Price Increases and Special Memorandum Accounts
When a security that has been bought on margin increases in value, the increased LMV in the margin account causes equity to increase by an equivalent amount. When the equity increases above 50% of the LMV, we say that excess equity has been created. Excess equity is the dollar amount above the 50% initial margin requirement.
For example, let’s say that the price of the stock you bought on margin rises from $60 to $70 per share. The LMV thus increases by $10,000. The debit balance remains unchanged, leading to the following equation:
|
LMV |
– |
debit balance |
= |
equity |
|
$70,000 |
– |
$30,000 |
= |
$40,000 |
Equity has risen to $40,000, or 57% of the LMV. The margin requirement is now 50% of $70,000, or $35,000. Thus, your margin account has $5,000 in excess equity ($40,000 – $35,000). Excess equity is put into a special memorandum account (SMA). Now your balance sheet might look like this:
|
LMV |
– |
debit balance |
= |
required equity |
+ |
SMA |
|
$70,000 |
– |
$30,000 |
= |
$35,000 |
+ |
$5,000 |
Having an SMA provides the customer with special privileges. First, customers may use that money to buy more securities on margin without depositing any additional funds into the margin account. In our example above, the customer has $5,000 in excess equity in an SMA. T