New York, NY. She has extensive experience in financial licensing and regulatory training, having authored, developed and presented courseware for numerous securities and insurance exam preparation and continuing education and compliance programs. Before joining Knopman Marks, Marcia was Director of Annuity Products and Business Development at CUNA Mutual Group, where she developed and marketed industry-leading annuity products and retirement solutions and implemented distribution relationships. She was previously VP, Securities Products for Kaplan Financial, managing securities training products and subsequently, international training and businesses development. Marcia has trained thousands of financial industry exam candidates throughout their careers, and also college students as an adjunct professor. Marcia was a summa cum laude graduate of Wartburg College with degrees in Business Administration and Piano Performance. Marcia also holds the designations of Chartered Financial Consultant® (ChFC®), Chartered Life Underwriter (CLU®), Certified Employee Benefit Specialist (CEBS), and Fellow Life Management Institute™ (FLMI®). She currently teaches the SIE, Series 6, 7, 24, 50, 52, 63, 65, and 66 exams.