Requirements and Characteristics of Margin Accounts
Before diving into margin calculations, you need to understand what a margin account is, how it's opened, and what securities can be traded on margin.
What Is a Margin Account?
- A margin account allows a customer to borrow money from the broker-dealer to purchase securities (buying on margin) or borrow securities to sell short
- The broker-dealer charges interest on the margin loan; the customer's securities serve as collateral
- Margin accounts are governed by three levels of regulation, each progressively stricter:
| Level | Regulator | What It Sets |
|---|---|---|
| Federal | Federal Reserve Board (Regulation T, or "Reg T") | Initial margin requirements (currently 50% for nonexempt securities) |
| Self-Regulatory Organization (SRO) | FINRA (Rule 4210) | Maintenance margin requirements (25% long, 30% short) |
| Firm | Broker-dealer ("house" requirements) | May impose requirements stricter than Reg T or FINRA minimums |
- A firm can always require more margin than the regulatory minimum, but never less
Opening a Margin Account
The customer must sign a margin agreement with three components:
| Component | Purpose | Required? |
|---|---|---|
| Credit agreement | Discloses loan terms, interest rate calculation, and repayment schedule | Yes |
| Hypothecation agreement | Pledges the customer's securities as collateral for the margin loan | Yes |
| Loan consent form | Authorizes the firm to lend the customer's securities to others (e.g., for short sales) | No - optional |
- The loan consent form is the only optional component
- The firm must also deliver a margin disclosure statement (FINRA Rule 2264) at or before opening the margin account
- This disclosure must be provided at least once per calendar year to all non-institutional margin customers
Exam Tip: Gotchas
- The loan consent form is the ONLY optional part of the margin agreement. If the exam asks which document a customer does NOT have to sign, this is the answer. The credit agreement and hypothecation agreement are both mandatory.
Hypothecation and Rehypothecation
- Hypothecation: The customer pledges securities as collateral for the margin loan from the broker-dealer
- Rehypothecation: The broker-dealer re-pledges the customer's securities to a bank as collateral for its own loan (to finance customer margin lending)
- Under SEC rules, the broker-dealer may rehypothecate customer securities up to 140% of the customer's debit balance (not 140% of market value)
Example: If a customer's debit balance is $10,000, the firm can pledge up to $14,000 of the customer's securities to the bank. Any securities above that threshold are excess margin securities and must be segregated.
Exam Tip: Gotchas
- The 140% rehypothecation limit is based on the DEBIT BALANCE, not the market value. The exam may present a scenario with both figures and ask which securities can be pledged. Always multiply the debit balance by 1.4.
Minimum Equity Requirements
- FINRA Rule 4210 requires a minimum deposit of $2,000 to open a margin account
- If the purchase is less than $2,000, the customer must deposit the full purchase price (no borrowing allowed)
- The $2,000 minimum must remain in the account at all times
- For short sales, the minimum equity is also $2,000
Think of it this way: The $2,000 minimum acts as a safety deposit. If your purchase costs less than $2,000, you pay the full amount (no borrowing at all). The firm only lets you borrow when there is enough equity to absorb potential losses.
Eligible and Ineligible Securities
Not all securities can be purchased on margin:
| Marginable (Eligible) | Non-Marginable (Ineligible) |
|---|---|
| Listed stocks on exchanges (NYSE, Nasdaq) | OTC (non-Nasdaq) stocks priced under $5/share (penny stocks) |
| Most Nasdaq stocks | New issues (IPOs) for the first 30 days after issuance |
| Corporate bonds | Mutual fund shares for the first 30 days after purchase |
| Government and municipal bonds | Options (premium must be paid in full) |
| ETFs |
Key rules on timing and options:
- After the 30-day holding period, mutual fund shares and IPO stock become marginable if they meet other eligibility criteria
- Options cannot be purchased on margin; the premium must be paid in full by the next business day (T+1)
- Options can serve as collateral in a margin account (e.g., covered call writing uses the underlying stock as margin)
Exam Tip: Gotchas
- Mutual funds and IPO stocks are NOT marginable for the first 30 days. This timing rule is frequently tested.
- Options cannot be bought on margin but CAN be used as collateral. These are two different concepts that are often confused.