4.3. Understanding Margin

Investors are allowed to purchase securities on loan from their broker-dealer if they open a margin account. Buying securities on margin means to purchase them with credit. The investor pays for part of the price of the security and the broker-dealer loans the investor funds for the rest. Margin is the amount or percent of money the investor deposits. Debit balance is the amount of money borrowed. The broker-dealer is the investor’s creditor. The loans must be secured by the customer with money or securities and placed in a margin account established by the creditor.

The Securities Exchange Act of 1934 gave the Federal Reserve Board the power to regulate margin requirements. In Regulation T (Reg T), the Fed lays out a set of initial margin requirements and describes how a margin account is to be maintained. For equity securities bought on margin, Regulation T sets the initial margin requirement at 50%. This means that the customer must put down at least 50% of the price of the stock in a margin account, and the broker-dealer (creditor) will extend the customer credit for the rest of the price. Once the security has been purchased, the investor must maintain at least a 25% margin on that position for as long as the customer holds it. The maintenance margin requirement is set by FINRA Rule 4210.

4.3.1. Opening a Margin Account

Prior to opening a margin account, the customer must sign a margin agreement. The margin agreement sets the terms and conditions for enabling the client to borrow from the brokerage to buy securities. It identifies how much collateral will be placed in the margin account and the interest rate on the margin loan, and it permits (or does not permit) the customer’s broker to pledge the securities on margin as collateral for its own borrowing. Margin agreements typically contain three parts: the hypothecation agreement, the credit agreement, and the loan consent agreement.

Hypothecation agreement. Se