Short and Combined Margin Account Questions on the Series 7 Exam: Key Formulas and Sample Questions

Margin account questions on the Series 7 Exam can be intimidating. So a step-by-step method for breaking down short and combined margin account questions can make all the difference. We’ve compiled some tips to help you out, along with necessary formulas and free sample questions.

Let’s get started!

Step 1: Understand Long Margin Accounting

A fundamental understanding of long margin accounts is the first step to building skills with short and combined accounts. Long accounts are a bit more intuitive and give you background in key margin account concepts, like the impact of market movement on equity and the creation and use of SMA. Before you go any further, invest a few minutes in our post on long margin accounting.

Step 2: Know the Short Margin Account Basics

Investors that sell short borrow shares of stock from a broker-dealer (BD), and then sell the borrowed shares at the current market price. Their hope is that they can later buy the securities they owe the BD at a lower price and profit from the price difference. For example, assume an investor borrows shares from a BD and sells them at their current market price of $50 per share. If the share price falls to $40, the investor profits $10, because the shares can be bought at the lower price to repay the BD. Any investor that sells short must do so in a margin account and must deposit collateral to borrow the securities from the broker-dealer.

Here are some key abbreviations:

  • SMV is short market value, which is the sales price of the securities that have been borrowed from the broker-dealer for the short sale.
  • EQ is the customer equity, or the customer’s ownership interest in the account.
  • CR stands for credit register, which is the total of the sales price of the borrowed securities (the SMV) and the EQ the customer had to contribute to meet the initial Reg T requirement (the greater of 50% of the SMV or the FINRA minimum). The CR is just a “bunch of cash” that acts as a buffer for the BD’s protection in case the market goes strongly against the investor.

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

CR – SMV = EQ

The Short Margin Mindset

A critical concept for mastering short accounts is recognizing that a short investor profits from downward market movement. So, a decrease in the market value of the securities is good news and actually increases the investor’s equity in the account. This is just the opposite of what is desirable in a long margin account.

Short Margin Sample Questions

Let’s go through some examples of the short margin accounting process.

Short Account Question #1:

In a new margin account, an investor sells short 1,000 shares of XYZ stock at $80 per share. If the market value of the stock falls to $70, what is the equity in the account?

Solution:

  • To open this position, the customer must meet the Reg T requirement and deposit equity of 50% of the short sale amount. The short sale value, or SMV, is $80,000, so the equity, or EQ, required is $40,000.
  • The credit balance, or CR, is calculated by adding the SMV and the EQ: SMV of $80,000 + EQ of $40,000 = CR of $120,000. The set-up of the short account is now complete. An important point to remember is that, once the CR has been established, it does not change when the market value moves. It is only used to determine the new equity in the account by following the short margin account equation: CR – SMV = EQ. Using the numbers in our example, the current equation is $120,000 CR − $80,000 SMV = $40,000 EQ.
  • The short market value now falls to $70 (remember, a falling price is good in a short account), so the account and equation are updated as follows: CR = $120,000; SMV = $70,000; EQ = $50,000. By using the formula CR – SMV = EQ, we see that the equity increases to $50,000 because of the stock price decline.

Key Takeaway: Short Account Status and SMA

After a market move, a margin account must be marked to the market, whether it is long or short. 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. Reg T is 50% for both long and short accounts, but the FINRA minimum requirement is different for short accounts. It is 30% of the SMV, instead of 25% of the LMV as with a long account. Let’s work through this with another question.

Short Account Question #2:

In a new margin account, an investor sells short 1,000 shares of XYS stock at $100 per share. If the market value of the stock appreciates to $120, how much must the customer deposit to meet the maintenance call?

Solution:

  • To open this position, the customer must meet the Reg T requirement and deposit equity of 50% of the short sale amount. The short sale value, or SMV, is $100,000, so the equity, or EQ, required is $50,000.
  • The credit balance, or CR, is calculated by adding the SMV and the EQ: SMV of $100,000 + EQ of $50,000 = CR of $150,000.
  • The short market value now rises to $120 (remember, a rising price is bad in a short account), so the account and equation are now updated as follows: CR = $150,000; SMV = $120,000; EQ = $30,000. By using the formula CR – SMV = EQ, we see that the equity decreases to $30,000 because of the stock price appreciation.
  • Does the customer need to deposit additional equity? Answering this question requires the calculation of FINRA minimum maintenance. The minimum equity of 30% of the SMV is 0.30 × 120,000, or $36,000.
  • Because the current equity in the account of $30,000 is below the minimum maintenance of $36,000, the customer must deposit $6,000.

Like long margin accounts, short margin accounts can also have SMA. SMA is created when the market value of the securities depreciates, and the account has equity in excess of the Reg T requirement of 50% of the SMV.

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Key Takeaway: Short Maintenance Market Value

A final consideration for short margin accounts is the market value at maintenance formula. This formula, CR/1.3, calculates the market value to which the securities in a short account can rise before there is a maintenance call. For example, in a short account that has CR of 130,000, SMV of 80,000 and EQ of $50,000, the maintenance market value is $130,000/1.3 (CR/1.3) = $100,000. If the short market value is just $1 more, this investor will be in violation of the FINRA minimum maintenance requirement and will receive a maintenance .

If you can follow these examples and do these computations, you’ll have great success with short margin account questions!

Combined Margin Accounts

A combined account question might just pop up on your exam. The good news is that you already know how to do this accounting if you know both the long and short margin account equations. The question will typically require you to determine the combined equity given a variety of positions, as in the example below.

Combined Account Question:

A customer has the following margin account positions: SMV of $90,000, LMV of $100,000, DR of $40,000, and CR of $120,000. What is the customer’s combined equity?

Solution:

Once you’ve learned the equations for long and short margin accounting, this type of question is just a “plug and play.” Plug the values from the question into the equations, and add the long and short equity. These are easy questions.

  • For the long equity, LMV – DR = EQ, so $100,000 − $40,000 equals $60,000 of long account equity.
  • For the short equity, CR – SMV = EQ, so $120,000 − $90,000 equals $30,000 of short account equity.
  • So, Combined Equity = $60,000 + $30,000 = $90,000.

The Final Step to Margin Mastery

Once these concepts make sense, it’s all about practicing what you’ve learned. Work margin accounting questions slowly and thoroughly, and 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, which usually account for at least 10 questions each.

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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.