How to Calculate Short Margin Accounts on the Series 7 Exam
On the Series 7 exam, you may be asked to calculate the numbers in a short margin account. You have to start by setting up the formula correctly. The basic short margin account formula is as follows:
SMV + EQ = CR
In other words, short market value plus equity equals the credit balance.
When a customer purchases securities, he has the choice of whether to pay in full or purchase on margin. When a customer is selling short (borrowed) securities, there is no option: The transactions must be executed in a margin account.
Short market value . . .
The short market value (SMV) is the current market value of the securities sold short in a margin account. Just as the LMV in a long account varies, so does the SMV. The SMV changes as the market value of the securities changes. If an investor is short the securities (selling borrowed securities), he wants the SMV to decrease so the investor can repurchase the securities at a lower price.
When a customer sells short securities on margin, the margin call (the amount the customer has to come up with) is based on the SMV of the securities. With Regulation T set at 50 percent, an investor has to deposit 50 percent of the value of the securities purchased on margin.
. . . Plus equity . . .
The equity (EQ) is the investor’s part of the account. When an investor initially opens a short margin account, the equity is equal to $2,000 or Reg T (50 percent of the market value of the security), whichever is greater.
In a short margin account, the equity increases when the SMV of the securities decreases; when the SMV of the securities increases, the equity decreases.
When an investor has more equity than the Regulation T requirement, he has excess equity and develops an SMA; if an investor has less equity than the Reg T requirement, the account is restricted.
. . . Equals the credit balance
There’s no debit balance (DR) in a short margin account because investors aren’t borrowing money; they’re borrowing securities. Instead, short margin accounts have a credit balance (also called a credit record, credit register, or CR for short).
The credit balance is initially made up of the amount of money the investor received for selling the stock short (the short market value) and the amount that the investor had to deposit into the margin account to pay for the trade (the equity). The credit balance remains fixed unless the investor removes excess equity, more securities are shorted, or the investor covers some of his short positions.
For example, say that in an initial transaction in a margin account, an investor sells short $50,000 worth of securities with Reg T at 50 percent. First you determine the margin call:
Margin call = SMV × Reg T (50%)
Margin call = $50,000 × 50% = $25,000
Then you use the margin call and the following formula to determine the credit balance:
CR = SMV + margin call
CR = $50,000 + $25,000 = $75,000
Put the equation together
The following question tests your ability to determine the credit balance in a short margin account.
In an existing short margin account, Melissa Rice sold short 1,000 shares of HIJ common stock at $30. Prior to this transaction, the short market value of securities in the account was $52,000 and the equity was $25,000. What is Melissa’s credit balance after the transaction?
The answer you want is Choice (D). This question is a little more difficult because the transaction happened in an existing margin account. Prior to this transaction, Melissa had a short market value (SMV) of $52,000 and an equity of $25,000, which means that the CR was $77,000:
SMV + EQ = CR
$52,000 + $25,000 = CR
CR = $77,000
Because you know the existing CR, you only need to determine what happened to it as a result of the new transaction. Melissa shorted another $30,000 worth of stock (1,000 shares × $30 per share), so you need to enter $30,000 under the SMV (short market value).
Next, figure out how much she needs to pay. Multiply the $30,000 × 50 percent (Regulation T), and you know that Melissa has to come up with $15,000, which goes under the EQ (the investor’s portion of the account). If the SMV increases by $30,000 and the EQ increases by $15,000, the CR (credit balance) has to increase by $45,000:
SMV + EQ = CR
$30,000 + $15,000 = CR
CR = $45,000
Because the initial credit balance was $77,000 and it increased by $45,000, the credit balance after the transaction is $122,000.