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9.3.1 Long Margin Accounts

A comprehensive guide to understanding long margin accounts, including regulations, examples, risks, and frequently asked questions as per IIROC guidelines.

Overview

Long margin accounts are financial structures that allow investors to take positions in securities by borrowing funds from dealer members. The amount of credit extended to clients is strictly regulated by the Investment Industry Regulatory Organization of Canada (IIROC) to ensure proper margining of client accounts.

IIROC Regulations

The amount of credit that a dealer member may extend to its clients for the purchase of securities, both listed and unlisted, is closely monitored by IIROC. Regular spot checks and field examinations are conducted to ensure compliance.

Maximum Loan Values

Maximum loan values for listed equities are shown in Table 9.1:

Price Range Loan Value
$2.00 and over 50% of market value
$1.75 to $1.99 40% of market value
$1.50 to $1.74 20% of market value
Under $1.50 No loan value
Securities Eligible 70% of market value
for Reduced Margin

Note: These are IIROC maximums; firms may set more stringent requirements.

Margin Calculation

When a long position is established on margin, several factors need to be estimated:

  • Initial Purchase Price: The total cost of buying the securities.
  • Loan Amount: The maximum amount that the dealer can lend (based on market value).
  • Client’s Margin: The amount financed by the client.

Examples and Scenarios

Let’s walk through an example. Assume a client buys 1,000 shares of ABC Company at $25 per share, on a margin with a loan rate of 50%.

Example Calculation:

  • Total Cost: 1,000 shares * $25/share = $25,000
  • Loan Amount: 50% * $25,000 = $12,500
  • Client’s Margin: $25,000 - $12,500 = $12,500

We now analyze two scenarios: a price decrease and a price increase.

Scenario 1: Margin Call (Price Drops to $22)

  • New Loan Amount: 50% * ($22 * 1,000) = $11,000
  • New Margin Requirement: $25,000 - $11,000 = $14,000
  • Margin Deficiency: $14,000 - $12,500 = $1,500 (Margin call issued)

Scenario 2: Excess Margin (Price Increases to $29)

  • New Loan Amount: 50% * ($29 * 1,000) = $14,500
  • New Margin Requirement: $25,000 - $14,500 = $10,500
  • Excess Margin: $12,500 - $10,500 = $2,000

This excess can be used to purchase additional securities or withdrawn from the account.

Risks Associated with Margin Accounts

Market Risk

Borrowing to buy securities magnifies outcomes. If prices rise, profits soar, but if prices fall, losses worsen.

Loan and Interest Requirements

Clients must pay interest on borrowed funds and will need to pay back the loan irrespective of whether the security’s value increases or decreases.

Potential Margin Call

If the client fails to meet a margin call, the dealer may sell the securities without notice, causing potential losses to the client.

Protective Measures

Clients are advised to maintain additional funds or securities in their accounts to provide a buffer against price fluctuations and reduce the likelihood of a forced sale by the dealer.

Frequently Asked Questions (FAQs)

What is a Margin Call?

A margin call occurs when the equity in a margin account falls below the broker’s required level. The client must deposit additional funds or securities to meet the margin requirement.

How is the Loan Amount Determined?

The loan amount is usually a percentage of the security’s market value, determined by IIROC regulations. Dealer members may set more stringent requirements.

What Happens if I Can’t Meet a Margin Call?

If the client cannot meet a margin call, the dealer member can sell the securities in the account without client notification to cover the shortfall.

Glossary

Margin

The amount of funds put up by a client to cover the direct cost of transactions or maintain invested securities.

Margin Call

A demand for additional capital or securities to be deposited into the margin account when it falls below the required maintenance level.

Loan Amount

The funded percentage of the market value of securities that a dealer or broker lends to the client.

Excess Margin

The amount by which a client’s equity in a margin account exceeds the required margin level, allowing for additional purchases or withdrawals.

Market Risk

The potential for financial loss due to fluctuations in the market prices of securities.

Key Takeaways

  1. Understanding: Grasp the core concepts of margin accounts and their regulations by IIROC.
  2. Calculation: Capability to calculate margin, loan amounts, and recognize margin calls and excess margin scenarios.
  3. Risk Management: Recognize the risks associated with leveraging and margin investing.
  4. Practical Insight: Identify real-world scenarios of both favorable and unfavorable fluctuations in market prices and their impact on margin positions.

Stay vigilant in monitoring market conditions, adhere to margin requirements, and employ risk management strategies to ensure balanced and well-managed investments in long margin accounts.


CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

Good luck!

## What organization strictly regulates and enforces the amount of credit a dealer member may extend to clients for the purchase of securities? - [ ] FINRA - [ ] SEC - [x] IIROC - [ ] FCA > **Explanation:** The Investment Industry Regulatory Organization of Canada (IIROC) regulates the credit that dealer members can extend to clients for the purchase of securities. ## What happens if the price of a security falls in a margin account? - [ ] The client receives a dividend - [ ] The loan amount increases - [x] A margin call is issued for the client to deposit additional funds - [ ] The account balance remains the same > **Explanation:** If the price of a security falls in a margin account, the value of the loan drops accordingly, leading to a margin call requiring the client to deposit additional funds. ## According to Table 9.1, what is the loan value percentage for securities priced at $1.75 to $1.99? - [ ] 50% of market value - [ ] 20% of market value - [x] 40% of market value - [ ] No loan value > **Explanation:** Securities priced between $1.75 and $1.99 have a loan value of 40% of market value. ## What is the term used to describe a surplus amount in a margin account when security prices rise? - [ ] Margin call - [ ] Risk margin - [x] Excess margin - [ ] Loan surplus > **Explanation:** Excess margin refers to the additional funds available in the margin account when the price of the security rises. ## What must the client provide immediately if a margin call is issued? - [ ] Additional securities - [x] Additional funds - [ ] Commission fees - [ ] Market data > **Explanation:** If a margin call is issued, the client must immediately provide additional funds to cover the shortfall. ## Which of the following describes the maximum loan value for a security priced under $1.50? - [ ] 50% of market value - [ ] 30% of market value - [x] No loan value - [ ] 20% of market value > **Explanation:** Securities priced under $1.50 have no loan value, meaning no credit can be extended for these securities. ## When a security price rises, what happens to the loan amount in a margin account? - [ ] It remains unchanged - [ ] It decreases - [x] It increases - [ ] It becomes void > **Explanation:** The loan amount increases when the security price rises, giving the client access to additional funds. ## What is a key risk involved in using a margin account as opposed to a cash account? - [ ] Lower return on investment - [x] Borrowing funds magnifies both gains and losses - [ ] Higher brokerage commission - [ ] Limited access to market data > **Explanation:** Borrowing funds to invest magnifies outcomes, which means higher potential risks and rewards compared to using a cash account. ## According to IIROC rules, what are the characteristics of securities eligible for reduced margin? - [x] High liquidity and low price volatility - [ ] High dividend yield and low earnings volatility - [ ] Large market capitalization and low debt ratio - [ ] High growth potential and moderate risk > **Explanation:** Securities eligible for reduced margin must demonstrate high liquidity and low price volatility according to IIROC rules. ## What is the minimum margin required in a long margin account? - [ ] The loan amount minus excess margin - [x] The initial cost of the transaction minus the loan amount - [ ] The market value of securities minus the commission fees - [ ] The loan amount plus interest > **Explanation:** The minimum margin required is the initial cost of the transaction minus the loan amount provided by the dealer member.

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Sunday, July 21, 2024