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Restricted Accounts Calculations on the Series 7 Exam

Often, securities don’t go in the direction customers hope for and you have to deal with restricted accounts. The Series 7 will expect you to be prepared for both scenarios. When this happens in a margin account, investors lose money at an accelerated rate.

If the equity in a margin account drops below the Regulation T (or house) requirement, the account becomes restricted. However, if the equity in a long margin account drops below 25 percent (30 percent for a short account), the situation becomes much more serious. Read on for info on restricted accounts and minimum maintenance.

What should you do if the market price of the securities held in a long margin account decreases instead of increases? What if the securities in a short margin account show wild success? If this happens, the account becomes restricted. Restricted accounts show up when the equity in the account is below the margin requirement.

However, a restricted account doesn’t mean that investors can’t buy (or short) securities in the margin account; investors may still do so by coming up with the margin requirement of the new purchase.

Restricted long margin accounts

A restricted account is calculated the same way as the excess equity, only the investor has less than 50 percent of the long market value (LMV) in equity instead of more than 50 percent. Check out the following example.

Macy Bullhorn purchased 500 shares of LMN common stock on margin when LMN was trading at $30 per share. If LMN is currently trading at $25 per share, by how much is Macy’s margin account restricted?

(A)    $1,250
(B)    $2,500
(C)    $5,000
(D)    $6,250

The correct answer is Choice (A). You may notice the similarities between figuring out excess equity and determining whether an account is restricted. If an account is restricted, the account contains less equity than needed to be at 50 percent of the LMV.

First, figure out Macy’s debit balance. Macy purchased $15,000 worth of securities (500 shares × $30 per share), so enter $15,000 under the LMV (long market value). Then Macy had to deposit the Reg T amount (50 percent) of the purchase, so enter $7,500 (50% × $15,000) under the EQ (the investor’s portion of the account). She borrowed $7,500 (the DR) from the ­broker-dealer:

LMV – DR = EQ
$15,000 – DR = $7,500
DR = $75,000

Next, find the investor’s current equity. The LMV changes to $12,500 ($25 × 500 shares), so enter that under the LMV. Because the DR (the amount borrowed from the broker-dealer) doesn’t change, bring the $7,500 straight down from the preceding equation. You find that the EQ has decreased to $5,000 ($12,500 – $7,500):

LMV – DR = EQ
$12,500 – $75,000 = EQ
$5,000 = EQ

Now multiply the LMV by Reg T to get the margin requirement, the amount Macy should have in equity to be at 50 percent. Take the $6,250 ($12,500 × 50%) and compare it to the current equity. Because Macy has only $5,000 in equity, her account is restricted by $1,250:

Margin requirement = Reg T × LMV
Margin requirement = 50% × $12,500 = $6,250
Restriction = margin requirement – EQ
Restriction = $6,250 - $5,000 = $1,250

You can calculate the excess equity (SMA) or determine whether an account is restricted in pretty much the same way. If the investor has more equity than needed, it’s an SMA; if the investor has less than needed, the account is restricted.

Restricted short margin accounts

If the market price of the securities held in a short margin account increases instead of decreasing, the situation isn’t so great. When this happens, the account becomes restricted. You can figure out whether the account is restricted the same way you figure out the excess equity, only the investor has less than 50 percent of the SMV in equity instead of more than 50 percent.

The following question tests your knowledge of restricted short accounts.

Mr. Willing sold short 400 shares of RST common stock on margin at $40 per share. If RST is currently trading at $44 per share, how much is the account restricted?

(A)    $2,400
(B)    $6,400
(C)    $8,800
(D)    $16,000

The answer you want is Choice (A). First, figure out the credit balance. Mr. Willing sold short $16,000 worth of securities (400 shares × $40 per share), so enter $16,000 under the SMV (short market value). Then Mr. Willing had to deposit the Reg T amount (50 percent) of the purchase, so enter $8,000 (50% × $16,000) under the EQ. You find that the credit balance (CR) is $24,000:

SMV + EQ = CR
$16,000 + $8,000
$24,000 = CR

Next, find Mr. Willing’s current equity. The SMV changes to $17,600 ($44 × 400 shares), so you need to put that under the SMV in a new equation. In a short account, the CR remains the same as the market price changes, so you need to bring the $24,000 straight down from the preceding equation. You can see that the EQ has decreased to $6,400 (difference between $17,600 and $24,000):

SMV + EQ = CR
$17,600 + EQ = $24,000
EQ = $6,400

Now multiply the SMV by Regulation T to get the amount Mr. Willing should have in equity to be at 50 percent. Take the $8,800 ($17,600 × 50%) and compare it to the EQ. Because Mr. Willing has only $6,400 in equity ($2,400 less than the Reg T requirement), his account is restricted by $2,400:

Margin requirement = Reg T × SMV
Margin requirement = 50% × $17,600 = $8,800
Restriction = margin requirement – EQ
Restriction = $8,800 – $6,400 = $2,400
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