Table of Content
Transaction Analysis	Excess Equity
Special Memorandum Account	House Excess

Once the margin call generated by an initial purchase or short sale (remember that this is called a Fed Call) has been satisfied, the various values in the margin account (customer equity, debit (loan) balance, and total market value) will change as the market prices of the securities held change. When the market value of the securities purchased go up, the customer equity increases.

For example, a customer opens a margin account and purchases 100 shares of ABC at $55. The total cost of the purchase is $5,500. The customer hasn't sent in any money yet, so his account looks like the following:

Market Value:	$5,500 (100 ABC @ 55)
Debit Balance:	-5,500 (owed to broker)
Customer Equity:	0

The customer will be issued a margin call (Fed Call) for 50% of the purchase price of the securities purchased. 50% of $5,500 is $2,750. The customer immediately sends in his check for $2,750 and after it is posted, his account looks like the following:

Market Value:	$5,500 (100 ABC @ 55)
Debit Balance:	-2,750 (owed to broker)
Customer Equity:	2,750

Let's assume that the ABC stock that the customer bought goes up to $65 per share from the $55 that it was purchased for. We'll assume that everything else stays the same. The various components of the margin account will now look like this:

Market Value:	$6,500 (100 ABC @ 65)
Debit Balance:	-2,750 (owed to broker)
Customer Equity:	3,750

The changes to the account balances from an increase in the market price of the stock are:

1. The market value of the securities in the account increased from $5,500 to $6,500.


2. The customer's equity increased from $2,750 to $3,750.

Any change to a margin account (increase in market value, a purchase or sale, a deposit or withdrawl of cash, etc.) always affects only two of the three account components.

The 100 shares of ABC in the account could now be sold for $6,500. After paying the brokerage firm the $2,750 owed on the margin loan, the customer could withdraw a check for the remaining $3,750.


The initial requirement for an account that purchases $50,000 worth of stock is $25,000. The customer is required to have $25,000 worth of equity in order to purchase $50,000 worth of stock. Put another way, the initial equity requirement for a stock purchase on margin is 50% of the amount purchased. Reminder: this is a Fed requirement.

Let's look at what happens when another customer (Customer B) purchase 100 shares of ABC stock, just like the customer in our first example (who we'll call Customer A). But instead of buying the stock at $55 per share, Customer B pays $65 per share, and promptly deposits a check for $3,250 (equal to 50% of the purchase price of $6,500).

Here is how the two accounts compare at this point:

	Customer A	Customer B
Market Value:	$6,500	$6,500
Debit Balance:	-2,750	3,250
Customer Equity:	3,750	3,250

Comparing the two accounts, we can see that Customer B has met the 50% initial equity requirement and his account is in good condition, but Customer A's account is in even better shape, with greater than 50% equity in the account. The requirement is for equity of $3,250, but thanks to the rise in the price of ABC stock, actual equity is $3,750, $500 more than the requirement.

This equity above the 50% requirement is referred to as "excess equity." Excess equity is recognized by an entry to the Special Miscellaneous Account, commonly referred to simply as "SMA". Customer A's excess equity is $500, which is the amount by which his actual equity of $3,750 exceeds the initial required equity of $3,250. Note that this is all based upon the current market value of the ABC stock held in the account. Calculations of excess equity are made daily by the margin department at a brokerage firm and are based upon the previous day's closing prices of the stocks in the margin account.

Just to make sure that you truly understand these concepts and relationships, let's work through another example to see how the movement of stock prices in a margin account affect the various components.

Customer C buys 1000 shares of XYZ at $10 per share in a new margin account and immediately deposits the required 50% initial equity of $5,000. A month later, XYZ is trading at $12 per share. Let's see what the excess equity is in Customer C's account:

Stock at $10/share
Market Value:	$10,000 (1000 XYZ @ 10)
Debit Balance:	-5000 (owed to brokerage)
Customer Equity:	5000

Stock at $12/share
Market Value:	$12,000 (1000 XYZ @ 12)
Debit Balance:	-5000 (owed to brokerage)
Customer Equity:	7000

The initial requirement for an account with a market value of $12,000 is 50% of that amount, or $6,000. As we can see above, the account now has equity of $7,000, or $1,000 excess equity above the requirement.

Accounts that have no excess equity (i.e.: the equity is less than the 50% initial requirement) are referred to as restricted accounts.


The margin department at brokerage firms maintains a separate account called the "Special Memorandum Account" in conjunction with all margin accounts. The SMA account is the most misunderstood account in the brokerage industry. The primary purpose of the SMA is to preserve the customer's buying power. When the equity in an account exceeds the required 50%, excess equity is created. This excess equity is known as SMA. When excess equity exists in a margin account, an entry is made to SMA. Once this entry is credited to the SMA, it remains there until used. It does not disappear even if the account loses the excess equity that created the SMA in the first place. Stocks held in a margin account that go up in price create SMA, but a later decrease in the price of the same stocks doesn't decrease the SMA.

