Regulation T & Margin Equity

📌 Exam relevance note (from the text)

This chapter is long and dense, and it’s usually tested lightly. Although any of this material could appear on the exam, it’s rare to see more than one or two margin-related questions. Approach this chapter with that in mind, and don’t overinvest time trying to memorize every detail.

Cash vs margin accounts

• At brokerage firms, there are two main types of accounts: cash and margin accounts.
• When an investor borrows money for investment purposes, they’re using leverage. Leverage magnifies both gains and losses.
• With a margin account, you can earn more when your investment is right, but you can also lose more when the market moves against you.

Casino analogy (the text’s illustration of leverage)

• Imagine you have $5,000 of your own money and borrow another $5,000 from a friend. Then you take all $10,000 to the casino and bet it on one game.
• If you win, you double your money to $20,000 — more than you could’ve made with only your $5,000.
• If you lose, you lose your $5,000 and you still owe your friend $5,000.
• Borrowing money to invest works the same way: you can increase returns if you’re right, but you can also increase losses if you’re wrong.

Opening margin accounts

Margin accounts require more than a basic new account form. Customers opening margin accounts must complete and sign the margin agreement, which has three parts.

Definitions — the three parts of the margin agreement

Rehypothecation and Regulation U

• Broker-dealers are not banks and typically don’t have large amounts of cash available to lend. Instead, they rehypothecate (re-pledge) customers’ securities to banks in exchange for a loan.
• The relationship between the bank and the broker-dealer is governed by Regulation U.

Example: if a customer borrows $10,000 through a margin loan, the broker-dealer may rehypothecate $14,000 of the customer’s securities to the bank as collateral.

• The broker-dealer then lends the bank’s money to customers at a slightly higher interest rate.
• 🔑 The difference between the interest rate the broker-dealer pays the bank (the broker loan rate) and the interest rate charged to customers is how broker-dealers earn revenue from margin lending.

Commingling

Deposit requirements

Deposit requirements are the amount of money required to execute an investment strategy in a margin account. When borrowing money from a broker-dealer, investors are subject to Regulation T and FINRA requirements.

Sidenote — FINRA

• The Financial Industry Regulatory Authority (FINRA) is an industry-funded, non-governmental regulator.
• While organizations like the Securities and Exchange Commission (SEC) and the state administrator are government regulators, FINRA is a self-regulatory organization (SRO).
• SROs are granted regulatory authority within their industries. If the industry didn’t fund and enforce its own rules through an SRO, the government would typically impose more direct regulation.
• FINRA is sometimes compared to internal affairs within a police department: it investigates and disciplines member firms and representatives to help maintain investor confidence and market integrity.
• 📌 You don’t need deep detail on FINRA for the exam, since the SEC and state administrators are more commonly tested. Still, you’ll see FINRA referenced throughout securities regulation.

Worked example — long purchase deposit

An investor opens a new margin account and subsequently executes a purchase of 100 shares of ABC stock at $30. What is their deposit requirement?

Answer = $2,000

The investor is purchasing $3,000 of stock (100 shares x $30). They must deposit the greater of 50% or $2,000. A 50% deposit equals $1,500. Therefore, the investor must deposit $2,000 to execute this transaction.

Purchases below $2,000

• What if an investor purchases less than $2,000? For example, suppose an investor purchases $1,200 of a security.
• Requiring a $2,000 deposit wouldn’t make sense when the maximum loss is $1,200 (assuming the stock becomes worthless). In that case, the investor deposits 100% of the purchase amount.
• Practically, the account is treated like a cash account for that transaction.

🔑 Margin initial deposit rules — LONG accounts

🔑 Margin initial deposit rules — SHORT accounts

• These rules differ for short accounts. When an investor sells short stock, losses can exceed the initial value of the position.
• Example of unlimited risk: assume an investor shorts 100 shares at $15. The initial short position is $1,500, but the investor could lose an unlimited amount if the stock rises. If the stock price rises to $50, the investor must spend $5,000 to buy it back ($50 x 100 shares), resulting in a $3,500 loss ($1,500 short sale − $5,000 repurchase).
• Because short positions have higher risk, margin rules require a minimum deposit equal to the greater of 50% or $2,000.

Example: An investor opens a new margin account and subsequently executes a short sale of 10 shares of ABC stock at $40. What is their deposit requirement?

Even though the position is only worth $400 (10 shares x $40), the investor must deposit $2,000.

Unlike long purchases, short sales below $2,000 still require at least a $2,000 deposit. If this example were a long purchase of 10 shares at $40, the required deposit would be only $400.

Regulation T settlement / payment deadline

• Regulation T also sets a payment/delivery deadline for both margin and cash accounts.
• Although different securities have different settlement times, 🔑 Regulation T settlement is always two (2) business days after regular-way settlement.
• This is the last day cash for a purchase or securities for a sale can be delivered.

If the investor doesn’t deposit by Reg T settlement

The broker-dealer must take action. It can:

🔑 Frozen accounts

• A frozen account isn’t completely unusable. The customer can still trade, but only if the funds are already in the account.
• In other words, the customer must have the required cash on deposit before placing a purchase order.
• The freeze lasts 90 days.

