Margin accounts are a type of brokerage account that allows investors to borrow money from their broker to purchase securities. This leverage can amplify gains but also increase the risk of losses.
Which of the following is NOT a characteristic of a margin account?
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Select an option above to see an explanation here.
A) Borrowing money from a broker to purchase securities is a characteristic of a margin account. B) Paying for all transactions in full without borrowing funds is a characteristic of a cash account, not a margin account. C) Facing potential margin calls if maintenance margin requirements are unmet is a margin account characteristic. D) Charging margin interest on borrowed funds is a characteristic of a margin account.
What is the primary difference between initial margin and maintenance margin?
A) Initial margin is the minimum amount of equity required to open a margin account, while maintenance margin is the minimum amount of equity that must be maintained. B) Initial margin is not the interest charged on a margin loan. C) Initial margin is not the money borrowed from a broker. D) Initial margin is not the value of an investor's account minus the margin loan.
Which of the following is an example of leverage in a margin account?
A) An investor deposits $10,000 and purchases $20,000 worth of stock, borrowing the additional $10,000 from their broker, an example of leverage in a margin account. B) An investor purchasing stock without borrowing funds is not using leverage. C) Selling borrowed securities with the expectation of repurchasing them at a lower price is an example of short selling, not leverage, in a margin account. D) An investor purchasing less stock than their available funds is not using leverage.
In the late 1920s, many investors used margin accounts to purchase stocks, contributing to the stock market bubble. When the market crashed in 1929, these investors faced margin calls and were forced to sell their stocks, further exacerbating the decline.
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Example Series 65 Example Practice Question
An investor opens a margin account with an initial deposit of $10,000. Next, they purchase $20,000 worth of stock, borrowing the additional $10,000 from their broker. If the stock's value increases by 10%, its equity increases to $12,000, resulting in a 20% return on its initial investment. However, if the stock's value decreases by 10%, their equity decreases to $8,000, resulting in a 20% loss on their initial investment.
Margin accounts can amplify gains, but beware the risk it contains. Borrowed funds increase your stake, but losses too can escalate.
- Regulation T: A Federal Reserve Board regulation governs the amount of credit brokerage firms, and dealers may extend to customers to purchase securities on margin. - Initial Margin Requirement: The minimum amount of equity must be deposited in a margin account, as set by Regulation T, currently at 50% of the purchase price. - Maintenance Margin Requirement: The minimum amount of equity must be maintained in a margin account, typically set at 25% for long positions and 30% for short positions.
- Regulation T example: If a customer wants to purchase $10,000 worth of securities on margin, Regulation T requires the customer to deposit at least $5,000 (50% of the purchase price) in the margin account. - Initial Margin Requirement example: If a customer wants to buy $20,000 worth of securities on margin, the initial margin requirement would be $10,000 (50% of the purchase price). - Maintenance Margin Requirement example: If a customer has a long position worth $8,000 in a margin account, the maintenance margin requirement would be $2,000 (25% of the market value).