Saturday, June 27, 2009

One More on Margin

A good way to dig into the concepts behind "margin accounts" is to download the margin handbook at an online broker-dealer. After reading TD Ameritrade's Margin Handbook, I felt as if I could go on and on for hours about the topic . . . if I could get anyone to, you know, listen.

Or, you might just want to slog through annoying practice questions, like this:

If your investor sells 1,000 ABC short @37, makes the required Reg T deposit, and then sees that ABC is trading for $18, what is true of the equity in the account?
A. the equity is unchanged
B. the equity is below the minimum maintenance requirement
C. the equity has decreased by $19,000
D. the equity in the account is $37,500

EXPLANATION: whenever someone sells stock short, he wants the stock price to drop. Since ABC does drop, you know that A and B can't be right. The equity has certainly changed even if you aren't sure how. And, since the stock went the correct direction, the equity is improved not "below the minimum maintenance requirement." Do this type of work before you start calculating--knock things off your plate as soon as possible. Now, really, you could eliminate "C," since the equity has increased, and then to check your work do this . . . add the $37,000 the investor receives on the sale plus 1/2 that amount ($18,500), which is the cash he puts down. His Credit - $55,500. Just subtract the current market value of $18,000 from that, and you get the correct answer of $37,500. The opening credit on a short sale is "half again as much" as the short sale. Subtract the market value of the stock from that, and you've figured the "investor's" equity.

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