Equity

A key margin concept is equity, which is the customer’s net ownership value in the account. When borrowed funds are involved, you have to account for the loan that must be repaid to determine what the customer truly owns.

Example: a $50,000 margin account with a $20,000 loan has $30,000 of equity.

There are two equity formulas: the long account equity formula and the short account equity formula.

🔑 Long account equity formula

LMV − Debit = Equity

Worked example 1 — long equity at opening

An investor purchases 100 shares of ABC stock at $50 in their newly-opened margin account and deposits their Regulation T requirement. Determine the equity.

$5,000 (LMV) − $2,500 (debit) = $2,500 (equity)

The investor purchases $5,000 of stock (100 shares x $50). The investor must deposit the greater of 50% of the purchase or $2,000. Here, 50% is greater, so the investor deposits $2,500. The remaining $2,500 is borrowed from the broker-dealer, which becomes the debit.

Worked example 2 — long equity after a price increase

An investor purchases 200 shares of ABC stock at $70 in their newly opened margin account and deposits their Regulation T requirement. The market then rises to $80. What is the equity?

Answer = $9,000

How the account starts:

$14,000 (LMV) − $7,000 (debit) = $7,000 (equity)

The investor purchases $14,000 of stock (200 shares x $70). The investor deposits 50% (which is greater than $2,000), so they deposit $7,000. The other $7,000 is borrowed, creating a $7,000 debit.

Next, incorporate the price increase to $80:

$16,000 (LMV) − $7,000 (debit) = $9,000 (equity)

The LMV rises because the stock is now worth $16,000 (200 x $80). The debit doesn’t change because the investor didn’t borrow more or repay the loan.

Worked example 3 — long equity when shares are sold

Two values change when shares are sold in a long margin account:

• LMV decreases because the account holds $3,000 less stock (100 x $30).
• Debit decreases because the $3,000 sale proceeds are used to repay the loan.

🔑 Short account equity formula

Equity works the same way in a short account, but the formula is different:

Credit − SMV = Equity

Worked example 1 — short equity at opening

An investor sells short 100 shares of XYZ stock at $80 and deposits the required margin.

First, find the credit:

• Short sale proceeds: 100 x $80 = $8,000
• Required deposit: the greater of 50% or $2,000
• 50% of $8,000 is $4,000, so the deposit is $4,000

So the credit balance is $8,000 + $4,000 = $12,000.

*The credit balance represents cash “on the sideline.” Since the investor must eventually repurchase the stock, the broker-dealer requires cash in the account to support that future buy-in. In this example, $12,000 is available to repurchase the 100 shares.

Next, find the SMV:

• SMV = 100 x $80 = $8,000

Now apply the formula:

$12,000 (credit) − $8,000 (SMV) = $4,000 (equity)

Worked example 2 — short equity after a price decrease

An investor sells short 300 shares of BCD stock at $60 and deposits the required margin. The stock then falls to $50. What is the equity?

Answer = $12,000

How the account starts:

$27,000 (credit) − $18,000 (SMV) = $9,000 (equity)

The credit equals the short sale proceeds plus the deposit:

• Short sale proceeds: 300 x $60 = $18,000
• Deposit: 50% of $18,000 = $9,000 (greater than $2,000)
• So credit = $18,000 + $9,000 = $27,000

Next, incorporate the price decrease to $50:

$27,000 (credit) − $15,000 (SMV) = $12,000 (equity)

The SMV falls to $15,000 (300 x $50). The credit doesn’t change because the investor hasn’t shorted more shares or repurchased any shares.

Worked example 3 — short equity when part of the position is closed

Two values decline when part of a short position is closed:

• Credit decreases because $7,500 of cash is used to repurchase shares (50 x $150).
• SMV decreases because half the short position is closed, reducing SMV by $7,500.

Key points

Margin accounts

• Borrow money for investment (leverage)
• Only suitable for risk-tolerant investors

Margin agreement components

• Hypothecation agreement
• Credit agreement
• Loan consent form

Hypothecation agreement

• Investor pledges securities as collateral
• Must be signed by the customer
• Firms rehypothecate securities to the bank

Regulation U

• Governs B/D to bank relationship
• B/Ds can rehypothecate 140% of debit

Credit agreement

• Margin loan details and specifics
• Must be signed by the customer

Loan consent form

• Allows B/D to lend out securities
• Does not have to be signed

Commingling securities

• Allowed for margin account securities
• Prohibited for cash account securities

Regulation T

• Requires 50% deposit for margin trade

Regulation T settlement

• 2 business days after regular-way settlement

FINRA margin requirement

• Minimum equity of $2,000

Frozen accounts

• Implemented if the customer misses Reg T settlement
• Purchases only occur if cash is in the account
• Lasts for 90 days

Long equity formula

• LMV − debit = equity
• LMV is the long market value
• Debit is the amount borrowed
• Equity is the account’s net worth

Short equity formula

• Credit − SMV = equity
• Credit is the amount sold short plus the amount deposited
• SMV is the short market value
• Equity is the account’s net worth

Combined equity formula

• 🔑 LMV + credit − debit − SMV = equity
• Can be rewritten in multiple ways

Sources

Primary/official references for the material in this chapter. Every link was fetched and returned HTTP 200 on 2026-08-15.