Thus, an account can be restricted (equity less than 50%), and still have SMA. This SMA was obviously created at an earlier date when the stocks that are held in the account were trading at a price above their purchase price.

SMA is also created (increased) when:

• A security held long in the margin account is sold. SMA is increased by one-half the proceeds of any long sale. Example:If a customer sells 1,000 shares of stock at $10 per share, the net proceeds are $10,000. SMA would be credited (increased) by $5,000.


• The customer makes a deposit of cash to his account. SMA is credited by the amount of the deposit.

Think of SMA as a line of credit in a brokerage account. This credit line may be used to make additional securities purchases or to make cash withdrawls from the account. While useable SMA can always be used for purchasing additional securities, there are restrictions to using SMA to withdraw cash. This subject is covered later in its own chapter in this tutorial, Cash Withdrawls.

Here is a reprint of Regulation T, Section 220.6:

(a) A special memorandum account (SMA) may be maintained in conjunction with a margin account. A single entry amount may be used to represent both a credit to the SMA and a debit to the margin account. A transfer between the two accounts may be effected by an increase or reduction in the entry. When computing the equity in a margin account, the single entry shall be considered as a debit in the margin account. A payment to the customer or on the customer's behalf or a transfer to any of the customer's other accounts from the SMA reduces the single entry amount.

(b) The SMA may contain the following entries:

• dividend and interest payments;


• cash not required by this part, including cash deposited to meet a maintenance margin call or to meet any requirement of a self-regulatory organization that is not imposed by this part;


• proceeds of a sale of securities or cash no longer required on any expired or liquidated security position that may be withdrawn under section 220.4(e) of this part, and;


• margin excess transferred from the margin account under section 220.4(e)(2) of this part.

Remember that the primary purpose of SMA is to preserve the customer's buying power, and buying power is created by having equity in excess of the Regulation T requirement.


As mentioned in the previous lesson, the primary purpose of the SMA is to preserve buying power. The concepts and practices of margin math confuse so many investors (with almost universally unpleasant results) that we are going to present the exact same concepts as the previous chapter, in a slightly different format.

Let's take a sample account and follow it through some typical activities and watch what happens to the various components of the account.

Sample Margin Account
Market Value:	$10,000
Debit Balance:	4,000
Customer Equity:	6,000

Given the above conditions, here is a conventional "T" account structure as used in accounting to show the components:

Required Equity (50%)	Actual Equity
$5,000	$6,000 equity
	-5,000 required
	1,000 excess equity
	x2 50% equity on new purchases
	2,000 buying power

As shown, this account has excess equity of $1,000. Excess equity can either be withdrawn from the account, or converted into buying power equal to double the excess. Thus, the customer could purchase $2,000 worth of additional marginable securities without depositing any additional funds.

Assume that the customer does nothing, and the market value of the securities declined to $9,000. The account would now look like this:

Sample Margin Account
Market Value:	$9,000
Debit Balance:	4,0000
Customer Equity:	5,000

The "T" structure would now appear as follows:

Required Equity (50%)	Actual Equity
$5,000	$5,000 equity
	-4,500 required
	500 excess equity
	x2 50% equity on new purchases
	1,000 buying power

By not using his buying power before the market value in his account declined, the customer lost $500 of excess equity and $1,000 of buying power. This situation reflects what would happen if there were no SMA account. In order to preserve his buying power, a customer would have to withdraw funds from his account whenever there was an excess available. Then when a purchase was made, the enough of the withdrawn funds would be re-deposited into the account to meet the 50% requirement on new purchases.

Recognizing that this would be not only silly but a nightmare for both the brokerage firms and customers to keep track of, Regulation T allows the establishment of an Special Miscellaneous Account. This account is has also become commonly known as the Special Memorandum Account to better describe the account entries and use of the account.

Today, margin clerks, with the help of computers, make daily entries to the SMA when necessary. For our discussions, we'll use the following format for recording SMA.

SMA
Date	Debit	Credit	Balance

By making entries to the SMA, the customer's buying power was maintained, and since it was just a memorandum entry, lots of bookeeping was avoided.

Let's look at an example of this memorandum method of tracking SMA:

Sample Margin Account
Market Value:	$10,000
Debit Balance:	4,0000
Customer Equity:	6,000

The $1,000 excess is placed in the SMA account as follows:

SMA
Date	Debit	Credit	Balance
10/6/96		$1000	$1000

The $1,000 excess has now been recorded in the SMA, a separate and distinct account, and will now preserve the customer's buying power of $2,000 even if the securities prices drop.

Note that after the memorandum entry to SMA, the customer's margin account still looks the same:

Sample Margin Account
Market Value:	$10,000
Debit Balance:	4,0000
Customer Equity:	6,000

None of the components of the margin account changed because the entry to the SMA is only a memorandum entry. Funds haven't left the account and ther is no increase in the balance loaned to the customer on margin.

If the market value of the securities does decline,

Sample Margin Account
Market Value:	$9,000
Debit Balance:	4,0000
Customer Equity:	5,000

the customer would still have buying power of $2,000 because the $1,000 of excess was noted in the SMA account at the time it existed.