It is an agreement with your brokerage firm to lend you money based on the equity in your account.
How do I open a margin account?
Ask your broker to send you a margin agreement. Typically this is sent with the original new account application. You may have already signed the agreement. Call your broker to find out.
Are there any restrictions on who can open a margin account?
Yes. Custodial accounts (accounts opened for minor children), Retirement accounts (IRA, Keogh, Qualified Plans, Retirement Trust), and Estate accounts are not allowed to have margin. The rationale is that the purpose of these accounts is for long term investing with a low risk tolerance. Margin substantially increases the risk of losses, therefore it is not appropriate for these type of accounts.
What accounts can have Margin?
Individual and joint accounts can with a signed margin agreement. Trust accounts can, but must be specifically allowed by the trust agreement. Your broker will require a signed margin agreement (by trustee) and a copy of the section of the trust that gives permission for margin to be used. Corporate or partnership accounts can, but you will be required to complete additional forms to open the account.
How does margin work?
Your broker will lend you money backed by the securities in your account. Like any loan, you will be charged interest on the amount borrowed.
How much interest will be charged?
Brokers will charge a percentage above the Broker Call rate, which is the rate that banks charge brokers on the loans.(In actuality, many brokers are able to receive a lower rate than the Broker Call rate.) The Broker Call rate is variable and moves in tandem with other market rates. You can find this rate in the Wall Street journal, along with other primary rates.
Typically brokers will charge a lower amount for larger loans. Make sure to ask your broker what rate you will be charged prior to borrowing from them. The rates vary widely from broker to broker and can be negotiated, in particular if you borrow a large amount.
What am I agreeing to when I sign the Margin Agreement?
The margin agreement will include all of the rules you must follow. It also gives the broker the right to hypothecate (use your securities as collateral) at the bank to guarantee the loan. The securities in a margin account are held in street name (the name of the firm). This is done so that if you fail to meet a margin call (a request for additional equity in a margin account to bring the account above the minimum equity requirement.) the broker can sell your securities to satisfy the call.
How are Margin accounts regulated?
The Securities and Exchange Act of 1934 made the Federal Reserve Board responsible for the regulation of extension of credit by brokers for the purchase of securities. The Federal Reserve’s Regulation T sets the guidelines by which brokers are allowed to lend money.
How does Reg-T affect me?
It sets the initial margin requirement on a loan. The current requirement is 50%. This means that every time you purchase a stock you must deposit 50% of the purchase price. Although the Federal Reserve can adjust this rate, it is done very rarely.
The Federal Reserve also generates a list of marginable securities. Pink Sheet and Bullitin Board traded securities can not be purchased on margin. Low priced stocks on the listed exchanges (NYSE, AMEX) are also not eligible to be margin. This means that these securities have to be paid for in full. To be sure, ask your broker prior to purchasing a stock if it is eligible to be purchased on margin.
What is a maintenance requirement?
Reg-T only deals with the initial margin requirement. That is, how much money you have to deposit at the time of purchase. The maintenance requirement dictates the minimum equity requirement. In other words, what portion of the account must be yours at all times. This rate is set by your broker and can vary. Most firms require a 35% minimum equity requirement. Assume that you have an account whose total value is $10,000. If the maintenance requirement is 35%, your equity in the account can not drop below $3,500. Which would place the borrowed amount at $6,500.
Are there any other requirements?
Yes. You must have a minimum of $2,000 in equity to maintain a margin account.
Brokers can, at their discretion, increase margin requirements. If you concentrate your account ( you have only a few positions), the broker may require that you maintain the account at a higher level (usually 50% minimum equity).
Additionally, if a stock is particularily volitile the broker may make the maintanance requirement as high as 100%. Meaning that you must pay for the stock in full.
Lately, many brokers are requiring many internet related stocks be paid for in full because of the risk involved in trading these stocks. If you have any doubts ask your broker prior to buying a stock on margin. It is your responsibilty to find out.
Can other securities other than stocks be purchased on margin?
Yes. Corporate bonds, Government bonds, and treasury issues. Options are not marginable. Mutual Funds must be paid for in full but after 30 days can be borrowed against.
What is a margin call?
There are two types of calls.
1. Reg-T call.
A Reg-T call is generated at the time of purchase. The amount of the call is equal to the amount required to pay for 50% of the purchase. Assume the only position you have in your account is $3,000 in cash. You purchase several stocks which total to $15,000. The Reg-T requirement is $7,500 (50%). The Reg-T call is $4,500 ($7,500 - $3,000).
2. House Call.
This call is generated when the equity in your account drops below the broker’s minimum equity requirement. Assume the minimum equity requirement is 35%, the total value of the account is $10,000, the amount borrowed (debit) is $7,500. This account would generate a house call of $1,000. The equity is currently $2,500 which is 25% of the total value of the account (2,500/10,000).
How can I satisfy a call?
- Deposit a check equal to the amount of the call.
- Deposit marginable securities equalling twice the amount of the call. (Fully paid for securities will release ½ of their value towards a call).
- Sell securities in the account to cover the call. The amount that must be sold can be confusing. It will be based on what type of call it is and what percentage of equity you own in the account. Always ask your broker how much you have to sell to be sure. Basically the amount that must be sold can be calculated by how much of a release the sale of stock will bring. Let me explain through an example.
Total Value of account: $10,000
Debit (loan amount): $ 5,000
Equity (your portion): $ 5,000 Equity % (5,000/10,000) = 50%
You enter an order to purchase $3,000 worth of stock.
The account now looks like this:
Total Value : $13,000
Debit : $ 8,000
Equity : $ 5,000 Equity % (5,000/13,000) = 38.46%
Reg-T call:
3,000/2=1,500.
To cover this call by selling, you must sell 2 x 1500 = 3,000 worth of stock. The sale must be securities other than the one creating the call.
House call:
Assume the value of the shares in the account drop and the original position now looks like this:
Total Value : $ 7,000
Debit : $ 5,000
Equity : $ 2,000 Equity % (2,000/7,000) = 28.57%
The equity % in the account has dropped below 35% and therefore a house call is generated requiring the account be brought up to 35% equity. 7,000 X .35 = 2,450 (minimum equity). 2,450-2,000 = 450 (house call).
To calculate how much must be sold, remember that your ownership in the account is only 28.57%. Therefore for every dollar you sell, .2857 is yours. The remainder came from a loan provided by the broker. To calculate how much you need to sell to cover this call: 450/.2857=1575. You would have to sell $1,575 worth of stock to bring the account up to 35% Equity.
The account now looks like this:
Total Value : $ 5425
Debit : $ 3425
Equity : $ 2,000 Equity % (2,000/5425) = 36.86%
The best thing to do is verify the amount with your broker.