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Special Memorandum Accounts: Characteristics & Requirements

Instructor: Yusuf Abdullah

Yusuf has taught Science and Mathematics at school level and Finance and Economics at University level. He has recently earned his Ph.D in Financial Econometrics.

This lesson deals with the special memorandum account (SMA) and their characteristics and requirements. You'll learn about buying power, receipt of cash dividends and earned interest, margin call, liquidation of securities in the account, cash or securities withdrawals, etc.

Special Memorandum Account (SMA)

Jack is a veteran investor with significant knowledge of finance and investments. He is meeting with his financial advisor, Judy, who has advised him for nearly a decade now. Jack has invested through margin in the past when he was very confident of the outcome and has made significant gains. He knows investing through margin requires making investments by using debt or loan through a bank or a broker. Since he makes profits more than he makes losses, he is concerned with the fact that a number of times, his equity on the margin account exceeds the initial margin.

Judy suggests he set up a special memorandum account (SMA), which is a special type of margin account where excess equity or profit generated can be used to invest more or buy more securities. It is to be noted that SMA's exist only when the margin exceeds 50% which is required by Federal Regulation T.

Key Features

Judy tells Jack that margin or equity above the initial margin is put into the SMA account automatically. Initial margin is the 50% margin or investors' own investment as required by Regulation T. The SMA also includes equity increase due to any interest or dividend payments. Jack states that he had made margin investments a while back and would like to know the value of his equity and SMA account. Judy says that she has the investment data and would be happy to share it.

SMA Calculations

Jack had bought ABC shares on margin with an investment of $10,000. He had borrowed $10,000 from the broker and bought 2000 shares at $10 apiece. Currently, each share is worth $11. Over this period, the stocks were paid $150 dividends in total. Therefore, the total value of the margin account is:

($11 * 2000) + $150

=$22,150

Now the excess equity is:

Total account value - Initial investment

=$22,150 - $20,000

=$2,150

Excess equity = SMA Value = $2,150

Buying Power & Withdrawal

This excess equity, or SMA value, is the balance on the margin account. Now $2,150 can be withdrawn from the account or used to purchase the securities. This can also be used to invest in another or the same margin account for a long or short position. Now since the margin investment can be made using only 50%, another $2,150 can be borrowed against the excess equity doubling the investment value. This doubling of investment value against excess equity is known as buying power and is twice the excess equity. The buying power would be:

$2,150 * 2 = $4,300

The excess equity can also be withdrawn in the form of securities with equal current market value. In the previous example, the number of securities that could be withdrawn is:

$2,150 / $11

=195 shares approximately

Margin Call

In case the accounts fall in value, the SMA account would be negative and there would be a margin call, which requires the investor to add equity in the account if the equity in the account falls below a certain percentage (usually 30%). The addition in equity can be made by depositing cash or securities. In case, the deposition is not made within the stipulated time, the remaining equity would be sold off called liquidation and the owed amount recovered.

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