Series 27: A Brief Digression On Equity And An Example

A Brief Digression on Equity and an Example

You may have noticed an apparent inconsistency here. Previously, we had defined margin as the equity in a margin account. Yet here we describe a 150% initial margin requirement and in the same breath declare equity to be 50%, a small fraction of the initial margin.

While it is true that we equate margin with equity, we have not yet defined equity. That is because the Federal Reserve Board (FRB), which establishes the initial margin requirements, and FINRA, whose Rule 4210 prescribes the maintenance margin requirement, define equity in two different ways.

The difference does not impact long positions. For both the FRB and FINRA, equity is the difference between long market value and debit balance. Long market value is the market value of the security, not only when it is purchased, but also through time as its value rises and falls in the market. Debit balance is the amount of money borrowed by the investor.

Short sales are a different story. For the FRB, equity is identical to the credit balance in the margin account. Credit balanc