Margin Accounts

A margin account allows customers to borrow money from their broker-dealer to purchase securities, using those securities as collateral. Margin trading amplifies both gains and losses, making it a higher-risk strategy that requires careful understanding.

What is Margin Trading?

When customers buy securities "on margin," they:

1. Deposit a portion of the purchase price (margin requirement)
2. Borrow the remainder from the broker-dealer
3. Pay interest on the borrowed amount (margin interest)
4. Use the purchased securities as collateral

Example: To buy $20,000 of stock, a customer deposits $10,000 (50%) and borrows $10,000 from the broker. The stock serves as collateral for the loan.

Opening a Margin Account

Margin accounts require additional documentation beyond cash accounts:

Hypothecation: The customer's securities are pledged as collateral for the margin loan. The broker may "rehypothecate" (repledge) securities up to 140% of the customer's debit balance to their own lenders.

Regulation T Initial Margin

Regulation T sets the initial margin requirement at 50% for most equity securities. This means customers must deposit at least half the purchase price.

Initial Margin Rules

Example Calculations:

Key Point: For purchases under $2,000, customers must pay in full because the purchase is too small to justify margin credit.

Minimum Maintenance Requirements

After the initial purchase, maintenance margin requirements help ensure the account maintains adequate equity as a cushion against losses.

FINRA Maintenance Requirements

Key Point: These are minimums. Most broker-dealers set "house requirements" higher than FINRA minimums to provide additional protection.

Margin Calls

A margin call occurs when the account equity falls below maintenance requirements. There are several types:

Federal (Reg T) Call

Issued when initial margin requirement isn't met on a new purchase. Customer must deposit additional funds to meet the 50% requirement.

Maintenance Margin Call

Issued when equity falls below the maintenance requirement. The customer must deposit funds or securities to bring the account back to compliance.

House Call

Issued when equity falls below the firm's internal requirements, which are typically higher than FINRA minimums.

Meeting Margin Calls

Customers can meet margin calls by:

1. Depositing cash — Most common method
2. Depositing marginable securities — Must be fully paid for
3. Selling securities — Reduces the loan balance
4. Combination — Any mix of the above

Deadline: Margin calls typically must be met within 2-5 business days, depending on the firm's policies and the type of call.

Margin Interest

Customers pay interest on their debit balance (the amount borrowed). Key points:

• Rate: Based on the broker call rate plus a spread
• Calculation: Daily on the outstanding balance
• Payment: Monthly or as charged to the account
• Tax treatment: May be deductible as investment interest expense

Securities Not Eligible for Margin

Certain securities cannot be purchased on margin:

Margin Advantages and Risks

Advantages

• Leverage: Control more securities with less capital
• Increased buying power: Can purchase more than cash balance
• Flexibility: Borrow without selling holdings

Risks

• Amplified losses: Losses exceed the amount invested
• Margin calls: May force sales at unfavorable times
• Interest costs: Erode returns over time
• Forced liquidation: Broker can sell without consent

Important: In extreme market declines, customers can lose more than their initial investment in a margin account.

Regulation T Violations in Margin Accounts

If a customer fails to meet a Reg T call, the broker must:

1. Liquidate securities sufficient to meet the call
2. Freeze the account for 90 days
3. Require full cash payment for future purchases during the freeze

On the Exam

The Series 7 exam frequently tests:

• Calculating initial margin requirements (50% or $2,000 minimum)
• Understanding maintenance margin levels (25% long, 30% short)
• Knowing what triggers margin calls
• Identifying securities not eligible for margin
• Understanding the risks of leverage