Reg T initial requirement and the $2,000 minimum

Buying on margin means part of the money is borrowed

What does it mean to buy stock on margin? You pay part of the price and borrow the rest from your firm. Think of buying a house. You put some cash down, and the bank lends you the rest.

Say Maya buys $10,000 of stock. She pays $5,000, and her brokerage firm lends her $5,000. The first word is market value. Market value is what the stock is worth today. For Maya, that's $10,000.

The second is the debit balance. The debit balance is what you owe the firm. Maya owes $5,000. The third is equity. Equity is the part of the account that's yours. For Maya, that's $5,000.

Equity is market value minus the debit balance. Like a house, what it's worth minus what you owe is what you own. Say the stock rises to $12,000. Maya still owes $5,000, because the loan doesn't move with the price. Her equity is now $7,000.

The mistake on the exam is mixing up the debit and equity. The debit is the loan. Equity is what's left after it. Remember this: equity is market value minus the debit balance. It's what the stock is worth today, minus what you owe.

Reg T says you put up half

When you buy stock on margin, how much of your own money do you have to put in? Buying on margin means you pay part and borrow the rest. The answer comes from Regulation T, or Reg T. Reg T says you deposit 50% of what you buy, and you can borrow the rest.

The Federal Reserve Board writes Reg T. That's the board that runs the Federal Reserve, the U.S. central bank. The 50% is called the Reg T initial requirement. Say Sam buys 300 shares at $40 in his margin account. Three hundred times 40 is $12,000 of stock.

Reg T says half. Half of $12,000 is $6,000, so Sam deposits $6,000 of his own money. The firm lends him the other $6,000. That's his debit balance, the money he owes the firm. His equity, the part that's his, starts at $6,000.

Two mistakes show up on the exam. One is saying FINRA or the SEC sets Reg T. It's the Fed. The other is using 25%. That number is for later, after you buy. Remember: Reg T is the Federal Reserve Board's rule. You deposit 50% of the purchase and borrow the rest.

A new margin account needs at least $2,000

Reg T says you deposit half of what you buy on margin. But what if half is only a small amount? FINRA, the regulator that writes rules for brokerage firms, adds a floor. A new margin account needs at least $2,000 of equity. Equity is the part that's yours.

Say Leo opens a new margin account and buys $3,000 of stock. Half of that is $1,500. That's under the $2,000 floor. So Leo deposits $2,000, the bigger number. The firm lends him the last $1,000. That's his debit balance, what he owes.

Now say Ana buys just $1,500 of stock. Nobody pays $2,000 for $1,500 of stock. She pays the full price, $1,500, and borrows nothing. On a big purchase, the floor doesn't matter. Half of $12,000 is $6,000, which is already more than $2,000.

The mistake on the exam is asking for $2,000 on a purchase that costs less than $2,000. You never deposit more than the stock costs. Remember: in a new margin account, deposit the bigger of 50% or $2,000, but never more than the price.

Worked example: New account, small purchase: the deposit and the debit

1. A customer opens a new margin account and buys 100 shares at $24. How much do they deposit, and what's the debit balance?
2. Step one: find the purchase price. A hundred shares times $24 is $2,400.
3. Step two: apply Reg T, because it sets the deposit. Half of $2,400 is $1,200.
4. Step three: check the $2,000 floor, because this is a new account. $1,200 is under $2,000.
5. The stock costs $2,400, which is more than $2,000. So the floor applies, and the deposit is $2,000.
6. Step four: the firm lends whatever the deposit doesn't cover. $2,400 minus $2,000 leaves a debit balance of $400.
7. So the customer deposits $2,000, owes $400, and starts with $2,000 of equity.

Common mistakes

The $2,000 minimum: bigger of the two, capped at the price

You mixed up the $2,000 minimum. In a new margin account, deposit the bigger of 50% or $2,000. But never deposit more than the stock costs. A $3,000 purchase needs $2,000. A $1,500 purchase needs just $1,500.