Margin requirements play a critical role in managing margin accounts, especially when preparing for the FINRA Series 7 exam. This chapter will guide you through the intricacies of calculating both initial and maintenance margin requirements. Understanding these calculations is crucial for managing risk in securities trading and avoiding costly margin calls.
Initial Margin Calculation
The initial margin is the minimum amount of equity a customer must deposit when purchasing securities on margin. The Federal Reserve sets these requirements, currently under Regulation T. Let’s examine how to calculate the initial margin requirement using a straightforward example.
Example: Buying Stock on Margin
Imagine you’re buying 100 shares of a stock priced at $50 per share. With a Regulation T requirement of 50%, the calculation for the initial margin is:
$$\text{Initial Margin Requirement} = \text{Purchase Price} \times \text{Percentage Requirement}$$
Using the values from our example:
$$
\begin{align*}
\text{Purchase Price} &= 100 \text{ shares} \times $50 = $5000 \
\text{Initial Margin Requirement} &= $5000 \times 0.50 = $2500
\end{align*}
$$
You need to deposit $2500 to proceed with the purchase.
Maintenance Margin Calculation
Once the purchase is made, maintenance margin comes into play, representing the minimum equity that must be maintained in the margin account. The FINRA requirement for maintenance margin is typically 25%. If the stock price falls, the equity in your account decreases, potentially leading to a margin call.
Example: Handling a Decline in Stock Value
Continuing with our previous example, suppose the stock price drops to $40 per share. Here’s how to calculate whether you meet the maintenance margin:
- Current Market Value = 100 shares × $40 = $4000
- Equity in the Account = Current Market Value - Loan Balance
Assuming a loan balance of $2500, the equity calculation is:
$$
\begin{align*}
\text{Equity in the Account} &= $4000 - $2500 = $1500 \
\end{align*}
$$
The maintenance margin requirement is 25% of the current market value:
$$
\begin{align*}
\text{Maintenance Margin Requirement} &= $4000 \times 0.25 = $1000 \
\end{align*}
$$
Since the equity in the account ($1500) exceeds the maintenance margin requirement ($1000), no margin call occurs. If the equity had fallen below $1000, you would face a margin call to deposit additional funds or sell assets.
Conclusion
Understanding how to calculate both initial and maintenance margins is essential for passing the FINRA Series 7 exam and managing margin accounts. Properly managing these accounts helps prevent margin calls, safeguarding your investments.
Glossary
- Initial Margin: The minimum required deposit before purchasing on margin.
- Maintenance Margin: The minimum equity that must be kept in a margin account.
- Regulation T: A Federal Reserve Board regulation that governs the amount of credit that brokerage firms can extend to customers.
Additional Resources
- FINRA’s rules on Margin Accounts
- Interactive margin calculators to practice real-world scenarios.
Quizzes
Test your understanding of margin calculations with these practice questions for the Series 7 exam:
### What is the initial margin requirement for purchasing $10,000 worth of stock on margin, given Regulation T requires 50%?
- [x] $5000
- [ ] $2000
- [ ] $8000
- [ ] $3000
> **Explanation:** The initial margin requirement is 50% of the purchase amount, $10,000 × 0.50 = $5,000.
### If a stock purchased on margin drops in value, which margin requirement comes into play?
- [x] Maintenance margin
- [ ] Initial margin
- [ ] Option margin
- [x] Margin loan
> **Explanation:** The maintenance margin is the minimum required equity, which if not met can trigger a margin call due to stock depreciation.
### How much equity is required to maintain in a margin account if the market value drops to $4,000, and maintenance margin is 25%?
- [x] $1000
- [ ] $2000
- [ ] $400
- [ ] $800
> **Explanation:** Maintenance margin is 25% of current market value, $4000 × 0.25 = $1,000.
### What does a margin call signify?
- [x] Deposit additional funds
- [ ] Sell shares
- [ ] Close the account
- [ ] Increase equity
> **Explanation:** A margin call means additional funds must be deposited to meet minimum margin requirements.
### In a margin account, which is NOT a determining factor for a margin call?
- [x] Original purchase price
- [ ] Current equity
- [x] Federal interest rates
- [ ] Stock price volatility
> **Explanation:** Original purchase price and federal interest rates do not directly trigger margin calls; they are based on equity and stock price changes.
### Calculate the required equity for a $5,000 stock purchase with a maintenance margin of 30%.
- [x] $1500
- [ ] $1200
- [x] $2500
- [ ] $1000
> **Explanation:** Required equity for maintenance is 30%, $5,000 × 0.30 = $1,500.
### What occurs if the equity in a margin account falls below the maintenance requirement?
- [x] Margin call
- [ ] Short sale
- [ ] Default
- [x] Option exercise
> **Explanation:** Falling below the maintenance margin triggers a margin call requiring additional funds or asset liquidation.
### Determine the new margin loan if $3,000 cash is added to the account, initially loaning $10,000 against $20,000 in stocks.
- [x] $7000
- [ ] $13000
- [ ] $10000
- [ ] $5000
> **Explanation:** Initial loan is reduced by the deposit, $10,000 - $3,000 = $7,000 margin loan.
### Margin call forces action when equity falls below which percentage of account value?
- [x] Maintenance margin
- [ ] Initial margin
- [ ] Total margin
- [ ] Government margin
> **Explanation:** A margin call is triggered when equity falls below the maintenance margin percentage.
### True or False: Margin requirements vary based on the type of asset purchased.
- [x] True
- [ ] False
> **Explanation:** Different securities may have different margin requirements according to FINRA rules and broker policies.
These questions and the knowledge gained from this chapter will prepare you effectively for the challenges of margin accounts in the Series 7 exam.