Lesson 11 Margin

There are three forms needed to add margin borrowing to an account

a credit agreement

a hypothecation agreement

a consent to loan agreement.

Credit Agreement

The credit agreement discloses the terms of the credit extended to the customer by the BD, including the method of interest computation and a description of situations under which interest rates may change.

Hypothecation Agreement

The hypothecation agreement allows the BD to hold the securities in the account as collateral for the loan.

By signing the margin agreement, a customer hypothecates (pledges) the securities to the broker-dealer who then ________ (pledges) them to the bank as collateral for the margin loan.

rehypothecates

Consent to Loan Agreement

gives the firm permission to loan the customer's margin securities to other customers or BDs, usually to provide shares for short sales where securities need to be borrowed.

To open a margin account, it is mandatory that the customer sign the

Credit agreement and hypothecation agreement.

Before a customer may open a margin account, the BD must provide the customer with

a risk disclosure document

The BD must also provide this information to margin customers

on an annual basis

Risk associated with margin trading

• Customers can lose more money than initially deposited.

• Customers are not entitled to an extension of time to meet a margin call. Margin calls are covered in a later lesson.

• Firms can increase their in-house margin requirements without advance notice.

account types that may have margin

• Most individual and joint accounts

• Corporate and partnership accounts

• Trust and other fiduciary accounts require that the trust (or similar) document be checked for information on margin.

To add margin to a corporate and partnership accounts

• The corporate charter or bylaws (partnership agreement in the case of a partnership) must be checked to see if a rule against margin exists.

• If margin is prohibited, then no margin is allowed.

• If margin is allowed, then it may be added.

• If the document is silent as to margin, then margin is allowed.

To add margin to a Trust and fiduciary accounts

• The trust (or similar) document must specifically allow margin.

• If the trust document is silent, then margin is not allowed.

Accounts that cant have margin

• IRAs and other retirement plans

• custodial accounts

securities that may be purchased on margin and used as collateral for a margin loan:

• Exchange-listed stocks and bonds

• Nasdaq stocks

• Over-the-counter (OTC) issues approved by the Federal Reserve Board (FRB) for margin

• Warrants

The following cannot be purchased on margin or used as collateral for a margin loan:

• Options (both calls and puts)

• Rights

• Non-National Market System (non-NMS) securities

• OTC issues not approved by the Federal Reserve Board (FRB)

• Insurance contracts

The following cannot be purchased on margin but can be used as collateral after being held for 30 days:

• Mutual funds

• New issues, if the securities can be used as collateral for a margin loan

marginable

refers to securities that can be used as collateral for a margin loan.

Who regulates the initial margin requirements

Regulation T and by FINRA

minimum amount to deposit will always be the

higher of the two rules

Regulation T

The customer must deposit 50% of the purchase price in the margin account.

FINRA

The customer must deposit $2,000 or 100% of the purchase price if less than $2,000 in the margin account.

FINRA minimum applies to

smalless investments

Regulation T rule will always be greater than FINRA rule if

the deposit is greater than $4000

securities that are exempt from the FRB's Regulation T margin requirements.

• U.S. Treasury bills, notes, and bonds;

• government agency issues; and

• municipal securities.

A certain amount of equity must be maintained in a margin account at all times

true

If the customer's equity drops below ____ of the account's market value, the customer receives a maintenance call

25%

a margin maintenance call

a demand to the client to deposit additional assets to bring the equity in the account up to the 25% minimum.

If a customer fails to make the required deposit (normally required by the end of the day),

the BD may liquidate (sell off) assets from the account to bring the account's equity up to 25%.

discretionary trade

A customer may give trading authority to a registered representative (RR) to place trades in the customer's account without the customer's permission.

With a discretionary account

• the customer can continue to enter orders themselves.

• A trading authorization or limited power of attorney is required

• The customer is bound to accept all trades done by the party given the discretion and churning.

• trades done only for the purpose of generating commissions, is never permitted.

proper authorizations for discretionary trade

• the customer must authorize discretion.

• all trades must be promptly approved by a principal at the firm.

• a principal at the firm must authorize discretion.

A registered representative placing trades in a customer account must have discretionary authority if they choose which of the following aspects of the trade?

The action to be taken, the asset to be traded, or the amount of the trade

transaction that can only be done in a margin account

Selling to open (a short sell)

When securities will be held in street name, The customer remains as the_____ and the broker-dealer as ____.

beneficial owner, named or nominal owner