Excess equity and SMA

Equity above the 50% line goes to SMA

What if your margin account has more equity than it needs? Equity is market value minus the debit, the part that's yours. Excess equity is the equity you have above the Reg T line. The Reg T line is 50% of today's market value.

The firm credits that excess to SMA, the special memorandum account. SMA is a line of credit in your account that you can use later. Say your stock is worth $20,000 and you owe the firm $8,000. Your equity is $20,000 minus $8,000, which is $12,000.

Now find the Reg T line. Half of $20,000 is $10,000. You have $12,000, and the line is $10,000. That's $2,000 of excess equity, and it's credited to SMA.

The mistake on the exam is measuring against the 25% maintenance line, or against the debit. Excess equity is always measured against 50%. Remember: excess equity is your equity above 50% of today's market value, and it's credited to SMA.

SMA stays when prices fall and drops when you use it

Say your account built up some SMA, and then the stock falls. Does your SMA fall with it? SMA, the special memorandum account, is a line of credit in your margin account. It holds the excess equity the firm credited to you.

Once SMA is credited, a falling price doesn't take it away. It stays until you use it. Ben built $5,000 of SMA when his stock hit $60. Then it falls to $45, and his excess equity is now only $2,500. His SMA stays at $5,000.

SMA drops only when you use it. You can use it to take out cash, or to buy more stock. Taking SMA out as cash means borrowing it from the firm. So if Ben withdraws $5,000, his debit balance, what he owes, goes up by $5,000.

Two mistakes show up on the exam. One is cutting SMA when prices fall. The other is lowering the debit when cash comes out. It goes up. Remember: SMA is a line of credit. It stays when prices fall, and it drops only when you use it.

SMA buys twice its size in stock

You have $5,000 of SMA in your margin account. How much stock can you buy with it without adding cash? The answer is called buying power. Buying power is how much marginable stock you can buy without depositing any cash.

Reg T says you deposit 50% of a purchase. SMA, the special memorandum account, can cover that 50%. The firm lends you the other half. So each dollar of SMA supports two dollars of stock. Buying power is SMA divided by 0.50, which is twice the SMA.

With $5,000 of SMA, you can buy $10,000 of stock. Your SMA is the deposit, and the firm lends the other $5,000. Doubling is only for buying stock. If you take SMA out as cash, it's dollar for dollar. Taking $5,000 adds $5,000 to your debit.

The mistake on the exam is halving SMA, or dividing by 25%. Buying power uses Reg T's 50%, so divide by 0.50. Remember: buying power is twice your SMA, because SMA covers the 50% deposit on a new purchase.

Worked example: Find the SMA and the buying power, step by step

1. A margin account holds $40,000 of stock and has a $14,000 debit. How much goes to SMA, and what's the buying power?
2. Step one: find equity, because excess is measured from it. Market value minus the debit is $26,000.
3. Step two: find the Reg T line. It's half of today's market value, so $20,000.
4. Step three: equity above that line is excess equity. $26,000 minus $20,000 is $6,000, and it's credited to SMA.
5. Step four: SMA covers the 50% deposit, so divide it by 0.50. The buying power is $12,000 of marginable stock.
6. So SMA is $6,000, and the buying power is twice that, $12,000.

Common mistakes

SMA doesn't fall with prices

You cut SMA when the stock price fell. SMA is a line of credit. Once it's credited, a market drop doesn't take it away. It drops only when you use it, to take out cash or to buy stock.